With shares down 14% from an all-time high of $136 hit two months ago, Nvidia's (NASDAQ: NVDA) rocketship rally seems to be unraveling, even as revenue and earnings continue to hit new records. While the chipmaker is still arguably one of the best companies in the world, the market may be losing excitement about the artificial intelligence (AI) industry in general.
Let's explore the pros and cons of the current situation to decide whether investors should buy the dip or avoid this declining stock.
Why is Nvidia declining?
The truth is that no stock can continue rising at a parabolic rate forever. After gaining over 600% since the start of 2023, Nvidia was due for a pullback. That said, some emerging macroeconomic challenges could eventually spell fundamental trouble for the high-flying company.
Analysts at J.P. Morgan think the U.S. economy has a 35% chance of entering a recession by the end of the year. A downturn could wreak havoc on Nvidia's business model, because its high-end AI graphics processing units (GPUs) are essentially tech sector luxury items.
For starters, these chips are expensive, with Nvidia's H100 costing between $30,000 and $40,000 per unit. Thousands of these units are needed to train and run large language models (LLMs). The industry is also notoriously difficult to monetize because of high competition, weak competitive moats, and technical limitations. Corporations would most likely slash their investments in this speculative sector during a recession.
Nvidia faces increasingly challenging comparisons
If Nvidia has anything, it's a spectacular growth rate. First-quarter revenue soared 262% year over year to $26 billion, powered by sales of the company's most advanced data center chips like the H100. Most importantly, these products boast high margins, which allowed Nvidia to increase its operating profit by almost 700% to $16.9 billion.
However, a stock's performance is typically based on future expectations, not past performance. It's unclear how Nvidia will manage to top these already breathtaking results, especially without a substantial breakthrough on the consumer-facing software side of the AI industry.
The company's remarkably high gross margin of 78.4% also suggests it is selling its products at an unsustainable markup over the cost of producing them. This dynamic is sure to draw attention from suppliers like TSMC, which announced plans to raise its production fees in 2025. And while Nvidia is successfully keeping the competition at bay through its rapid update cycle, there is no guarantee that the company can maintain its deep economic moat forever.
The valuation might be unsustainable
With a forward price-to-earnings (P/E) of 40, Nvidia doesn't look expensive compared to its astronomical growth rate. For context, rival chipmaker Advanced Micro Devices trades for the same multiple despite only growing sales by 9% in its most recent quarter (Nvidia grew 262%).
That said, Nvidia's business model has become incredibly overexposed to AI hardware demand, making it tied to a very speculative industry that isn't backed by a track record of revenue and profits. Increasingly difficult comps will also make it harder for the company to sustain its current levels of growth over the coming years.
All in all, Nvidia stock isn't horrible, and most of the near-term downside might already be priced in. However, I would like to see more progress on the consumer side of the AI industry before buying this dip.
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Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
Should You Buy the Dip in Nvidia Stock? was originally published by The Motley Fool