We recently created a list of Morgan Stanley’s Best Overweight & Quality Stocks: Top 25 Stocks. In this article, we’ll take a look at where NVIDIA Corporation (NASDAQ:NVDA) ranks on our list of overweight and blue-chip stocks.
The end of September cemented a paradigm shift on Wall Street. The first rate cut by the Federal Reserve was a 50 basis point cut, which was all investors could hope for, but since the cut, the flagship S&P index and broader Nasdaq index have They have increased by 2% and 3%, respectively. The rate cut also shifted Wall Street’s focus to the next big trigger for the stock market: third-quarter earnings season.
For a market that has hit new highs this year thanks to artificial intelligence, the second quarter earnings season was nothing short of fireworks. After the world’s leading AI GPU designer and the semiconductor industry weighed in on the fate of the semiconductor manufacturing stock that ranked No. 5 on Jim Cramer’s “Top 12 Stocks to Watch” list, the results were mixed. The AI story was briefly shaken.
Starting with semiconductor manufacturers, their second quarter earnings were nothing short of a bloody disaster. They confirmed that the company’s non-GAAP net income declined by a significant 85% for the year, turning a year-ago GAAP net income into a loss of $1.6 billion in non-GAAP net income. At the same time, gross profit margin fell by 0.4 percentage points, and in a worst-case scenario, the company announced it would suspend its dividend starting in the fourth quarter. As a result, the company’s stock price plummeted 30% after the earnings release, and since then we’ve seen multiple reports that other companies are interested in acquiring the company.
For GPU designers, revenue rose 122% in the second quarter. This is no small feat considering the company’s revenue of $13.5 billion in the same period last year. However, the stock’s second-quarter revenue of $30 billion beat analysts’ expectations of $28.7 billion, helped by a 154% year-over-year increase in sales in the AI data center division. Shares fell 6% in after-hours trading. The decline was centered on a lukewarm third-quarter outlook of $32.5 billion (analysts expected $31.77 billion), a 0.1 percentage point decline in gross margin, and third-quarter earnings This was due to a 0.5 percentage point lower rate outlook and a delay in the launch of Blackwell GPUs. Fourth quarter. The margin miss wasn’t particularly comforting to investors who were already concerned about AI’s ability to generate profits. As a result, the company’s stock price has fallen 1% since the earnings announcement.
But investment bank Morgan Stanley priced the GPU designer’s stock price at 6.8 in September with bullish comments saying the company could make $10 billion in the fourth quarter alone with its latest Blackwell chips. % soared. The upgrade comes as MS remains consistent in its analysis of the stock market this year. Key themes identified by the firm include the labor market, commercial real estate, and the large- and small-cap divide in the stock market.
“There is plenty of room for equity performance to expand, but this will require a cyclical recovery,” the bank said in July. Simply put, this means that MS believed that the economy had to perform well in order for small-cap stocks to catch up with large-cap stocks. If you’re wondering how big the difference is, data shows that small- and large-cap stocks have higher expected price-earnings ratios when they are in the top 20% by free cash flow margin . As of April 2024, the ratio to large-cap stocks is 0.74x, which is considerably lower than the April 2009 peak of 1.62x. MS reiterated this idea in its August report, sharing that small-cap stocks’ outperformance “necessitates faster economic growth driven by lower interest rates.” Recent inflation data and associated lower interest rates have boosted small-cap stocks, but weak economic data could limit continued outperformance. ”
However, MS’s September report was a little different. He focused on clean energy and infrastructure investments in the United States and shared that these could help some segments of the U.S. stock market that typically rely on growth in economic activity. Government spending through the Inflation Control Act (IRA), the Bipartisan Infrastructure Act (BIL), CHIPS, and the Science Act has committed the private sector to invest nearly $500 billion in areas ranging from roads to public transportation. . Clean energy manufacturing and heavy industry.
“Government policies such as the CHIPS Act, the Inflation Control Act (IRA), and the Infrastructure Act are supporting growth in many sectors of U.S. manufacturing,” the bank said. These trends could provide structural support throughout the cycle for what is traditionally a highly cyclical sector of the economy. ” In terms of data, MS revealed that in 2022, the proportion of U.S. manufacturing capacity in 2017 production remained at about 126%, but this has jumped to nearly 129% in 2024. are.
Shifting gears, Q3 earnings season will soon shape how investors view the market. The flagship S&P index is expected to see an annual revenue increase of 5.4% in the third quarter, according to LSEG data. FactSet is more cautious, expecting the index’s earnings to rise 4.6% annually to achieve a sixth consecutive quarter of growth. MS believes that for the stock market to perform well, the economy needs to continue to perform well on the data front.
In a recent podcast, Mike Wilson, the bank’s chief investment officer and chief strategist, said, “Unemployment needs to fall and payrolls should exceed 140,000 without a month-over-month negative revision.” . However, I also closely monitor several other variables to determine our growth trajectory. Earnings revisions, the best indicator of a company’s earnings forecast, continue to trend flat across the S&P 500 and continue to trend negative in the Russell 2000 Small Cap Index. Due to seasonal patterns, this variable could face negative headwinds over the next month. ”
our methodology
To create our list of Morgan Stanley’s best overweight and blue-chip stocks, our recent list of 66 stocks with overweight ratings, above median quality scores, and 1-month EPS upside revisions Ranked by analysts’ average monthly revision rate. Average EPS data was obtained from Yahoo Finance as of September 26, 2024, and the top 25 stocks with non-zero percent revisions were selected.
We also mentioned the number of hedge fund investors in these stocks. Why are we interested in stocks that hedge funds invest in? The reason is simple. Our research shows that by mimicking the top stock picks of the best hedge funds, you can outperform the market. Our quarterly newsletter strategy selects 14 small- and large-cap stocks each quarter and has returned 275% since May 2014, outperforming the benchmark by 150 points. (Click here for details).
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NVIDIA Corporation (NASDAQ:NVDA)
Number of hedge fund holders in Q2 2024: 179
Average analyst EPS % revision: 4.2%
NVIDIA Corporation (NASDAQ:NVDA) is a GPU designer that has led Wall Street’s excitement around artificial intelligence. The company’s GPUs are the world’s most advanced for computing AI workloads, making them a mainstay in the AI industry. Additionally, another key to NVIDIA Corporation’s (NASDAQ:NVDA) rapid growth is GPUs, which power high-speed computing that can handle heavy non-AI workloads faster despite the physical limitations of CPU manufacturing. It is the ability of NVIDIA Corporation (NASDAQ:NVDA) is giving GPU users more control over their chips through CUDA, and its success depends on maintaining its market dominance. NVIDIA Corporation’s (NASDAQ:NVDA) GPUs are needed by most businesses, and as long as there are no strong competitors or substitutes, the company can continue to grow. Morgan Stanley believes the company could generate $10 billion in revenue in the fourth quarter alone thanks to Blackwell GPUs due to its strong competitive advantage.
Baron Funds mentioned NVIDIA Corporation (NASDAQ:NVDA) in its Q2 2024 investor letter. The fund says:
“But just recently, we have entered a period of doubt and doubt, some of which is real and normal in the early stages of a new paradigm, and some of which is being encouraged by short sellers. Given the explosive profits of NVIDIA and other AI leaders, AI bears and fearmongers are comparing the current AI market winners to the Internet bubble of the late 1990s and early 2000s. We compare NVIDIA’s stock price movement to Cisco’s stock price at the time: First, before the Internet bubble burst, many stocks were based on nosebleed valuations and fabricated metrics (like price per eyeball). As I’ve said many times, the Internet has proven to change the world and create the digital age.Second, the fluctuations in NVIDIA’s stock price are a sign of a company of this size. Almost all of that has been driven by explosive growth in sales, profits, and cash flow over the past 12 months, rather than multiple business expansions. effectively tripled, but the forward P/E multiple was nearly flat, blowing away Wall Street’s expectations even though NVIDIA was covered by more than 60 sell-side analysts. The only parallel in my career is when Apple first introduced the iPhone and surprised Wall Street with its growth. Most of Cisco’s moves in the late 1990s were due to multiple expansions, with Cisco’s peak P/E ratio exceeding 130x, more than 4x its five-year average of 37x. At the end of the second quarter, NVIDIA’s P/E ratio was 40x, which is in line with its five-year average, and in line with consensus expectations, NVIDIA’s 2025 P/E ratio was 0.8x next year. We aim to increase earnings per share by 40%.
Additionally, we discuss the financial impact of AI and whether the sharp increase in capital expenditures (Capex) in the technology industry as a whole, and in particular the large cloud players known as hyperscalers (Microso, Google, Amazon, Meta), is justified. Home concerns have arisen. and earn a reasonable return on invested capital (ROIC). First, the adoption and penetration of new technologies is typically thought of as following a classic S-curve, or more precisely, a series of S-curves or phases. For at least the past year and a half, we’ve been in what we call the AI infrastructure build phase. As NVIDIA CEO Jensen Huang has clearly stated, we are building an AI factory and this phase is dominated by infrastructure. Layer players – Suppliers of accelerated computing chips such as NVIDIA and Broadcom, as well as data center, cloud infrastructure, and energy companies. Hyperscalers, other companies, and sovereign entities that are investing ahead of time understand that if they want to get in the AI game, they have to invest now – building infrastructure, building factories. Masu. Otherwise, you’ll end up in chaos on the sidelines or playing catch. Competing in the most important race, the biggest match of the technology generation. Only those who invest today even have a chance of becoming winners in the future. ”
Looking at Morgan Stanley’s top overweight stocks, NVDA ranks 6th overall. While we acknowledge NVDA’s potential as an investment, we believe some AI stocks are more likely to deliver higher returns and do so in a shorter time frame. If you’re looking for AI stocks with more promise than NVDA, but trading at less than 5x earnings, check out our report on the cheapest AI stocks.
Read next: A $30 trillion opportunity: 15 humanoid robot stocks to buy as NVIDIA has ‘become a wasteland’, according to Morgan Stanley and Jim Cramer.
Disclosure: None. This article originally appeared on Insider Monkey. All investment decisions should be made after consulting a qualified professional.
