Nvidia, the world’s most valuable chipmaker, has seen its stock price soar more than 200% this year, thanks to the surging demand for its high-end processors that power artificial intelligence technologies. However, the company’s forward price-to-earnings (PE) ratio, a measure of how expensive a stock is relative to its expected earnings, has dropped to its lowest level in eight months, according to Refinitiv data.
The forward PE ratio is calculated by dividing the current stock price by the expected earnings per share over the next 12 months. It indicates how much investors are willing to pay for a company’s future earnings. A lower forward PE ratio means that a stock is cheaper or undervalued, while a higher forward PE ratio means that a stock is more expensive or overvalued.
Nvidia’s stock closed at $468 on Monday, up nearly 2% from last Wednesday, when the company reported its quarterly results and forecast that exceeded analysts’ expectations. The company also announced that it would buy back $25 billion of its shares, signaling its confidence in its future growth and value. However, at that price, Nvidia’s forward PE ratio was around 33, compared to over 46 a week ago. This means that Nvidia’s stock is now trading at its lowest forward earnings multiple since December 2022.
One of the reasons for the decline in Nvidia’s forward PE ratio is the increase in analysts’ estimates of the company’s future earnings. Following Nvidia’s strong quarterly report, analysts on average expect Nvidia’s revenue for the fiscal year ending in January 2024 to reach $53 billion, nearly double the previous year. The company’s net income is expected to quintuple to over $22 billion in the same fiscal year, and then rise to $35 billion the following year. These projections reflect Nvidia’s dominant position in the fast-growing market for generative AI technologies, which can create realistic and engaging texts, images, sounds, and videos on any topic or style.
Another reason for the decline in Nvidia’s forward PE ratio is the uncertainty and risk involved in relying on analysts’ estimates of future earnings. Analysts may not be able to accurately predict the future performance of a company, especially in a new and volatile market like AI. Moreover, there may be some factors that could limit Nvidia’s growth potential, such as competition from other chipmakers, supply constraints from its chip manufacturer TSMC, or regulatory hurdles for its planned acquisition of Arm.
Therefore, investors should be cautious when using forward PE ratios to value stocks, as they may not reflect the true worth or potential of a company. As Ross Mayfield, an investment strategy analyst at Baird, warned: “Any time you use a forward-looking thing that involves an estimate in a very new market and very uncertain economic environment, I think at a minimum you have to take it with a pretty huge grain of salt.”