AI Giant Reports: What to Watch

Nvidia (NVDA) stock edged 1.5% higher on Tuesday, 27 August, as investors patiently wait for the highly anticipated earnings report on Wednesday, 28 August,  in aftermarket trading. 

The Artificial Intelligence (AI) giant has been a driver of broader market forces, adding approximately 5% to S&P 500 returns year-to-date (YTD) in 2024, according to BoFA securities (previously Bank of America Merrill Lynch - BAML). 

After posting four consecutive quarters of upbeat earnings and sales growth, which have impacted the “Magnificent Seven”, investors and market participants will want to watch whether this strong record continues. 

Nvidia Performance and Drivers

Nvidia stock has seen a substantial increase of approximately 3,000% since 2019 and over 150% this year alone. In fact, its shares have more than quadrupled since early 2023, driven by demand for its AI chips, resulting in about a third of the S&P 500's 17% gain this year.  

The company’s H100 GPUs have become the standard for running AI solutions and training large language models, and as demand outstripped supply, Nvidia increased prices for these chips significantly.

The upcoming earnings report is very important as Nvidia has posted huge growth in recent quarters, putting Nvidia in a sensitive position of having to exceed targets and upgrade guidance to satisfy high expectations. 

Earnings Focus on Data Center

Nvidia is scheduled to report its Q2 earnings after the market closes today, Wednesday, 28 August. Analysts estimate revenue of $31.7 billion with earnings per share (EPS) of 71 cents, suggesting strong demand for Nvidia's AI GPUs. Adjusted EPS is also forecast to increase by 140% to 65 cents. Nvidia's data centre products and AI-related revenue have been driving this growth.

In its last quarterly release, Nvidia achieved record quarterly data centre revenue of $22.6 billion, a 427% YOY and record quarterly revenue of $26 billion, a 262% YOY increase. The chipmaker's earnings report resulted in over 9% upside, the current 1-year price target equivalent from analysts at the current share price.

Notably, six out of the Magnificent Seven who have reported earnings so far in 2024 have fallen by an average of 4% the day after results, likely due to lower-than-expected revenues prompting cuts to AI spending.

Data centre revenue is expected to set another new record in the current quarter. Investors will be watching this key metric, along with any updates on the reported delays affecting Nvidia's new Blackwell AI chip. 

Nvidia stock has faced headwinds recently due to concerns over delays of its next-generation chip and questions over the sustainability of the AI boom. However, some analysts say near-term delays shouldn't impact the stock long term.

Has AI Run Its Course?

Investors expect strong results given the AI chip giant's recent success, and any miss could hurt Nvidia's stock price. Some risks for Nvidia include potential delays in launching its next-generation AI chips, rising costs from its supplier, TSMC (TSM), and ongoing antitrust scrutiny.

The company’s adjusted gross margin, which excludes some costs, is expected to drop significantly in Q2, suggesting that pricing power, fueled by the scarcity of AI chips, may be eroding as competitors ramp up production of cheaper alternatives. Nvidia's top customers, such as Microsoft (MSFT), Meta (META), Amazon (AMZN) and Alphabet (GOOG), are also developing their in-house AI chips, which will reduce their reliance on Nvidia's hardware over time. 

Morgan Stanley (MS) analysts believe these issues are overblown and that Nvidia needs to forecast revenue growth of around $2 billion higher than consensus estimates to satisfy investor expectations. If Nvidia can meet or beat revenue estimates of $28.84 billion for Q2, it would need to grow revenue by around 18% in Q3 to reach Morgan Stanley's target range.

Analysts remain bullish on Nvidia's overall prospects, seeing Nvidia as the "foundation for the AI Revolution". While some have warned of an AI bubble, others argue that Nvidia is still in the early stages of growth.

Investor Enthusiasm at High Levels

Historically, hype around new technologies tends to result in a bubble that eventually bursts as limitations and challenges become clear. If the AI bubble does start to burst, Nvidia, which has benefited the most from the AI boom so far, could be hit the hardest. 

There are likely many retail investors who have already bought the stock purely to join the herd, which could lead to a mentality where a slight setback could cause a larger sell-off. Only recently, the  Nvidia share price shed over $500 billion in a matter of days, suggesting that some already see the stock as overvalued at its current price to earnings ratio (P/E) of around 45 times.  However, it is important to note that past performance does not reflect future results and that only time will tell what actually lies ahead for Nvidia’s stock. (Source: Yahoo Finance)

Conclusion

As all eyes turn to the quarterly earnings of tech and AI leader Nvidia, concerns linger about the sustainability of growth in data centres and forward guidance. Nvidia has risen substantially over recent times due to increasing demand for AI solutions and beat analyst expectations handily. However, high investor expectations add a certain degree of sensitivity as a marginal miss or beat could shift the tide.

While AI has huge potential, there are concerns that high expectations and hype could lead to a market correction unless Nvidia can beat estimates and upgrade guidance. Otherwise, it may be one of the first to fall should the AI boom end.

Many investors have bought NVDA at different levels due to herd mentality, suggesting that pursuing the highly anticipated report may be risky.