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Nvidia, Hess valuations have 'gotten ahead' of themselves: Analyst

The AI rally behind tech stocks is pushing Nvidia shares higher, but is it too much, too soon for the chipmaker? Morningstar Chief U.S. Market Strategist David Sekera joins Yahoo Finance Live to discuss which companies may be overvalued. Sekera's top stock picks include AT&T and Taiwan Semiconductor Manufacturing Company.

Video transcript

- Well, the S&P 500 exiting the bear market territory driven largely by tech. One of the top performers in the sector, of course, is Nvidia. The chip giant up more than 150% so far this year. Our next guest says the stock is overvalued after this run. Joining us now is Morningstar Chief US equity strategist David Sekera.

David, you're certainly in the minority among some of the analysts that we've spoken to who said there's still more upside with Nvidia. I'm curious to get your take on where Nvidia trades at right now because there is the argument, and I'm sure you've heard it, that things are a little cheaper, actually, when you think about the outlook for Nvidia and the upside that we see.

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DAVE SEKERA: So right now, we rate Nvidia with two stars. Which means that we think it's overvalued. It's currently at about a 30% premium above our $300 fair value estimate. And, again, we have a very positive outlook on the company. It's just a matter of we think that the valuation has just gotten ahead of itself at this point in time.

And when I look at our projections, you know, I don't think that we're necessarily being especially conservative. We are looking for a 50% increase in the top line this year. And in fact, when I look over the course of the next five years, we're projecting revenue to grow at a compound annual growth rate of 23%. So essentially taking it from $27 billion in revenue in 2023 to $76 billion in 2028.

At the same point in time, we're also bringing our operating margins up. Essentially doubling them to about 50%. Over the past five years, they've averaged 28.7. So, essentially, we're taking our EPS growth rate from $3.34 in 2023 all the way up to $16.29. Essentially people are paying 23.6 times 2028 earnings right now. So, again, while we're very positive on the underlying fundamentals, I think it's just the valuation has just gotten ahead of itself.

- David, do you also think that, more broadly, when it comes to so many of these names that are associated with AI, this AI-fueled rally. Is that overdone across the board, or is this more specific to Nvidia's massive run-up that we've seen?

DAVE SEKERA: Well, in this case, I do think it is very specific to Nvidia. We do still see some other opportunities out there for investors. Taiwan Semi would be one that I would highlight that I think is good for people to take a look at. We do still think that there is additional upside there.

But I do think that we're going to see a lot more competition in the space. They're just generating too much revenue growth, too high a margins. Granted, they do have first mover margin-- first mover advantage right now. But with those kind of margins, it's just going to be attracting more and more competition over the next couple of years.

And competition, not just from the other chipmakers but also from some of the users. So Microsoft, Alphabet, Amazon, they're all moving into this space. They're trying to design their own chips as well.

- Let's talk about another sector that you're watching that you may not like as much. And we're talking about the energy sector. Obviously, the biggest winner last year. Certainly hasn't performed to the level that we saw in 2022. Hes is one that you've highlighted. Why?

DAVE SEKERA: Well, it's almost a similar story. In that, we're very positive on the underlying company and the fundamentals, but we do think that the valuation has just gotten ahead of itself. So we rate this company or the stock with just one star. It trades at a 60% premium over our $84 fair value estimates. Company does have some of the best assets in the space, great growth prospects, x but the valuation has just gotten ahead of itself too much.

So I talked to our energy analyst on some of the metrics he was looking at. Enterprise value to EBITDA. The stock's trading above 9 times right now. The next closest competitor is about six times. So our fair value estimate would actually still put a higher valuation on the company at 7 times but certainly lower than where it's in the marketplace today.

And I'd also note too that we do think oil prices will remain relatively high over the next year or two. We're looking for oil at $72 a barrel on average this year, dropping down to $66 a barrel next year. But when we look at our long-term supply and demand forecast in conjunction with the cost of production, we do think, over time, that oil prices will continue to keep coming down. Our long-term target on oil is $55 a barrel.

- David, let's move on to some of the names that you do like. One of those AT&T. It's actually been off just about 13% since the start of January. Telecoms haven't exactly been in favor here amongst investors. What do you see as the catalyst for AT&T?

DAVE SEKERA: Well, what I like about AT&T right now is I think that stock is at the intersection of being a deep value play. And with as much as growth as run-up thus far this year, I still think that the value in the market now is going to be in the value space and communications.

And, again, the communications sector is the most undervalued sector in our view at a 20% discount to fair value. So when I look at AT&T, it's currently rated five stars, which is our highest rating. Trades at a 36% discount to our $25 fair value. And our fair value estimate when I look at some of the metrics that's eight times enterprise value to EBITDA, 7% free cash flow yield. So again, not very stretched multiples in my mind.

I look at the stock it's paying at 7% or about a 7% dividend yield. And we do think, fundamentally, the company is in a relatively strong position. We rate the company with a narrow economic moat. Which means that we do think they have long-term structural cost advantages.

- What does that moat look like? I mean, when you highlight in your notes that there's only three players, really, when you talk about the wireless space right now. What makes AT&Ts moat particularly strong?

DAVE SEKERA: Well, there's a couple of things going on here. So one, we do have the merger now between T-Mobile and Sprint with only three major players in the market. We do expect that going forward pricing in the cell phone business and the wireless business should be much more rational going forward.

But some of the other things I like here is that in 2020 they did bring a new CE on. And he's been taking a lot of corporate actions really to unlock shareholder value. So he's been doing a number of things strategically to reposition the business, make sure that they're going to be able to address the ongoing evolution within the telecom sector.

But then he's also been refocusing the company strategy. We thought it was a good move to spin off, you know WarnerMedia. He also sold a stake in DirecTV. So we do think that as he's refocusing on that core business, stepping up investments in both the wireless and the fixed line networks, that CapEx spending will pay off for shareholders over time.

- David, do you also see some opportunity in a regional bank named US Bancorp? And this comes at a time when many investors are a little bit nervous to touch this sector. Why do you think US Bancorp is better protected amongst some of those risks out there for regionals?

DAVE SEKERA: Yeah, I mean, overall, it looks like the regional banks have been in kind of that bottoming-out stage. And this is probably our best pick in the regional area. So it's also rated five stars. Trades at a 38% discount to our $53 fair value.

We do believe that they do have a wide economic moat. And we also believe that the uncertainty there would be more of a medium rating. And again also pays a 7% dividend yield. So when we think about the regional banking business model overall, yes, it's definitely under stress here in the near term, but it's not broken.

And one of the things about US Bank is that they are larger than the typical regional bank. And I suspect that they're going to see less deposit flight. And in fact, if you look at the first quarter earnings, I think they only saw 4% of deposits leave. And I think that over time, they're just going to have some of the better earnings leverage out there.

So when I look at our model. We're looking at for the long term. You have 15% returns on tangible common equity, well above 9% cost of capital. And that puts it in the higher end of our regional bank coverage.

- Morningstar chief US market strategist David Sekera. It's good to have you on today. Appreciate the time.