Caution on a Chip Maker

07/14/2008 12:00 am EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer’s Investment Research says a recent magazine story painted a grim picture of graphics chipmaker Nvidia.

A commentary in Barron's magazine’s Tech Trader column ("Nvidia Shares ClobberedAfter Gloomy Warning," July 7th) takes a pretty glum look at graphics-processor company Nvidia (Nasdaq: NVDA) and the technology sector as a whole. The piece begins with the idiom, "There's trouble brewing across the valley." The author notes that PC demand is weakening, and "competition from AMD seems to be taking a toll."

Furthermore, the article states that Nvidia expects to take a one-time charge of $150 million to $200 million related to packaging problems with a previous generation of chips used in notebooks. Basically, the author notes, "Nvidia is having trouble with old products and new products; trouble with competition; and trouble with market weakness."

However, the piece goes on to speculate that the shares could be an even bigger bargain at their current levels. Specifically, Wall Street appears to be on the undervalued bandwagon, as several analysts feel the stock is trading at the low end of its historical valuation range. What's more, the author states that "I do think the company's long-term position is strong," but closes with "Bargain hunt if you like, but go with caution."

Caution is always my first rule of investing, even when confronted with a seemingly sure thing (such as trouble with financial stocks, or strength in energy stocks). But investors should do more than apply caution when bargain-hunting with NVDA shares. The overall tone of negativity in the Barron's piece should be par for the course when it comes to NVDA. But the lingering hope expressed by the author is indicative of the same lingering bullish sentiment on Wall Street that needs to be unwound before more realistic expectations for the shares can prevail.

Specifically, despite the stock's plunge of more than 59% since January, sentiment on Wall Street remains overwhelmingly bullish toward the shares. Zacks.com reports that 13 of the 23 analysts following NVDA rate the equity a Buy or better, even after the company's profit warning last week.

Meanwhile, Thomson Financial reports that the consensus 12-month price target for the shares rests at $21.09 per share—a 76% premium to the stock's current trading range near $12 per share. It seems that Wall Street is still stuck on Forbes s designation of NVDA as "Company of the Year" for 2007.

So, yes, I would agree with the "cautious" approach to investing in NVDA at this point. I would be so cautious as to avoid the shares altogether, unless you are taking out a neutral-to-bearish position on the stock. With better opportunities within the technology sector, who needs the risk of a bullish position in NVDA?

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