In Nvidia’s latest quarterly report yesterday evening, the firm handily beat analysts’ expectations on revenue and earnings growth. However, and much to the surprise of many, the stock dropped in after-hours trading in response. At first blush, that might not seem to make sense. Why would investors punish the stock if it so handily outperformed analysts’ expectations?
First, an important warning is in order against getting too excited about trying to explain short-term stock returns. The returns on any given stock, especially over a short period of time (in this case, literally a few hours), are extremely noisy. It’s very difficult to ascribe short-term movements to any single factor or news story. Markets digest all available information and in real-time; therefore, trying to draw simplistic cause and effect conclusions around what’s moving a stock is typically nothing more than folly.
That said, Nvidia has certainly had an amazing run. Even despite recent volatility in the stock, Nvidia’s market capitalization has quintupled in 18 months, propelling the company to a total market capitalization of roughly $3 trillion. But heavy is the head that wears the crown; Nvidia’s stock, coming into yesterday’s earnings announcement, was arguably priced for perfection. The company’s valuation, a reflection of the views of millions of market participants, required absolutely everything to go just right for the company. The value of any company is ultimately the present value of all future expected cash flows (in this case, to equity holders). However, if those expected cash flows are called into question – no matter how popular or exciting Nvidia’s technology may be – any reduction in future expected cash flows should naturally push down the company’s stock price.
So how can Nvidia report more “good news” – surging earnings that beat analysts’ expectations – and the stock still falls? Within markets, there’s no such thing as “good” or “bad” news. Everything is evaluated within the context of current market expectations. And, crucially, the market isn’t just those analysts who attempt to accurately forecast earnings or revenues for a given company. The market is everyone. Owners, short-sellers, options holders (of both puts and calls), and even investors on the sidelines who might wish to own the stock. Nvidia’s after hours sell-off suggests that the broader market appears to have had higher expectations than Nvidia’s many stock analysts. This was indeed the case with respect to Nvidia’s revenues; while they outperformed analysts’ revenue projections, they actually underperformed the “whisper numbers” that the market was collectively expecting.
Finally, it’s important to note that Nvidia didn’t outperform across all metrics; while they beat analysts’ revenue and earnings estimates, they disappointed on its gross margin, which actually declined for the quarter. For a firm that was apparently priced for perfection, any disappointment would naturally lead to a sell-off in the stock. None of this is to take away from the fact that Nvidia has done amazingly well and seems to be well-positioned to continue doing so in the years ahead as the use of AI becomes more widespread.
Takeaways
1. Ask yourself: Do you know more than the market? It’s very unlikely that individual investors, no matter how much they may know about a stock, an industry, or company, will know more than the entirety of the market. None of us individually is smarter than all of us. Even insiders, folks who know their companies better than anybody, have a poor track record timing the purchases and sales of their stock. Consider Lehman Brothers in 2007. Lehman had some of the highest levels of insider ownership among Wall Street banks heading into the financial crisis – and some of the smartest, most talented financial professionals on the Street. The company ultimately became insolvent and filed for bankruptcy in September 2008.
2. Diversify out of concentrated stock risks. If you don’t know more than the market, the logical thing to do is diversify, rather than concentrate too heavily in a single stock. This doesn’t mean selling all of your Nvidia stock. Quite the opposite. It simply means taking a market-weight approach to owning the stock. For a $3 trillion market cap stock like Nvidia, a market-weight approach still means holding a sizable position.
3. Diversification doesn’t have to hurt. For those investors with large, low-basis positions in Nvidia, there are a plethora of strategies, tools, and solutions that can be used to help diversify in a tax-efficient way that minimizes, or even entirely avoids, the realization and recognition of capital gains taxes. This is where working with a trusted advisor and a deep bench of tax, estate, and investment specialists can make all the difference. After all, the only returns that matter are the returns we get to keep.
Your advisor can help determine how best to position your portfolio as rate cuts approach, and Mercer Advisors is experienced in working with Nvidia employees. Not a Mercer Advisors client but interested in more information? Let’s talk.
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