Take Some Risk Off The Table With NVDA Stock

With excitement over the rise of artificial intelligence (or AI) still strong, it’s no surprise that Nvidia (NASDAQ:NVDA) shares have continued to stay strong as well. In recent weeks, NVDA stock has remained on an upward trajectory.

Adding to its larger gains earlier in the year, when “AI mania” first took hold, shares in the leading semiconductor company are up by over 100% since the start of the year. Shares are also not that far away from their past all-time high, hit just before the beginning of 2021-2022 tech sell-off.

Yet while for now momentum remains on your side, you may not want to assume that the trend will stay your friend indefinitely. Bullishness for AI stocks, including this stock, could soon reverse.

If you own it today, you might pare down your position.

Valuation Concerns are Valid

On the surface, concerns about Nvidia’s current valuation may at best sound like an overreaction, at worst sour grapes from those who did not jump in when the stock’s AI-fueled rebound took shape. However, dig a little deeper, and it’s clear that these valuation worries are not overblown.

Instead, they are quite valid. Right now, NVDA stock trades for around 62.9 times estimated earnings ($4.59 per share) for this fiscal year (ending January 2024). Yes, rising adoption of AI and machine learning points to continued demand growth for Nvidia’s chip and software offerings.

Analyst forecasts call for earnings growth 34% and 28.1%, respectively, next fiscal year, and the fiscal year after that.

To most, annualized growth near or above 30% sounds like something that justifies NVDA’s super-premium valuation. Still keep in mind that these forecasts, including forecasts for the current fiscal year are not set in stone.

As InvestorPlace’s Dana Blakenhorn recently argued, analysts could be overestimating how much, and how soon, the AI revolution moves the needle for Nvidia’s bottom line. That’s not all. There’s something else that could lead to disappointment, and a reversal in investor sentiment.

Don’t Forget Non-AI Headwinds

The aforementioned 34% and 28.1% forecasts assume Nvidia’s earnings to rebound in a big way compared to the fiscal year ending January 2023.

Last fiscal year, reported earnings for NVDA stock came in at $1.74 per share, a 55% year-over-year earnings decline.

It’s been attributed to a drop in demand for graphics chips, which brought overall revenue growth to a screeching halt.

As a Seeking Alpha commentator argued earlier this month, demand is likely still weak in these end user markets. Chalk this up to continued belt-tightening as high inflation and uncertainty about a recession keep lingering.

Having said all of this, analysts have largely glossed off the potential for continued non-AI headwinds.

Instead, they have countered that surging demand for AI GPUs, sold at substantially higher prices, will more than make up for the difference. We’ll have a clearer idea of which of these arguments is on the money next week. That’s when Nvidia next releases quarterly results.

The Best Move Now

Sure, it’s possible that Nvidia could beat rising expectations in its upcoming earnings release. This could in turn drive a big post-earnings rally, pushing the stock back above $300 per share.

Conversely, however, any bit of disappointment could lead to a big post-earnings plunge.

Not only that, beyond just earnings, AI mania, like any bubble, could begin to deflate. This may also drive a moderate correction for shares.

Don’t get me wrong. The AI revolution may play out slower-than-expected, but it stands to have a dramatic impact on profitability for first-movers like Nvidia.

Still, given the uncertainty, against a “priced for perfection” valuation, you may want to play it safe with NVDA stock. That’s not to say you need to fully cash out, but taking some profit may be a wise move.

On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.