Nvidia: It’s Possible For The AI/Quality Compounder Momentum To Get More Extreme
Contributor since 2019 / 12561 Followers
Summary:
- We’ve long thought an AI bubble was possible: I’d say we’re there, though it may still be early.
- We recognized Nvidia’s potential and bought it early in the year.
- While we can’t make the case that it’s undervalued, we also don’t believe it’s significantly overvalued, which is typically where euphoria ends.
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The following segment was excerpted from this fund letter.
In the current bifurcated investment environment, winners win, and losers lose. Big time. Trends get taken to extremes. We’ve long thought an AI bubble was possible. I’d say we’re there, though it may still be early.
Fortunately, we recognized Nvidia’s (NASDAQ:NVDA) potential and bought it early in the year. It was capturing the bulk of AI profits with a significant market lead and deep competitive advantages. We believed it was more like Microsoft (MSFT) than Cisco (CSCO), which implied significant potential upside to its intrinsic value. It’s since more than doubled and reached our bull case level. To justify current market expectations, we believe Nvidia needs to accomplish something unprecedented, like sustaining its current 65% operating margins for decades.
That’s possible, but unlikely. Even if it happens, it won’t be linear. What’s more likely is that Nvidia continues to surpass near-term expectations with the launch of its Blackwell chips later this year, which will be undersupplied. Markets would likely extrapolate any strength.
Bill Miller once said markets go on a journey from undervaluation to overvaluation and back again. The same is true for securities. When we make an investment, we want to capture as much of that journey as possible. We recognize it’s impossible to time your entry and exit perfectly. We work actively to mitigate our (and investors broadly) behavioral tendency to sell winners too soon.
In this case, we still believe it’s possible for the AI/quality compounder momentum to get more extreme. Nvidia currently trades at 47x fiscal 2025 earnings, which corresponds to Cisco’s mid-1998 level (the ultimate peak in March 2000 was 152x!). Likewise, the S&P 500 Tech sector trades at 33x 2024 earnings, a similar level to late 1998 and early 1999. During that period, gains continued for another 12-18 months.
We don’t expect history to repeat but are cognizant that times of euphoria tend to last longer and get more extreme than most anticipate. This one may end the way of the Nifty Fifty euphoria of the late- 1960’s or the Tech Bubble of the 90’s, namely a crash. That would be a painful outcome. Though in those prior crashes, low multiple stocks vastly outperformed.
We don’t think we’re there yet, especially as some of the Mag 7 still trade at reasonable valuations (Alphabet trades at 24x next 12-month earnings; Meta at 26x).
For now, we are watching Nvidia closely. It continues to outperform on most days and the fundamental backdrop remains intact. The market will likely give us the first signal that change is afoot. We never like to sell our winners after only a matter of months, especially in taxable accounts. We aim to maximize returns, which requires we remain flexible. Nvidia’s giant move this year closed the discount to intrinsic value. While we can’t make the case that it’s undervalued, we also don’t believe it’s significantly overvalued, which is typically where euphoria ends. We will be monitoring it carefully.
We see the most compelling long-term opportunities in unloved areas of the market, which we’ve been shifting more into gradually. While that’s hurt us short-term, we have conviction it’s the right move long-term.
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