Market Pulse: Nvidia Earnings Preview

In 6 minutes, understand what to expect from Nvidia’s pivotal Q4 earnings call today.

This will be a big week for markets, mainly because Nvidia announces its Q4 earnings results today after market close.

Many see Nvidia as the leader of the ongoing bull market and a bad earnings call from them could trigger a large sell-off. If the call goes well, the market can breathe a sigh of relief.

In 6 minutes, understand what to expect from Nvidia’s pivotal Q4 earnings call today.

💡 Since the last earnings call…

First, let’s review how the stock has performed since the most recent earnings call in November.

The stock price rose 56% at its peak last week since the last earnings call, adding $620 billion to its a market cap (approximately one Tesla) in just 3 months. A massive run.

Earnings wise, this is actually just a normalization of its Price-to-Earnings (PE) ratio, from about 100 prior to its Q3 earnings to 53.8 afterwards back to 97 at last week’s peak.

Nvidia’s PE ratio fell from 100 to 58 in its last earnings call despite the company crushing estimates, outperforming revenue and Earnings Per Share (EPS) estimates by 12% and 18.5% respectively.

The slight decline of the stock and its EPS was the result of guidance concerns. Many thought AI capex was going to decline in 2024 and Nvidia’s China business will decline further from increasing semiconductor export sanctions to China.

While sanctions did increase, there are significant signs that AI capex (capital expense, aka spending on AI chips) is increasing this year rather than falling and a leaky sanctions regime is not preventing China from accessing Nvidia’s chips.

On China, curiously, revenue from Singapore grew from $562 million in 2022 to $2.7 billion in 2023.

💡 Market expectations

If Nvidia meets revenue expectations of $20.5 billion this quarter, its full year revenue would reach $54.21 billion.

If Nvidia meets EPS expectations of $4.20, its full year net income would reach $27.87 billion.

At a $1.7 trillion market cap, this will give it a current Price-to-Sales ratio of 31.35 and a Price-to-Earnings ratio of 61.0.

This is actually not too unreasonable. Consider the PS and PE ratios of the other Magnificent 7s and AMD (higher means more expensive, AMD is an exception):

• AMD: PS ratio of 12, PE ratio of 314

• Tesla: PS ratio of 7.20, PE ratio of 58.6

• Apple: PS ratio of 7.30, PE ratio of 27.9

• Google: PS ratio of 5.90, PE ratio of 27.0

• Amazon: PS ratio of 3.10, PE ratio of 57.9

• Microsoft: PS ratio of 13.2, PE ratio of 36.4

The higher the ratio, the more expensive the stock is. AMD is an exception.

We see that Nvidia’s current PS and PE ratios are surprisingly reasonable compared to the other Magnificent 7s and AMD, despite the tremendous rise in its stock price over the past year.

As such, the stock price going gangbusters last year is mostly the result of its rapid revenue and earnings growth rather than speculation.

In fact, its ratios become even more reasonable if we factor in this year’s huge expectations for revenue and earnings growth. Wall Street mainly cares about forward-looking metrics than current ratios anyways.

So, even though the stock price has risen 56% in just one quarter, this is really just a return to its prior earnings-normalized high and the earnings report tomorrow is not as tenuous as one would think.

Nvidia will likely crush its earnings estimates again this quarter, like it typically does in previous quarters since the company tends to be conservative with its estimates.

❗As such, the most important factor determining how the price moves post-earnings is its guidance.

What’s worrying is the sky-high expectations that was priced into the stock over the last two months.

💡 Biggest Risks

1. Last week, Groq, a small AI startup founded by former Google TPU team members, unveiled a specialized AI chip with blazingly fast inference speeds. It took the AI community by storm.

   1. One of the biggest bottlenecks in AI right now is the speed of inference. For large models like OpenAI’s GPT 4.0 or Google’s Gemini Ultra, inference is slow enough that they aren’t quite ready for day-to-day consumer interactions.

   2. Groq’s LPUs (Language Processing Units) can run inference at 500 tokens/s, which is insanely fast when compared to GPT 4.0’s measly 25 token/s or Gemini 1.5’s 50 tokens/s.

   3. Groq’s LPUs seriously challenge the idea of Nvidia’s AI chip market dominance. When they do come to market, there’s no reason to spend tens of thousands of dollars on H100s/H200s to output 25 tokens/s when you could use LPUs instead.

2. Nvidia currently enjoys exceptionally high margins as the unrivaled leader in AI chip design.

   1. Despite tremendous efforts by competitors like AMD and Groq to catch up, they are still, at best, about a year to half a year out from being able to match Nvidia.

   2. However, Nvidia’s large headstart in AI chips won’t last and when comparable competing chips flood the market, they have to cut their margins. If the stock is still soaring at that point, cutting margins to fend off competition is definitely the end of the party. See what’s happening with Tesla.

3. There are murmurs of Nvidia artificially generating demand for their own GPUs by funneling large amounts of their revenues into startup investments and requiring those startups to purchase Nvidia GPUs.

   1. I haven’t looked into these accusations and so don’t have a point of view.

   2. A key example of this that many point to is Nvidia’s relationship with the startup CoreWeave.

   3. If the accusations are true, this is unethical accounting at best and fraud at worst. However, this seems unlikely given the intense scrutiny Nvidia faces as the hottest AI stock on the market.

💡 A Crowded Hedge Fund Trade

A major force driving the runaway success of Nvidia’s stock price is the heavy concentration of multi-strategy hedge funds buying the stock.

When I say multi-strat hedge funds, I’m referring to funds that invest in both VC and public markets.

A prime example is Brad Gerstner’s hedge fund Altimeter, which has 7% of its public portfolio invested in NVDA.

Altimeter is also heavily involved in VC investing and knows exactly how much startups in its VC portfolio are spending on Nvidia’s chips.

Being heavily connected to the VC space, Altimeter is also privy to rumors of how much other startups are spending and thus have a very good view of Nvidia’s near-term revenues.

This is largely the case for other multi-strat hedge funds.

It’s likely that Nvidia’s recent steep climb from $500 to $750 is the result of multi-strat hedge funds front-running the market given their exclusive views into how startups are deploying 2024 budgets.

In other words, if this theory is true, Nvidia’s better-than-expected Q4 earnings report has already been priced in.

💡 What is the Options Market Saying?

I’m learning how to derive specific and actionable insights from single stock options chains data.

This is a work-in-progress but I felt like sharing early.

Below are two charts representing the open interest for NVDA options expiring on 2/23 and 3/1. The y-axis represents how many contracts are open and the x-axis represents their strike prices.

You can also use the circle sizes to gauge the amount of open interest at each strike price.

A few rudimentary insights from these charts:

1. The 2/23 expiry has a massive amount of open $1,300 calls (13,000 contracts). This price is 85% above $700. Who the heck is buying $1,300 calls? What wanton speculation! 🤦

   1. Interestingly, these $1,300 calls were there last week as well and today’s NVDA sell-off significantly slashed their value.

   2. I’d be remiss not to mention that these could also be sold contracts and if so, they are very safe and significantly less speculative.

2. The 2/23 expiry expectedly has significantly more open interest than the 3/1 expiry, given that earnings is this week.

   1. 239,071 open calls for 2/23 vs 83,564 open calls for 3/1.

   2. 194,482 open puts for 2/23 vs 55,041 open puts for 3/1.

3. There is a significant call skew for both expiries.

   1. 239,071 open calls vs 194,482 open puts for 2/23.

   2. 83,564 open calls vs 55,041 open puts for 3/1.

   3. This shows that the market generally veers bullish for earnings. Given the stocks meteoric rise over the past few months, this is not surprising and I wouldn’t consider it a reliable signal for where the stock is headed post-earnings.