NVIDIA (NASDAQ:NVDA) shares are now up 240% since the start of 2020. Sales of the company’s GPUs (graphics processing units) are booming for high-end video gaming and for data centers, riding a massive upgrade cycle and global shortage of chips in the wake of pandemic lockdowns last year. With AI and all of its many use cases only just beginning to reshape the business and personal computing landscape, this is a top semiconductor stock to own for the decade ahead.
But let me offer some counterpoints. Yes, I’m as bullish as ever on NVIDIA’s long-term potential, but the most recent stock price surge (up 30% in the last month alone) has me scratching my head. It could be the result of the company’s stellar quarterly earnings update at the end of May, but those results were no surprise. After all, management had been signalling for a while now it expects its torrid double-digit percentage pace of sales to continue through the rest of this year. Rather, I have a suspicion that this latest jump has more to do with the four-for-one stock split that was announced just days before the last quarterly update, and approved by shareholders to take place on July 19.
If you weren’t planning on buying (or adding to an existing position) a month ago, but are wanting in now because of FOMO (fear of missing out), take pause. NVIDIA is a long-term investment powerhouse, not a short-term one.
A stock split is no fundamental reason to buy
There are valid reasons companies choose to split their stock. Oftentimes it’s simply to make the share price look more approachable for retail investors, thereby increasing liquidity (the number of shares being bought and sold every day), or to generate buzz about new products and services. NVIDIA believes its pending acquisition of chip technology licensor ARM Holdings will be complete by early 2022, and the company is releasing new data center chip and cloud computing capabilities at a rapid rate right now. Clearly, this business is ascending at the expense of legacy operations like Intel, so a stock split that encourages more investors to become shareholders and to increase awareness of its leading chip tech could make a lot of sense right now.
But bear in mind that a stock split in and of itself does nothing to change the fundamentals. If NVIDIA shares were to split right now, it would still trade for 26 times trailing-12-month sales and 91 times trailing-12-month free cash flow — both before and after the split and distribution of new shares to existing shareholders. This is an “expensive” stock, one priced under the assumption it will continue its semiconductor industry conquest for years to come.
The real reason to buy NVIDIA
If NVIDIA stock is suddenly running higher solely due to the pending split, take heed. Price run-ups like this one often face a steep pullback after the split takes place. Recent history bears this out. Look what happened to Apple after its most recent split last August. After an initial tear, shares took a tumble and are only just now getting closer to all-time highs.
However, if someone doesn’t own NVIDIA stock yet and has the ability to purchase more when an ultimate pullback happens, I’d still advise a purchase now just to get one started, but with a caveat: Buy for the long term. Don’t buy because the share price is soaring or because a stock split makes the company appear “cheaper.” Patience is always rewarded, and keeping some dry powder handy to go shopping again later on is a sound strategy. Though NVIDIA is only beginning to overturn an industry long dominated by Intel (and even Qualcomm on the mobile front, which unsurprisingly doesn’t want an NVIDIA-ARM tie-up as it could spell new competition), stock prices don’t move in a straight line.
Put simply, buy NVIDIA for the massive long-term potential it still possesses, but be ready for some turbulence at some point. When that turbulence hits, that will be the time to back up the truck and buy more, not right now on euphoria surrounding a stock split.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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