Nvidia be stock of the century

Nvidia is the stock to own as artificial intelligence is all the rage right now. But after the most recent rise placed it on dizzying value multiples, should you purchase now? Edmond Jackson, an analyst, offers his viewpoint.

I think there are good reasons why investors are now fascinated by NVIDIA Corp NVDA 4.95%. Uncertainty surrounds the justification of the nearly 200 times trailing earnings, yet this stock is no fluff.

It increased 30% last week, however within the framework of a constantly rising trend; it started off 2023 at $143 and is now testing $400. This is a new record high compared to $346 in November 2021, when it peaked, and $108 in October 2022.

Conservative experts would argue that the sudden collapse was only a tremor in a single, wildly overvalued tech stock, and that once the US economy enters a recession, another moment of truth will loom.

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I believe that the stock decline was caused by two factors: 

Macro: As the Federal Reserve finally addressed inflation, Nvidia’s decline occurred at the same time as expectations for interest rates changed from being extremely low to considerably rising. Growth stock values were particularly affected by this. Since it is widely believed that the Fed won’t raise rates any higher for fear of triggering a recession, tech stocks have been on the rise once more as investors anticipate a rate cut from the Fed in the near future. We’ll see. 

Micro: After a pandemic-driven surge in PC and graphics card sales, Nvidia has not been immune to a recent downturn in the gaming industry. 

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Something of a parallel now, with the late 1990s

Do you remember when the widespread use of the internet required businesses to reinvent themselves as “dot com” businesses? Online commerce was a significant shift even if the frenzy ended with a fall in the tech stocks.

The likelihood that Amazon.com Inc. AMZN 0.42% would ever turn a profit was doubted by conservative investors. Despite being down 80% from 2021, it still generated $4.3 billion (£3.5 billion) net last year.

Artificial intelligence (AI) is undergoing a similar paradigm shift, and despite certain maniacal parts, we can anticipate that the world will be far more dependent on it in five to ten years. 

Since the private company OpenAI debuted ChatGPT last year, it has captured investors’ attention, leading Microsoft and Google to counter-offer with search engines, bots, and AI-driven operations. 

Nvidia makes me think of ARM Holdings, a maker of microchips, which became a monster after splitting from Acorn plc in 1998 and having its chips used in a wide range of products. 

A dedicated graphics processing unit (GPU), as opposed to only a central processing unit (CPU) for general operations, would be required to meet the increasing needs of computer graphics, according to the philosophy behind Nvidia’s founding in 1993.

It moved into semiconductors for high-performance computing and AI after becoming recognised as the top GPU supplier for gaming. 

Nvidia and ATI, both owned by Advanced Micro Devices Inc. AMD, now control the majority of the GPU industry. 2.30%

Thought to be the industry leader in AI after a decade of investment, Nvidia is unlikely to relinquish that position anytime soon.

In the years when ARM was publicly traded, I seem to recall that its price-to-earnings (PE) multiple typically ranged from 30 to 60 times, which over time was supported by its earning ability. Operating margins of roughly 30% were present, matching what Nvidia had attained in its most recent fiscal quarter ending on April 30.

ARM tested 200 times earnings during the tech market bubble of 1999–2000, exactly like Nvidia is doing right now. 

The main reason, in my opinion, that ARM is presently re-listing from private ownership to Nasdaq is because Wall Street rates promising tech on far greater multiples than London, despite the fact that Nvidia’s price is definitely dangerous.   

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Dramatically raised revenue guidance makes Nvidia unique

Even though first quarter 2024 revenue (through 30 April 2023) was up 19% from the prior quarter, it actually declined 13% to $7.2 billion when Nvidia’s stock soared from approximately $300 on 24 May. Earnings did increase by 28% to $0.82 per share from a year before, or by 44%. Still, it exceeded expectations. 

The surprise was significantly increased second quarter guidance: $11 billion in sales is 50% more than consensus expectations of $7.2 billion. Can you discover surprises of this magnitude anywhere else?

It demonstrates how significant technical advancements can produce growth surprises at any point in the economic cycle. Here is a bright light for investors as they worry about a potential US recession dampening the vast bulk of business earnings.

Yes, the rating is extremely high and ultimately unsustainable, but if revenues soar while enjoying an operating margin of about 30%, then profits growth will drive it down, just as it did with ARM.

Although last year witnessed a drop in Amazon’s 2021 result after exceptional revenue during the pandemic abated, I acknowledge to sceptics that Amazon trading on over 300 times 2022 profits reveals US tech ratings as bloated.

Investors have noticed that Nvidia is a “defensive” stock that is more intriguing than typical sectors like consumer goods, utilities, and tobacco. 

For momentum traders, “buying the upgrade break-out” makes sense given that Nvidia’s story is still significantly more compelling than that of the majority of other firms over the long run. 

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Strong leadership in systems and software

The general architecture for AI is another area that Nvidia dominates as a “solutions” firm, in addition to processors. 

In the near run, this has given the stock market the impression that it is the only game in town.  

The evidence may be seen in operational profits that have totaled over $40 billion over the previous six years, with an attractive clientele that includes almost all of the big IT giants. 

Even though Google’s upcoming Tensor processor could be competitive, it is unlikely to displace Nvidia’s market dominance. 

This risk seems to be posed by AMD and/or other hardware manufacturers who are creating their own CPUs, such as Tensor in Google phones. Everyone wants to increase their profit margin, but some operators may decide strategically and long-term to stop supporting Nvidia’s 30% market share. 

While it’s unclear exactly how that range looks in the trade, a search of Nvidia’s chips sold in the UK reveals, for instance, a range of about £500 to £5,000 for retail.

Another potential concern is legislation, particularly if it turns out that Nvidia is eventually seen as having monopolistic-type power as AI develops. Since the railway barons, the US has a long history of “anti-trust” regulation. AI itself may be a target for undermining social norms (starting with school essays), or there may be a reaction, for example, if autonomous cars cause an accident. But I think trying to halt this tide is Canute-like. 

A strategic ‘buy’ but be mindful of volatility ahead

Investors are more inclined to take on risk in the near term now that US Congressmen are cooperating over the approaching US debt ceiling deadline.

The major medium-term danger is still a US recession that starts later this year or in 2024, but if consumer spending doesn’t decline, it could merely highlight Nvidia as exceptional for success.

Investors should appropriately let last week’s euphoria to cool; for there to perhaps be some sort of market setback; with a news-sensitive stock like this.

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