Overvalued and undervalued are terms that need context.

Even after getting blasted by the bear market this year, top semiconductor company Nvidia ( NVDA -3.71%) currently trades for 38 times trailing-12-month earnings, or 45 times enterprise value (EV) to trailing-12-month free cash flow. That’s sky-high compared to other top-tier, fast-growing chip stocks. AMD ( AMD -3.51%), for instance, trades for 24 times earnings and 27 times EV to free cash flow. Qualcomm ( QCOM -2.16%) trades for just 10 times earnings and 20 times EV to free cash flow.

For many investors, Nvidia’s current valuation means that the stock is still too expensive. What’s more, the company is also facing a host of challenges that are contributing to its plunging share price.

But Nvidia is already making strides to address many of those troubles, as evidenced by its decision to offload an excess of gaming chip inventory last quarter on the cheap. So, the question remains: How expensive is Nvidia stock today? The big elephant in the room: A new round of the U.S.-China trade war

Before diving into details, let’s spend a moment on what’s dragging down Nvidia’s share price. The semiconductor stock is dealing with a slowdown in consumer spending, an excess of PC inventory, a cryptocurrency market winter (in which Ethereum no longer needs GPUs to manage the blockchain network), the elimination of sales to Russia, and the U.S. Federal Reserve aggressively raising interest rates. With such a laundry list, what else could possibly go wrong?

Oh, right, the U.S.-China trade war. The U.S. just formally expanded its restrictions on high-end chips used in data centers (sometimes referred to as supercomputers) and other AI applications, ordering Nvidia and other chip companies to halt shipments until they receive approval to do so. Late in September at the company’s semi-annual developer event, Nvidia CEO Jensen Huang had expressed confidence that a license to sell to China could be obtained, or otherwise other chips could be sold instead of its latest and greatest offerings.

Nvidia has yet to provide an update if that viewpoint has changed, which could further impact the company’s growth and profitability prospects in the coming quarters. Other semiconductor companies are getting hit by these restrictions as well. But given Nvidia is a top developer of high-end data center chips, restrictions to China could put a serious damper on sales of its newest semiconductor designs. A tale of two very different half-years

Ok, now that the present bad news is out of the way, let’s talk valuation. Nvidia may not be a “cheap” stock, but earnings and free cash flow valuations aren’t just about the price of the stock. The denominator in the equation is equally (if not more) important to calculating just how attractive a company is.

This is where things get really interesting for Nvidia. Fiscal year 2022, which corresponds mostly with calendar year 2021, was a record-breaker for Nvidia in terms of net income and free cash flow . That strength carried into Q1 fiscal 2023, offset by the $1.3 billion acquisition termination expense after Nvidia was forced by regulators to abandon its takeover of chip design company ARM. The company also halted sales to Russia at that time, which will be a slight headwind for the duration of the current year. And then Q2 fiscal 2023 was the aforementioned excess inventory fire sale, which plunged earnings into a deep, dark abyss. Period Net income Free cash flow Q3 fiscal 2022 $2.46 billion $1.28 billion Q4 fiscal 2022 $3.00 billion $2.74 billion Q1 fiscal 2023 $1.62 billion $1.35 billion Q2 fiscal 2023 $656 million $824 million Data source: Nvidia.

Some investors have said Nvidia’s record profitability masks what is still a hefty price tag, and that is partially true. However, peak profit is already in the rearview mirror at this point. As a refresher, the chipmaker is now trading at 38 times trailing-12-months earnings and 45 times enterprise value to trailing-12-month free cash flow. But, as Nvidia laps two more quarters of peak earnings in the upcoming third and fourth quarters of this year, its valuation could consequently sink.

But then, headed into the new calendar year (fiscal 2024 for Nvidia), the company could have a pretty low bar to clear if earnings and free cash flow start to rebound. Those metrics offer a clearer measure of a business’s cash-generating ability.

The thing investors need to watch out for now is how much new restrictions on sales to China will further impact the bottom line — as well as hints that […]

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