A price-to-earnings (P/E) ratio of nearly 74 will usually be considered a nosebleed valuation for any stock. To put that multiple into perspective, it’s nearly three times the P/E ratio for the S&P 500.
Nvidia (NASDAQ: NVDA) currently trades at nearly 74 times trailing-12-month earnings. Unsurprisingly, many investors think the chip stock is priced at a steep premium. But could they be wrong? Is Nvidia stock actually undervalued?
In the eyes of the beholder
Let’s first define the term “undervalued.” Oxford Languages, the world’s top dictionary publisher, defines it as “not valued or appreciated highly enough” or “having an underestimated financial value.”
I’d argue that any rational investor who owns Nvidia shares thinks the stock is undervalued based on that definition. Why? It wouldn’t make any sense to hold onto the stock if they didn’t think it was already valued and appreciated enough or had a financial value that was higher than it should be.
Of course, not everyone will agree with these investors. However, that’s how the stock market works. Buyers of a stock think a stock has more room to run (i.e., it’s not valued highly enough). Sellers usually don’t. Valuation, like beauty, is in the eyes of the beholder.
Of the 36 analysts surveyed by LSEG in June, 21 rated Nvidia as a buy or a strong buy. Many on Wall Street seem to view the stock as undervalued. How can they hold such an optimistic opinion in light of Nvidia’s sky-high P/E ratio? That’s easy: They think the company’s growth more than justifies its current price tag.
How much growth does Nvidia need to deliver?
That raises the next question: How much growth does Nvidia need to deliver to be undervalued now? There are several ways to determine an answer.
One quick-and-dirty approach is to use the price-to-earnings-to-growth (PEG) ratio. This ratio is calculated by dividing the P/E ratio by the expected annual-earnings per share (EPS) growth rate — typically the projected growth over the next five years. Any PEG ratio of below 1 is considered an attractive valuation.
The math is simple using the PEG ratio….
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