The Number Changing My View on Nvidia Stock

I recently reviewed Nvidia's (NASDAQ: NVDA) latest quarterly SEC filing, and what I read persuaded me to change my call on the stock. In the recent past, I called Nvidia a buy amid its rapid revenue growth and comparatively low valuation.

Today, as I look more closely at the numbers, I worry more about its near-term future. Amid that concern, I am now switching my call on Nvidia from buy to hold. Here's why.

Image source: The Motley Fool.

Nvidia's positive attributes

First, making this shift does not mean I have turned on Nvidia. I still see it as an excellent choice for the long term. The company continues to dominate the artificial intelligence (AI) accelerator market and is investing enough into research and development to stay on top of the market and pivot into cutting-edge technologies.

Moreover, it currently trades at just 28 times earnings. Considering the S&P 500's average P/E ratio is 27, that looks like a reasonable valuation for a top company.

Furthermore, Nvidia plans to buy back $235 billion of its stock between now and January 2028. Between its future sales growth and its dwindling outstanding share count, the stock could easily outperform the market over the longer term.

The challenge with Nvidia

A quarter-century ago, the internet industry endured the dot-com bust. A similar event is likely to hit the AI industry at some point. An AI bust would be unlikely to destroy Nvidia, but the company has a key vulnerability that makes its near-term direction less certain.

Buried in Nvidia's latest quarterly filing was the revelation that five companies each make up between 10% and 22% of its accounts receivable balance, for a total of 70%.

Nvidia did not reveal which specific companies they were. Still, one is likely to be OpenAI, a company that's underperforming its financial expectations. Additionally, even better-established hyperscalers like Amazon have borrowed heavily and turned free-cash-flow negative. Those factors could limit its spending over time.

For now, Nvidia's growth remains exceptionally strong. In the first half of its fiscal 2027 (a period that ended July 26), its revenue was $178 billion -- a 96% increase from the prior-year period. Analysts forecast that its growth will remain in the high-double-digit percentages through at least the next fiscal year.

Unfortunately, if one or more of Nvidia's top customers reduce or stop their purchases of its processors, its growth rate could easily slow in the near term -- or its top line could even contract. Since investors have been reluctant to bid its stock price higher despite its relatively low P/E ratio, such a slowdown could make the stock's direction uncertain for a time.

Nvidia stock is likely a hold

Nvidia looks more like a hold than a buy when considering the company's high dependence on a small number of customers.

Indeed, with its leadership in AI accelerators, relatively low valuation, and efforts to reduce its share count, the chip stock appears well-positioned to benefit from growth, as the potential downside seems limited.

However, an AI bust, even if it ultimately proves temporary, could bring significant uncertainty to Nvidia stock if those five customers slow their purchases.

Hence, while Nvidia remains in a strong position over the longer term, the risk of near-term revenue growth slowing probably means investors should pause additional stock purchases for now.

Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and Nvidia. The Motley Fool has a disclosure policy.