The chip stocks are down big this year, but they’re not cheap.
One of the most dangerous traps an investor can fall into during a bear market is anchoring. You might find yourself saying something like: “My stock is down 60%; it’s so cheap!” Here’s the problem with that line of reasoning: It assumes that the peak is the “correct” price. In reality, no one knows what the “correct” price is. Sometimes a stock collapses and never recovers. Sometimes it takes many years for it to claw its way back.
There’s nothing stopping a stock that’s fallen 60% from falling another 60%. The stock market doesn’t care what your cost basis is. It doesn’t care about what happened in the past. What matters is the future. Combine dimming growth prospects with a frothy valuation, and you have the recipe for a nasty decline that would have been unthinkable when new all-time highs were being carved out daily.
NVIDIA (NVDA -0.66%) and Advanced Micro Devices (AMD -1.22%), two semiconductor stocks that were soaring until late 2021, have seen much of those gains come undone as chip shortages have given way to chip gluts. Both stocks are down around 60% from their all-time highs.
It’s an open question whether these two stocks are good long-term investments at their current prices. But they are certainly not clear-cut bargains.
Unwinding the excesses of the pandemic
Both NVIDIA and AMD were doing well before the pandemic hit. NVIDIA was dominating the market for gaming GPUs while building a lucrative data center GPU business aimed at artificial-intelligence and other computationally intensive workloads, and AMD was stealing market share in the PC and server CPU markets.
The pandemic supercharged both stocks. Graphics card prices went through the roof as cryptocurrency miners snapped them up, and PC sales surged to their highest level since 2012. From the beginning of 2020 to Nov. 1, 2021, shares of NVIDIA and AMD were up 339% and 173%, respectively.
Did those rallies make sense? Only if you believed the frenzied pandemic-era demand was the new normal. The cryptocurrency bubble has since collapsed, erasing a big chunk of demand for graphics cards and putting the industry into a state of oversupply. On top of that, PC sales are tumbling. Unit shipments are expected to be down around 10% this year, with the consumer side of the industry hit the hardest.
From their peaks in late 2021, NVIDIA and AMD stocks are down 59% and 63%, respectively. Are these buying opportunities? Here’s another way to look at it: The stocks are still up around 109% and 44%, respectively, from the start of 2020. If you anchor to the all-time highs, those steep declines create the illusion that both stocks are screaming bargains. But the truth is that both stocks are still well above their pre-pandemic levels.
Valuation is ultimately what determines whether a stock is cheap or expensive. Let’s look at the price-to-sales ratio.
Both NVIDIA and AMD trade at greatly reduced price-to-sales ratios compared to their peaks, but that doesn’t mean the stocks are cheap. The price-to-sales ratios for both stocks are now right around where they were three years ago. And the growth prospects for the companies, at least over the next year or so, are not particularly bright.
NVIDIA and AMD could very well be fine long-term investments, but they’re not bargains. Know what you’re getting yourself into if you decide to invest in these stocks.
