Shares of Nvidia (NVDA -0.36%) have more than tripled in 2023, racking up gains of 222% this year, which explains why the stock is trading at a ridiculously expensive valuation right now that might make investors wonder whether buying this high-flying semiconductor name makes sense anymore.
After all, Nvidia now commands a price-to-earnings (P/E) ratio of almost 240. That's significantly higher than the S&P 500's P/E ratio of 20 and Nvidia's five-year average trailing earnings multiple of 70. The only way Nvidia can justify such a rich valuation is by consistently outperforming Wall Street's expectations and delivering eye-popping growth.
The good part is that Nvidia's guidance for the current quarter and a look at its end markets suggest that it could deliver on those fronts. The chipmaker anticipates a 64% year-over-year jump in revenue in the ongoing quarter to $64 billion, driven mainly by artificial intelligence (AI)-fueled demand for its data center graphics processing units (GPUs).
But recent developments in one of Nvidia's key businesses suggest that the company could exceed its forecast and help the stock sustain its impressive momentum.
Nvidia's gaming business seems set for a solid quarter
When Nvidia released its fiscal 2024 first-quarter results (for the three months ended April 30, 2023), it reported a 38% year-over-year decline in revenue from video gaming to $2.2 billion. This sharp drop wasn't surprising as sales of personal computers (PCs) crashed big time in recent quarters.
In the first quarter of calendar 2023, which coincided with two months of Nvidia's fiscal Q1, PC shipments fell a whopping 30% year over year, as per Gartner's estimates. Weak PC sales translated into lower sales of gaming graphics cards for Nvidia, and as a result, its gaming revenue fell. Market research firm Jon Peddie Research estimates that shipments of discrete graphics cards, which Nvidia sells, were down a whopping 38% year over year. The quarter-over-quarter decline was 13%.
Given that Nvidia controlled 84% of this market in Q1 2023, the market's weakness negatively impacted the company's gaming business. However, it was worth noting that Nvidia's gaming revenue fell at a slower pace than the decline in the PC graphics card market. What's more, revenue from this segment was up 22% sequentially even though the overall PC and the discrete graphics card markets contracted by double-digit percentages in Q1 from the fourth quarter of 2022.
This serves to indicate that Nvidia's gaming business was already in recovery mode last quarter on a sequential basis, driven by the launch of new graphics cards at aggressive price points. Things could get even better for Nvidia in the current quarter thanks to a rebound in PC sales. According to Gartner, global PC shipments increased 8% on a sequential basis in the second quarter of 2023. The year-over-year decline also slowed down to 16% following the much bigger drop in Q1.
The sequential recovery in PC sales should ideally translate into stronger demand for the company's graphics cards, especially considering that 56% of Nvidia's installed base of users are currently on older, non-RTX graphics cards. Moreover, Nvidia has taken steps to ensure that it encourages more of its users to upgrade to its RTX-class GPUs by releasing new cards that start at $299 and are much faster than their predecessors.
At the same time, Nvidia's latest Ada Lovelace GPUs are enjoying stronger pricing power. The company points out that the cumulative sales of its Ada graphics cards priced at $699 and above are ramping up at three times the pace of the two-generation-old Turing cards. The Ada cards are also enjoying a much stronger cumulative sell-through over the previous-generation Ampere cards at $699 and above.
So, the gradually improving prospects of the PC market, Nvidia's solid market share, and its pricing power should give its gaming business a nice boost in the current quarter. More importantly, Nvidia's dominant position in the discrete GPU market should set its gaming business up for growth in the long run as well. That's because the demand for gaming GPUs is expected to grow at an annual pace of 33% through 2028, according to Mordor Intelligence.
The stock is richly valued, but the premium seems deserved
We have already seen that Nvidia is currently trading at an expensive multiple. However, the stock's forward P/E ratio of 55 points toward a massive jump in its bottom line. Analysts expect Nvidia's earnings to more than double in the current fiscal year to $7.85 per share from $3.34 per share in the previous one. Even better, the chipmaker is expected to sustain 30%-plus earnings growth over the next couple of years as well.
NVDA EPS Estimates for Current Fiscal Year data by YCharts.
While a big chunk of that growth is likely to be driven by the data center business, which is reaping the benefits of the adoption of AI, the recovery in the gaming market and Nvidia's solid prospects in other emerging areas, such as automotive and cloud gaming, are going to act as additional catalysts.
These multiple growth drivers could help Nvidia deliver faster-than-expected growth -- both in the short and the long run -- and justify its valuation, which is why investors who are looking for a growth stock can consider buying this semiconductor giant before it soars higher.
