Last fall, Nvidia (NASDAQ:NVDA) was trading at almost $300. Today, NVDA stock is trading at half that amount.
My InvestorPlace colleague Tom Taulli recently reminded investors that despite good things happening at Nvidia with its RTX gaming chip, the oversupply of chips makes NVDA stock a risky buy at this point.
It’s hard to argue with Tom’s logic.
Given China accounted for 24% of Nvidia’s revenue in the last year, a prolonged trade war with the U.S. would decimate the company’s revenues, profits, and of course, free cash flow. From that perspective, Nvidia is a falling knife you likely don’t want to catch.
However, assuming the trade dispute gets solved by the end of 2019, Nvidia’s current free cash flow generation makes its an interesting value proposition. Here’s why:
NVDA Free Cash Flow Generation
In the latest fiscal year ending January 31, 2019, Nvidia had $3.14 billion in free cash flow, which accounts for 27% of its annual revenue. While its free cash flow margin was down 300 basis points from fiscal 2018, it’s still significantly higher than many of its peers.
For example, Intel (NASDAQ:INTC) had $14.3 billion in free cash flow in fiscal 2018; that was 20.2% of its annual revenue. A year earlier, Intel’s free cash flow was $10.3 billion or 16.5% of its annual revenue.
A skeptical person might note that Intel’s free cash flow as a percentage of sales increased substantially between fiscal 2017 and 2018, while Nvidia’s decreased over the same period. However, Intel is significantly larger than Nvidia with six times as much revenue. It ought to be converting more of its revenue to free cash flow given the economies of scale.
But it isn’t.
For this reason, along with the growth runway Nvidia has with the cloud and artificial intelligence, it’s understandable that investors are willing to pay almost 30 times cash flow for NVDA stock compared to eight times cash flow for Intel.
Nvidia’s current free cash flow yield is 3.8%, almost double what it was a year earlier. And while it’s not 8%, what investors consider a true value stock, its slide over the past year has made the Nvidia stock price a much better buy.
Within 17% of a 52-week low, it’s getting closer to where it traded in June 2017.
In those two years, however, Nvidia has become a much more diversified business, which means to buy on the dip today is safer than if you had done so in 2017.
The Bottom Line on NVDA Stock
I continue to like Nvidia because of its free cash flow. Companies that efficiently convert revenues to free cash flow tend to perform better over the long haul.
InvestorPlace contributor Luke Lango recently argued that Nvidia is a victim of semiconductor-market inefficiencies that should resolve themselves.
“Right now, we are going through one of those down eras. Semiconductor demand is waning in the face of escalating global economic uncertainty and trade tensions. At the same time, in anticipation of massive secular demand in industries like Internet of Things and artificial intelligence, supply in the semi market has expanded tremendously over the past few years,” Lango stated June 11.
More importantly, Lango suggested, is that Nvidia’s revenues and margins were moving ahead of their long-term trend-lines, a sign that 2021 could be the year the chip maker’s growth reignites.
If you’re an aggressive investor and aren’t afraid of a little volatility, I would buy NVDA at current prices, saving a little if it moves lower to test its 52-week low of $124.46.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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