Nvidia (NASDAQ:NVDA) appears poised to recover. After a 57.5% drop from its 52-week high, the stock has moved steadily higher since December. Moreover, winning the bid to buy Mellanox (NASDAQ:MLNX) has bolstered the sentiment that Nvidia stock is the essential equity in the chip space.
However, as NVDA has recovered, the legacy of the crypto decline continues to weigh on company profits. Although Nvidia should continue to move higher, the company will have to stabilize its profit picture if it wants to remain an industry leader.
Mellanox and Nvidia Stock
I’ve often referred to Nvidia as the Intel (NASDAQ:INTC) of this generation. With the rise of artificial intelligence (AI), virtual reality (VR), and data centers, it is Nvidia and not Intel that has become today’s essential chipmaker.
That will only become more true with the company’s latest acquisition. The purchase of Israel-based Mellanox will enhance the company’s data center and cloud capabilities. Their technology could also improve Nvidia’s gaming and self-driving car capabilities.
Despite the benefits of buying MLNX, Nvidia’s recovery already had begun months before. NVDA has already risen by over 10% since the beginning of March and by more than 37% from its near-term low point on Dec. 24.
The lower forward price-to-earnings (PE) ratio that I had pointed out late last year has also begun to rise. Today, that forward PE now stands at 23.6. Given this surge in Nvidia stock, one has to wonder if any upside remains?
I believe it will, but with one condition.
At first glance, Nvidia stock looks like a buy. The decline in crypto has hit NVDA and peers such as AMD (NASDAQ:AMD) hard. As a result, analysts predict an 18.8% decline in profits as the industry works off its chip glut. They also believe that that will turn into a 33% increase in profits next year.
Watch for Earnings Revisions
My one area of hesitation involves the evolving views of analysts on the severity of the chip glut. This miscalculation keeps showing up in the falling earnings estimates. Profit estimates for this fiscal year now stand at $5.39 per share. This is down from $5.75 per share just one month ago and $7.14 per share the month before that.
Investors need to keep in mind that the stock has been rising as earnings keep falling. Hence, the PE ratio keeps surging due to two factors: a rising stock price and falling profits.
Longer-term profit estimates also create some concern. As of now, Wall Street projects average annual earnings increase for the next five years at only 8.37%. I do not expect NVDA stock to match the 59.81% average increases of the previous five years.
However, I also think investors should look at that five-year projection as a “way too early” number. Also, Nvidia stock beat earnings estimates in three of the four previous quarters. That should bode well for the equity.
Moreover, I will stay with my view that Nvidia is this generation’s Intel. As such, I think it can return profit growth rates to the double-digits and maintain PE ratios above 30.
The Bottom Line on Nvidia Stock
The immediate future of NVDA hinges on stabilizing profits. Nvidia has seen a significant recovery since the tech slump ended in late December. However, as NVDA stock keeps rising, profit estimates continue to fall.
Despite the unexpectedly severe effects of the crypto decline, the recovery will spike profits in the next fiscal year. However, investors should take notice of the falling profit estimates, and the fact that sentiments lean toward single-digit profit growth over the next few years.
Most experts see Nvidia as the current industry leader and expect growth to reflect that. Still, long-term profit growth numbers will also have to reflect that leadership. The future prosperity of Nvidia stock depends on it.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
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