NVIDIA is set to release its highly anticipated Q4 earnings next week, but according to Seek Alpha Analyst Damir Tokic, the chipmaker's upcoming financial report may burst the "AI bubble" due to disappointing earnings guidance.

Bearish Rating on NVIDIA

Damir Tokic had rated NVIDIA as bearish on June 19, 2024, when the stock was trading around $138 per share. As of now, the stock remains in the $138-$139 range, indicating virtually no movement in its price over the past eight months. However, its journey has been volatile. In August 2024, the share price plummeted to $91 before rebounding strongly to $150, only to fall back to $133. Currently, ahead of the earnings release on February 26, NVIDIA's stock has bounced back again, nearing its all-time high of just over $150.

Damir Tokic believes that over the past eight months, NVIDIA's stock has been forming a top. In June last year, he already voiced his bearish perspective due to two main factors: first, NVIDIA's stock was overvalued, and second, its revenue growth rate was gradually slowing down.

From the data, since January 2024, NVIDIA's quarterly revenue growth rate has declined from 265% year-over-year to 93.61%. Since April 2024, its gross profit growth rate has also dropped from 339% to 95%. The company is expected to report Q4 revenue of $38.09 billion, up 72% year-over-year, but the trend of slowing revenue growth continues.

In June 2024, NVIDIA's price-to-sales ratio was as high as 40 times, an extremely elevated figure. Although it has now dropped to 30 times, it remains at a high level. The sustained slowdown in revenue growth, coupled with a price-to-sales ratio of 30 times, indicates that its valuation has not yet returned to a reasonable range. Therefore, he still believes that being bearish on NVIDIA is justified.

Earnings Guidance Likely to Miss Expectations

NVIDIA is set to release its Q4 earnings after the market close on February 26. The market expects the company to report earnings per share of $0.84, up 3.7% quarter-over-quarter, and revenue of $88.09 billion, up about 8.5% quarter-over-quarter. However, given the growth expectations implied by the current price-to-sales ratio, such a quarterly growth rate is not very satisfactory.

In the past, NVIDIA has typically exceeded revenue expectations by $2 billion and also outperformed on profitability, while raising its guidance for the next quarter above market expectations. Investors have become accustomed to this pattern.

Given the strong performance of S&P 500 companies in Q4 2024, Damir Tokic expects NVIDIA's earnings and revenue to exceed expectations as well, although the excess may be smaller than in previous quarters, as this trend has been ongoing for some time.

However, this time, the earnings guidance could deliver a significant shock to the market. The technological innovation brought by DeepSeek has greatly changed the industry landscape. DeepSeek has successfully developed an outstanding large language model (LLM) using relatively low-end NVIDIA chips and fewer chips, at a cost that is only a small fraction of what large U.S. tech companies spend to develop similar models.

The direct impact of this technological breakthrough is that the number of chips required for GenAI models has been significantly reduced, and the dependence on advanced chips has also decreased. This means that capital expenditure in the GenAI sector may decline, which will impact NVIDIA's revenue.

DeepSeek's technological breakthrough occurred at the end of January, just as Microsoft, Meta, and Alphabet were preparing to release their earnings. Damir Tokic believes that due to the tight schedule, these companies likely did not have time to adjust their reports and still projected increased capital expenditure in GenAI based on the situation before the DeepSeek storm.

He argues that large tech giants will gradually realize the profound impact of the DeepSeek event on the capital expenditure landscape in GenAI. It is expected that capital expenditure in this sector will not see substantial growth in 2025.

When NVIDIA releases its earnings next week, it is likely to discuss this event in detail. Damir Tokic believes this will be directly reflected in earnings guidance that falls short of market expectations, and there may even be a scenario of zero quarter-over-quarter growth.

Macroeconomic Perspective: The Generative AI Is Becoming A Bubble

The genesis of the Generative AI bubble can be traced back to NVIDIA's earnings report in April 2023, when the company disclosed significant capital investment by hyperscale data center operators in this field.

Damir Tokic argues that if hyperscale data center operators cut capital expenditure, the bubble could burst at any time. This is partly due to the low capital return rate in the GenAI sector, which will eventually lead companies to reduce investment, and partly because the DeepSeek event may prompt companies to cut back on spending. Both factors will play a role, with the DeepSeek event serving as the most direct catalyst.

Therefore, if NVIDIA's earnings report next week reveals a slowdown in capital expenditure in GenAI this quarter, and this is reflected in the earnings guidance, the Generative AI bubble could very likely burst.

Currently, these negative forecasts are gradually becoming a focus of market discussion. Even Federal Reserve Vice Chair Michael Barr has discussed the possibility of GenAI was overhyped: "As I noted before, the economy should grow, if the incremental productivity gains are widespread. However, in this scenario, it is possible that the expected value creation from GenAI was overhyped, anticipating transformative breakthroughs rather than incremental productivity gains."

"This could trigger market corrections for the firms that have heavily invested in this technology if reality doesn't measure up to expectations," Barr continued.

Damir Tokic shares the same view, so he thinks that even without considering the negative impact of the DeepSeek event, NVIDIA's slowing growth rate and valuation in the bubble range already provide reasons to be bearish.

When the impact of the DeepSeek event is taken into account, the case for being bearish on NVIDIA becomes even more pronounced. Tokic predicts that NVIDIA will acknowledge the negative impact of the DeepSeek event in its earnings report, resulting in earnings guidance that falls short of expectations, which could very likely be the key factor in bursting the Generative AI bubble.