NVIDIA’s moon landing
· Growth expectations are stretching valuations too much
· Investors chasing momentum should be careful
Nvidia’s market cap (MC) went pretty much vertical from $279 billion inOctober of last year to over $1 trillion this week, asstronger-than-expected sales, driven by AI mania, propelled the stock’smarket price to an all-time high of over $400 a share, leaving many marketparticipants wondering if its explosive growth will continue — or if the AIcraze is merely temporary?
The company’s MC breached the $1 trillion mark this week, joining the elite$1 trillion MC valuation club with only five other names on planet Earth(or at least in the public valuation space) with the likes of 4 techjuggernauts (Apple, Microsoft, Alphabet, and Amazon) and 1 Oil Behemoth(Aramco). Thus, becoming the first-ever chipmaker to reach that incrediblemilestone.
Nvidia’s (trailing twelve months) revenues at $25.88 billion are only afraction compared to the other tech giants such as Apple, Microsoft,Alphabet and Amazon, all of which have top-line north of $200 billion.
Hence, why are investors pulling into it in the first place – the answer isNvidia’s enormous growth potential generated by the AI euphoria.
Tsunami of new orders
The company stock price is flying on the back of massive demand from AIservice providers selling graphics chips that powered everything from thevideo game boom to the rise of cryptocurrency and the industry’s big bet onthe metaverse as Q2’2023 sales are projected to topple $11B compared toanalysts (polled by Refinitiv) expectations of $7.15B!
"…we're seeing incredible orders to retool the world'sdata centers," said Jensen Huang, Co-Founder & CEO, on the latest conference call.
And that is only the beginning. Analysts, as per Tradingview figures,expect Nvidia’s annual revenue to skyrocket or effectively triple in thenext few years to a mind-blowing $90 billion by FY 2026, which translatesto an eye-popping growth rate of 231% compared to its latest FY 2022 resultof $27 billion.
AI hype or the real deal?
Pulling out, the Nvidia story as stock is just a series of waves ofinvestor euphoria that it has ridden, from graphics chips to data centersto crypto to AI. You can see below how its price-earnings-to-growth ratiohas soared and fallen over the last decade.
The latest narrative that drives the latest monstrous rally is about AI.What investors are betting on is that Nvidia will make enormous profitsfrom the chips used to power these AI systems. No one is betting againstthe incredible momentum as the short interest is only 1,17%. And rightfullyso, Nvidia’s breathtaking triple digits return of over 174% YTD is by-farthe highest in the S&P 500 as the stock added over $280bn in market capover the last few days.
Undoubtedly Nvidia’s processors have been the gold standard for training AImodels such as Google’s Bart and OpenAI’s ChatGPT.
However, valuations are stretched, and we might see some meaningfulpullback. Despite the current “AI” bubble being considered a “baby bubble”compared to previous ones, irrational exuberance times fuelled speculativeperiods that repeatedly recurred over the last 45 years as investors’imaginations outpaced the realities of the underlying fundamentals.
Hence, investors must be careful not to chase the stock as the fear ofmissing out (FOMO) is a dangerous emotion that traders often flirt with andis one of the critical ingredients that inflates an asset bubble.
Priced to perfection?
This insatiable hunger for returns has distorted the picture for Nvidia.The Stock trades at a jaw-dropping 30x sales and a hair-raising 182xearnings, despite having a fraction of the sales of the big ballers such asApple, Amazon, and Microsoft, as mentioned earlier. The big emphasis isplaced on the quantity of sales expected to jump 3x by 2026 to compressthose out of this planet multiples to more meaningful historical levels.Investors should ask themselves, what if the company cannot meet thoseexpectations? Well, then, the stock will have to adjust to the downside.
It’s worth pointing out that the only time when valuations were at suchincredibly high was during the dot.com bubble, and the stock did not live upto them. Hence, the subsequent periods were terrible for investors as“everyone had to own” the stock times proved awful for the company’sreturns.
Nvidia is not only richly valued on a historical but also on a relativebasis. It is the most expensive stock in the semiconductor space in the US,with a mind-blowing 12-month forward P/E ratio of over 50!
Bottom line:
The stock seems to be priced to perfection as the incredible growthexpectations are already embedded in the company’s share price, which doesnot mean the current momentum cannot continue.
“Markets can remain irrational longer than you can remain solvent” - JohnKeynes.