Nvidia Stock: A Reality Check

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Nvidia (NASDAQ: NVDA) stock has seen a 150% plus rally this year led by surging demand for the company’s graphics processing unit (GPU) for artificial intelligence applications and the company’s recent stock split. With a $3.1 trillion valuation, Nvidia’s market cap is in the vicinity of tech titans Microsoft (NASDAQ:MSFT) and Apple (NASDAQ: AAPL).  Nvidia has a lot going for it as companies are looking to shift their sizable installed base of traditional data centers to accelerated computing using GPUs to perform more artificial intelligence tasks. Nvidia’s financial performance has been solid and the company is on track to grow revenues by almost 2x this year to $111 billion, with earnings poised to more than double. Nvidia’s net margins stood at a whopping 57% last quarter.  The stock trades at about $126 per share or roughly 50x forward earnings. Now this isn’t an unreasonable multiple considering Nvidia’s recent growth.

With that being said, the key question investors must ask is if Nvidia can keep the momentum going. The stock markets are often myopic, extrapolating short-term trends for the long run.  In Nvidia’s case, the assumption is that demand will remain strong and profits will remain sizable, as GPUs effectively supplant CPUs in data centers with AI models also becoming more complex moving from handling just text to images, video, and 3D.  However, there are several questions worth asking for cautious investors.

While Nvidia remains in the pole position for AI chips, other chipmakers such as AMD (NASDAQ:AMD) and Intel (NASDAQ:INTC) are investing significantly to catch up given the high stakes. AMD unveiled the MI300X chip which is targeted specifically at large language model training and inference for generative AI workloads. AMD claims that its new chip outperforms Nvidia’s chips in several parameters. AMD’s Data Center segment – which includes sales of its server chips and the MI300 series AI chips – saw sales rise by about 80% year-over-year to $2.3 billion in the most recent quarter. Separately, big tech players including Google, Amazon, and Facebook are doubling down on AI and machine learning-related silicon. For example, Google’s Tensor Processing Units are specialized integrated circuits focused on machine learning. This could be an issue for Nvidia, as the company derives a bulk of its revenue from these players. Although Nvidia’s chips are superior in terms of overall performance at present, with the company also using proprietary software and programming languages to better lock in customers, competition will make Nvidia’s current revenue growth rates and abnormally high margins (57% net margins in Q1) unsustainable.

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The current surge in GPU demand is likely to ease over time. Large AI deployments typically occur in two stages. In the initial phase, AI models are trained on large datasets to learn patterns and adjust model parameters, a process that is very power-intensive and requires substantial computing capacity and GPU resources. Given that we are in the early stages of the AI era, the focus remains on the more compute-intensive training phase, which is driving Nvidia’s current surge in demand. After the training phase, the trained models are deployed in real-world applications and services. At this stage, the utilization of these models may shift toward lower power requirements or even on-device capabilities, reducing the growth in GPU demand.

Moreover, there are questions about how the massive investments companies are making in artificial intelligence infrastructure are going to pay off.  For perspective, venture capital firm Sequoia recently estimated that the AI industry spent $50 billion on Nvidia chips used to train advanced AI models over the last year. Considering other ancillary investments such as buildings, and power generation, it’s very likely that the total number for setting up AI data systems is likely to be about 2x this amount. However, the VC firm estimates that these capital investments only brought in a mere $3 billion in revenue. Although this is still early days for the AI industry, we have yet to see too many AI services besides ChatGPT that have a large base of paying customers. Considering that Nvidia’s revenues are projected to grow to almost $150 billion in FY’26, the bulk of which will come from AI-focused GPUs, it remains to be seen whether revenues will grow in tandem to justify these investments. Investments into AI data centers at this juncture appear to be driven in part by panic, or the fear of missing out on the next big thing in tech, rather than by consideration of potential returns and this could result in a bubble of sorts.

NVDA stock has seen extremely strong gains of 860% from levels of $13 in early January 2021 to around $125 now, vs. an increase of about 50% for the S&P 500 over this roughly 3-year period.
However, the increase in NVDA stock has been far from consistent. Returns for the stock were 125% in 2021, -50% in 2022, and 239% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that NVDA underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for other heavyweights in the Information Technology sector including MSFT, AAPL, and AVGO, and even for the megacap stars GOOG, TSLA, and AMZN.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could NVDA face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

We value Nvidia stock at $89 per share, about 30% below the current market price. See our analysis on Nvidia Valuation: Is NVDA Stock Expensive Or Cheap? for more details on what’s driving our price estimate for NVDA stock. Also, see our analysis of Nvidia Revenue for a closer look at the company’s key revenue streams.

Returns Jul 2024
MTD [1]
2024
YTD [1]
2017-24
Total [2]
 NVDA Return 2% 154% 4613%
 S&P 500 Return 2% 17% 149%
 Trefis Reinforced Value Portfolio 1% 7% 663%

[1] Returns as of 7/8/2024
[2] Cumulative total returns since the end of 2016

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