Data Center and Gaming Revenue Should Boost Nvidia Stock

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It’s certainly possible that Nvidia (NASDAQ:NVDA) stock has run too far. Nvidia stock has gained roughly 50% just since late May. Certainly, the news of late has been good — but it doesn’t necessarily seem to be that good.

With Its Story Intact, Nvidia Stock Can Keep Gaining

Source: Hairem / Shutterstock.com

Meanwhile, valuation after the big rally looks potentially questionable. Nvidia stock trades at nearly 30 times fiscal 2021 consensus earnings per share estimates. That’s getting closer to where NVDA stock traded last year. Soon after, the crypto bubble burst, and NVDA shares dropped by more than 50% in a matter of months.

As a result, many investors and analysts see Nvidia stock as simply too expensive. A current price of $210 is well past the average analyst price target of $195. InvestorPlace’s Will Healy pointed to a high valuation relative to other growth names in the semiconductor space, and Tom Taulli called the gains too much, too soon.

I understand those concerns, particularly with Nvidia earnings on tap next week. That earnings release looks potentially risky given the obviously building expectations. That said, the gains in NVDA stock make some sense — and could continue.

As I wrote back in March, Nvidia stock was a second half story. The second half of 2019, at least so far, is going almost exactly to plan. And that suggests that Nvidia stock, despite those valuation concerns, can continue to rise.

Data Centers and NVDA Stock

The effect of the crypto bust has been a focus of many headlines surrounding Nvidia stock. But one of the less-covered aspects of Nvidia’s recent struggles has been a slowdown in the company’s data center business.

Between fiscal 2017 and fiscal 2019, Nvidia’s data center revenue grew a staggering 253%, according to figures in its Securities and Exchange Commission Form 10-K. In the first half of FY20, however, data center revenue has declined 12% year-over-year, per the 10-Q. The cause has been an apparent “pause” in demand, as rival Intel (NASDAQ:INTC) told investors earlier this year.

Data center sales aren’t as important as those in the Gaming category (which includes crypto-related revenue). They accounted for barely one-fourth of total revenue in the first half. But the category still was a significant driver of Nvidia’s growth — and perhaps the most significant now that crypto demand has returned to more modest levels.

And the news here seems good, at least looking at the rivals in the data center space. Intel stock has rallied sharply off earnings, thanks in part to optimism toward renewed demand in data center. One analyst called NVDA the best play on that optimism, and moved his price target to a Street-high $251.

Advanced Micro Devices (NASDAQ:AMD) too sounded positive on its third-quarter call, though AMD has managed to get a big win, adding Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL).

Investors didn’t expect Gaming revenue to bounce back this year after the crypto bust. But they were hoping for a second-half recovery in data center. As I wrote in July, management continued to support those hopes. Commentary elsewhere in the sector suggests that management was right. If next week’s earnings confirm the recovery, Street price targets will likely come up and Nvidia stock can gain after the report.

Chip Optimism Drives Nvidia Stock Into Earnings

Taking a broader view, the news looks positive as well. Chip stocks have gained in recent weeks. The Philadelphia Semiconductor Index has rallied sharply from its own May lows to reach new highs. Demand seems healthy across the industry, and for the most part, earnings reports so far have been solid.

Admittedly, Texas Instruments (NASDAQ:TXN) sparked some concern with a disappointing outlook. But reports from Intel, AMD and equipment manufacturer Lam Research (NASDAQ:LRCX) suggest a healthy industry overall.

That does add some pressure to Nvidia earnings. The rally of late and the strong numbers elsewhere in the space don’t leave much room for error. If Nvidia disappoints, investors will wonder if the company is losing share to the likes of AMD. And the point that InvestorPlace’s Will Healy made this week — that NVDA is more expensive than AMD despite similar, if not weaker, growth prospects — will look prescient.

That said, there’s little evidence right now to suggest a miss. Rather, the evidence suggests the opposite. Demand is healthy, Nvidia is recovering from the crypto bust and there’s clear room for outperformance in data center revenue. I’d expect a strong quarter.

And a strong quarter supports the idea that Nvidia is back on track, which might lead to a run toward, if not necessarily to, last year’s highs above $300. No, NVDA isn’t cheap — but it shouldn’t be cheap when this company is executing and the industry is cooperating, If Nvidia can confirm on Thursday that both halves of that equation are true, NVDA stock can continue its rally.

As of this writing, Vince Martin has no positions in any securities mentioned.

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