Nvidia Stock: It’s Priced In

Summary:

• Nvidia Corporation stock has performed exceptionally well in 2023, up 244% year-to-date.
• The company beat expectations in its second quarter earnings release, but its stock now trades at a nosebleed valuation of 37 times sales.
• Competition is emerging in the AI chip market, which could impact Nvidia’s dominance and potentially make the stock even more expensive.
• Nevertheless, CEO Jensen Huang is very good at capitalizing on tech trends, and could pull off another miracle in the future.
• In this article, I explain why my position on Nvidia is more favorable than it was at the time my last article about it came out (though I maintain my “hold” rating).

Nvidia Corporation (NASDAQ:NVDA) has been 2023’s “stock of the year” in many ways. Up 244% year-to-date, it has been a massive outperformer. Last week, investors got a treat when NVDA put out its second quarter earnings, which revealed that the company did much better than expected. Specifically, Nvidia beat on revenue by $2.5 billion, and on earnings as well.

There’s just one problem:

The stock is trading at 93.4 times earnings, and 37 times sales!

While the growth observed last quarter was phenomenal, with revenue doubling compared to a year ago, NVDA stock commands a steep price tag. s37 times sales is quite the valuation, no matter how quickly you’re growing. Amazon (AMZN) has always traded at a high earnings multiple, thanks to its razor thin margins. However, it has always had very low price/sales ratios as well. Nvidia’s high P/sales ratio and fat margins, considered together, imply that the company’s earnings could decline (and earnings multiple rise) if competition arrives. If that’s the case, then Nvidia will look even more expensive going forward.

And, the competition is arriving. Or at least, it’s attempting to “arrive.” Qualcomm (QCOM) and Advanced Micro Devices, Inc. (AMD) are both known to be working on AI chips of their own. So far, they are not really competing with Nvidia, as NVDA is dominating the AI chip benchmark rankings. However, the competition is coming in one form or another. Qualcomm recently beat Nvidia’s H100 chip in a power efficiency test by MLCommons. This is important because power efficiency determines the cost per unit of performance. So far, nothing Qualcomm has released can compete with the H100 on raw power, but the efficiency aspect of their chips is important, as companies like Microsoft (MSFT) and Google (GOOG) (GOOGL) are scrambling to get AI services to market without server costs eating into their bottom lines. So, there is likely to be some demand for power-efficient AI-accelerator chips.

When I last covered NVIDIA, I wrote that the stock was a “hold” on the basis of the fact that its financial results were already priced in. Since then, the stock beat massively on earnings, and rose 9.85%. Today, I still consider the stock a hold – basically suitable for someone whose cost basis is lower than today’s price-because all relevant financial information is priced into the stock and then some. However, new information has come to light regarding CEO Jensen Huang’s management approach, which lends itself to the idea that Nvidia will fully capitalize on future trends in technology. For this reason, my view on the stock is now more of a slightly bullish-leaning hold rather than a purely neutral view. In the following paragraphs, I’ll explain why I have slightly elevated my opinion on Nvidia while maintaining a “hold” rating for the moment.

Nvidia’s Competitive Position

One of Nvidia’s biggest advantages right now is its near-monopoly on AI chips. The company has an 80% market share in AI accelerator chips-that is, graphical processing units (“GPUs”) that run in conjunction with the central processing unit (“CPU”) to handle high demand workloads. Nvidia’s massive market share is rooted in the fact that its chips outperform others. MLCommons does running tests of AI accelerator chips and so far, Nvidia’s A100 and H100 are winning all of them.

Nvidia enjoys a near monopoly in AI accelerator chips for the time being, but others are seeing the money that Nvidia is making off these chips, and are getting into the game themselves. QCOM and AMD are ramping up investments, as are smaller players.

H100s cost $30,000 a piece, and tech companies are buying them by the truckload. Meta Platforms (META) recently made waves by buying up “thousands” of Nvidia H100 GPUs. Google has 26,000 of them! And it’s not just tech companies buying these things. Entire Middle Eastern Nations like Saudi Arabia and Dubai are stockpiling them as well! The UAE has even apparently put its AI chips to use, developing its own in-house large language model (“LLM”) known as Falcon! Gulf nations aren’t known for vibrant tech sectors, but the fact that they consider these purchases necessary shows what hot commodities Nvidia chips have become.

Selling Shovels in a Gold Rush

It has often been noted that Nvidia is in the position of “selling shovels in a gold rush.” The world’s biggest tech companies are spending billions on AI research, often with minimal bottom line impact. Nvidia, on the other hand, is actively making money off their large purchases of AI chips. This does indeed appear to be a “selling shovels in a gold rush” situation, but it raises a question:

What happens when the gold rush ends?

It is well known that AI isn’t quite paying off for AI software developers just yet. Morgan Stanley (MS) once estimated that running a chatbot on Google Search would cost Alphabet $6 billion in EBIT. Basically, AI is so expensive that it cuts into companies’ margins. To run an AI app, you need:

• Nvidia H100 chips-cost of $30,000.

• At least a few top AI engineers-cost of $1 million per head if you want a truly world-class one.

• Servers and data centers, or cloud computing platforms as an alternative.

It’s an expensive game to play. And companies have been feeling the pinch. AI is now the biggest cost for 50% of top tech companies. Two-thirds of these companies say their AI investments are accelerating. And unfortunately, it’s not really paying off so far. For example, while Microsoft’s most recent earnings release was a beat, the growth came from Office and the Cloud; the segment including the AI-powered Bing actually shrank. It’s not clear that MSFT and other companies will turn a profit on their AI investments with the costs being what they are. If that turns out the case then perhaps the AI gold rush will dissipate, and Nvidia will find itself selling fewer H100s than it had been previously.

Valuation

Now we get to the part of the analysis that is the least flattering for Nvidia:

The valuation.

At today’s prices, NVDA trades at:

• 93.4 times earnings.

• 37 times sales.

• 44.6 times book value.

• 102 times operating cash flow.

It’s a steep valuation no matter how you look at it. If you take Nvidia’s $4.17 in trailing 12-month free cash flow per share and discount it at 10%, you end up with a $4.17 price target. If you discount it at the 10-year treasury yield (4%), you get a $103.5 target. Nvidia is absolutely not worth the investment in a “no growth scenario.” You need to assume growth for NVDA stock to be worth buying, and while Nvidia’s growth this year is off the charts, it’s not clear that it will continue in future years when it will be lapping the extremely strong 2023. Especially not if companies continue struggling to make their AI bets profitable, and scale back their investments.

Is NVDA Really So Overvalued?

Despite all that I wrote about Nvidia being overvalued based on concrete financial data, there are reasons to think that it may not be as overvalued as it looks.

In a recent YouTube livestream, NYU Professor Aswath Damodaran said that, while Nvidia is overvalued going by the numbers, there’s a certain unquantifiable value to having a CEO like Jensen Huang who can accurately predict tech trends. He went on to say that Huang saw both crypto and AI coming, and put out offerings for each industry. Damodaran was correct about that: Huang did make money off the last two big tech trends. This would tend to suggest that Nvidia deserves a “leader” premium, though it’s impossible to say how big of one.

It’s for this reason that, while my Nvidia rating remains a hold, it is now a more bullish-leaning hold than before. There’s a certain class of investor for whom Nvidia may be a good buy today. If you have high risk tolerance, work in the tech industry, are frequently being informed about developments at Qualcomm and AMD, and are willing to keep up with all the news about Jensen Huang’s adventures, you may be able to make an informed trade in Nvidia. Going by conventional financial analysis techniques, though, the stock is just a hold. You need to really believe in Huang’s vision, and have the facts to support that view, to justify a buy.

The Bottom Line

The bottom line on Nvidia Corporation is this:

It’s an extremely expensive stock that could easily grow into its valuation. The stock is growing the top line at 100%, is guiding for continued growth, and is delivering its widest margins ever. Additionally, the company could succeed at dominating the next tech trend after AI, if Jensen Huang can keep up his track record of having uncanny foresight. Buying Nvidia Corporation stock today isn’t the craziest idea out there. But for a defensive value investor like me, it’s a tough sell.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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