Nvidia Corporation‘s (NASDAQ:NVDA) fourth quarter earnings for fiscal 2024 are expected to come out after the close on February 21st. As I’ve written in past articles, Nvidia earnings releases are among the most significant of all tech releases. This is because Nvidia is the supplier of chips to the big artificial intelligence “AI” companies, such as Microsoft (MSFT), Alphabet (GOOG) and Meta Platforms (META). Although other companies build AI chips, only Nvidia currently offers chips powerful enough to handle the most demanding workloads.

NVDA stock has defied almost everybody’s expectations in the last two years. Since the start of 2022, it has risen 300% in price, and is a 20-bagger over a five year period. It has really been something to witness.

With that being said, nothing is worth an infinite price. Although Nvidia has fantastic growth and a wide moat, that doesn’t mean the stock is worth, say, $10 trillion. Any series of future cash flows is finite, which means asset prices are finite as well. The question, of course, is where the upper limit of fair value actually resides.

Attempting to find that upper limit for Nvidia’s price has proven difficult. The company currently has a higher market cap than Google and Amazon (AMZN), and is not showing signs of slowing down. With that said, it’s not just going to keep rallying forever. Major Nvidia bulls like Stanley Druckenmiller and George Soros were trimming their positions in the third quarter.

At today’s prices, NVDA trades at 83 times earnings, and 58 times forward earnings. The price/book ratio is an unheard-of 53.5. Although Nvidia is likely to continue growing for the next several quarters, and probably at high rates, much of the future growth is already priced in. If you take a $1 cash flow and grow it at 20% for five years, after which time the growth slows to 5%, then with a 10% discount rate, the cash flow is worth $39.
If the stock hits that price then it has a P/E ratio of 39-lower than Nvidia’s current multiple.

Although Nvidia’s growth was much faster than 20% last year, the company will soon have 2023’s sky-high profits in the base period. The economic principle of “base effects” says that maintaining the same percentage growth from one period to the next, requires even more dollar growth. In other words, high percentage growth becomes harder to achieve with scale. Currently, analysts expect Nvidia to deliver $12.33 in adjusted EPS for 2024. That represents 63% growth over the trailing 12-month sum ($7.53). That’s still well ahead of 20%, granted, but keep in mind that the TTM growth rate was 222%.

The expectation of 63% growth next year is consistent with a gradual decline to a 20% CAGR growth rate over five years. After five years, Google, Microsoft and Meta may well have their own AI chips in production – Google’s Tensor Processing Unit has already been built. Should all of these tech companies successfully launch advanced AI chips, then Nvidia will no longer have a wide moat, and its earnings growth will probably decline if not turn negative.

So, Nvidia’s growth story faces several long-term risks, which is why I rated it a hold the last time I covered it. I still think it is a hold if unhedged. However, it occurred to me recently that there was a way of enjoying the possible continued upside of Nvidia while mitigating risk: protective puts.

Nvidia puts are quite cheap these days: you can buy the right to sell on February 16 at $675 for $1.32 (midpoint price), and at $650 for $0.40. This results in total costs between $80 and $264 for puts giving you the right to sell 200 shares. You can protect a $72,100 position against 6.3% downside for $264-a mere 0.36% of what the shares are worth. Now, this “extreme cheapness” is a function of these contracts’ February 16 expiration date. It costs more for expiration dates further out. In the ensuing paragraphs, I will show that hedging 100 Nvidia shares all the way through the company’s upcoming earnings release is relatively inexpensive, too. First, though, we need to discuss this stock’s fundamentals to illustrate why hedging a long position is desirable.

Nvidia, a major player in the semiconductor industry, is currently experiencing strong growth and profitability, garnering the attention of investors and analysts. However, the company faces potential challenges in the near future amidst the shifting dynamics of the chip market.

The Impact of Supply and Demand Dynamics on Nvidia

While Nvidia’s current performance metrics are robust, its future prospects are clouded by the possibility of big tech companies developing their own chips, thereby reducing their reliance on Nvidia’s products. This shift in demand dynamics could significantly impact Nvidia’s revenue and margins, resulting in a decline in its earnings and growth rates.

Porter’s Five Competitive Forces analysis also suggests that Nvidia may face increased bargaining power from customers in the coming years, signaling potential headwinds for the company’s profitability.

Assessing Profitability and Growth Metrics

Currently, Nvidia boasts high profitability metrics and impressive growth numbers. However, there are indications that this upward trajectory may decelerate in the near future, with analysts projecting a slowdown in growth rates for the upcoming year.

Moreover, Nvidia’s valuation multiples are notably higher than the industry average, raising concerns about the stock being overvalued, especially in the context of potential future challenges.

Managing Risks with Protective Puts

To mitigate the impact of these uncertainties, investors are advised to consider hedging their positions in Nvidia. Protective puts, with strike prices reflecting potential downside scenarios, offer a cost-effective way to safeguard Nvidia holdings.

By incorporating protective puts into their investment strategy, investors can effectively cushion the impact of adverse stock movements, especially when Nvidia reports earnings and during periods of heightened market volatility.

Effectively Implementing Protective Puts

For investors holding Nvidia shares, a strategic approach involves acquiring protective puts at carefully chosen strike prices to ensure comprehensive coverage against downside risks.

By aligning protective puts with specific price levels and market conditions, investors can not only protect their positions but also leverage potential opportunities to profit from price fluctuations.

Ultimately, the utilization of protective puts serves as a prudent risk management tool for investors navigating the evolving landscape of the semiconductor industry.