Nvidia's subdued forecast dampens enthusiasm in AI chip stocks after steady rally

A sign for a Nvidia office building is shown in Santa Clara, Calif., Wednesday, Aug. 7, 2024. (AP Photo/Jeff Chiu)

Nvidia shares pared some losses in premarket trading on Thursday, shaking off an earlier decline as investors stayed confident about the chip giant's growth prospects despite a forecast that fell short of lofty expectations.

The company's shares were down 3.4 per cent after it forecast third-quarter gross margins that could miss market estimates and revenue that was largely in line, spurring a selloff across chip stocks including Broadcom, Advanced Micro Devices and Arm.

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Nvidia has crushed Wall Street's estimates for several quarters on surging demand for AI chips, leading investors to bank on the company's penchant for routine blowout forecasts. The stock's strength has been a pillar of the market's rally through both this year and the past year - leading to what some say are ultimately insurmountable forecasts.

"They beat but this was just one of those situations where expectations were so high. I don't know that they could have had a good enough number for people to be happy," said JJ Kinahan, CEO of IG North America and president of online broker Tastytrade.

The forecast followed strong second-quarter earnings that topped Wall Street expectations, and the AI bellwether announced a new US$50 billion share buyback as well.

Shares of other chip companies also recovered some losses and were last trading down between 0.2 per cent and 1 per cent. U.S.-listed shares of TSMC, Nvidia's chip manufacturing partner, were last down marginally.

TSMC's shares 2330.TW on the Taiwan bourse also closed lower as Asian tech stocks tracked weakness in Nvidia, with South Korea's KOSPI index falling to a two-week low.

"Investors want more, more and more when it comes to Nvidia," said Dan Coatsworth, investment analyst at AJ Bell.

"It looks like investors might not have taken the average of analyst forecasts to be the benchmark for Nvidia's performance, instead they've taken the highest end of the estimate range to be the hurdle to clear."

Analysts on average forecast second-quarter per-share profit of 64 cents, with 71 cents apiece being the highest estimate. Nvidia reported earnings of 68 cents per share.

Big Tech stocks also seemed to shrug off the overhang from Nvidia's results. Shares of Google-parent Alphabet, Meta Platforms, Amazon.com and Apple were all up between 0.4 per cent and 1.5 per cent.

"Nvidia is seen as a bit of a bellwether, but despite the numbers being a bit weak, I think people are just sort of happy that it's out of the way. The long-term AI story is still sort of intact. It's just a bit of a relief that the numbers weren't disastrous," said Ben Barringer, analyst at Quilter Cheviot.

That comes as investors have also become concerned about increases in already hefty spending by Microsoft, Alphabet and other major players in the race to dominate emerging AI technology. Microsoft and Alphabet's stocks remain down since their reports last month.

Nvidia delaying the production ramp-up of its next-generation Blackwell chips until the fourth quarter was not much of a concern, analysts said, with the company seeing strong demand for its current-generation Hopper chips.

Nvidia also disclosed it had received requests for information from regulators in the U.S. and South Korea, adding to inquiries from the EU, U.K. and China previously, raising concerns of increased regulatory scrutiny on the company.

"After the DOJ win over Google, large-cap tech has got to be more cognizant of regulatory intervention ... historically, the threat was a little bit toothless. But now that they've got this win over Google, investors have to pay a bit more attention to it," Barringer said.

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The lackluster response to Nvidia's earnings report could help set the tone for market sentiment heading into what is historically a volatile time of the year. The S&P 500 has fallen in September by an average of 0.8 per cent since World War Two, the worst performance of any month, according to CFRA data.

Investors are also watching next week's U.S. employment report for signs on whether the labour market weakness that roiled stocks in early August has dissipated.

Optimism about AI technology, in part due to Nvidia's explosive growth, has fuelled gains on Wall Street over the past year.

However, confidence in that rally has wavered in recent weeks following an earnings season that saw investors punish shares of tech companies whose results failed to justify rich valuations.

Nvidia forecast revenue of $32.5 billion, plus or minus 2 per cent, for its fiscal third quarter, compared with analysts' estimates of $31.8 billion, according to LSEG data. That revenue forecast implies 80 per cent growth from the year-ago quarter.

The Santa Clara, California-based company expects adjusted gross margin of 75 per cent, plus or minus 50 basis points, in the third quarter. Analysts on average forecast gross margin to be 75.5 per cent.

Nvidia's stock dropped 2.1 per cent in Wednesday's session, ahead of its report. It remains up about 150% so far in 2024, making it the biggest winner in Wall Street's AI rally.

The stock was valued at 36 times earnings ahead of its quarterly report, inexpensive compared to its average of 41 over the past five years. The S&P 500 is trading at 21 times expected earnings, compared to a five-year average of 18.

(Reporting by Noel Randewich in San Francisco, Saqib Ahmed in New York and Deborah Sophia in Bengaluru; Additional reporting by Aditya Soni, Kanchana Chakravarty and Medha Singh; Editing by Ira Iosebashvili, Lisa Shumaker, Mark Potter, Saumyadeb Chakrabarty and Shounak Dasgupta)