Why Nvidia’s Stock Surge Should Worry AMD Investors

Summary:

• Nvidia Corporation’s current premium valuation reflects its dominant market position, especially in AI and autonomous driving, while Advanced Micro Devices, Inc.’s lower valuation raises questions about its potential to catch up.
• Nvidia has a long-standing focus in the GPU domain, having introduced the first GPU in 1999. AMD deepened its GPU focus in 2006 and was a late entrant to AI.
• In various tech sectors like gaming and AI, Nvidia consistently leads in innovation, often launching new technologies 12-24 months ahead of AMD.

Investment Thesis

The remarkable surge in Nvidia Corporation’s (NASDAQ:NVDA) share price this year naturally leads potential investors to pause to assess the valuation. As one begins to navigate this landscape, it’s necessary to recognize Nvidia’s prime competitor, Advanced Micro Devices, Inc. (NASDAQ:AMD).

AMD trades at a noticeably lower valuation than NVDA, bringing us to the crux of the investor’s dilemma. Is NVDA’s current premium valuation a reflection of its dominant position and future growth prospects, or is it a sign of market exuberance? Conversely, is AMD’s relatively modest valuation an opportunity as it catches up with NVIDIA, or is it a fair assessment of its position in the market?

Although AMD’s share price sits at a noticeably lower multiple compared to Nvidia, this pricing distinction doesn’t exist without reason. Here is why:

1. NVDA’s innovations have placed it at the forefront of artificial intelligence (“AI”), Cloud, Autonomous Driving, and Gaming Graphics. AMD is playing catch-up in most, if not all, of these verticals.
2. AMD’s Forward P/E is trading near 52-week highs. NVDA’s Forward P/E is trading near 52-week lows.
3. Historically, NVDA forward P/E stood at 1.8x to 3x higher than AMD, exceeding current rates (as shown below). The market hasn’t fully recognized the rise in Forward EPS guidance after ChatGPT’s launch and the subsequent boom in Generative AI demand. NVDA’s price premium over AMD’s will soon return to historical averages, boosting NVDA shares or lowering AMD’s.

Given the potential of realignment in valuation between NVDA and AMD based on the historical average, investors might consider a pairs trading strategy; buying a long position in NVDA while simultaneously taking a short position in AMD.

How NVIDIA Established Its AI Presence

In the world of AI, the critical role of GPUs is undeniable. Initially designed for animation, these processors are now used to expedite the complex mathematical calculations essential for artificial intelligence. With GPUs, tasks that would take CPUS days can be accomplished in hours. Indeed, GPUs have become the backbone of AI, amplifying both computational power and efficiency.

NVDA’s legacy in this domain is noteworthy. Having introduced the world to the first GPU, the GeForce 256, in 1999, their dominance in the AI industry is well-earned. NVDA’s vision wasn’t just about producing GPUs; they championed using graphics processors for General-Purpose Computing.

Convincing the wider tech community of this wasn’t trivial. NVDA spent years pitching the concept to major tech giants. A landmark achievement for NVDA was in 2007 when they rolled out CUDA; a platform that simplified the process for developers to harness GPUs for General-Purpose Computing. Today, CUDA is at the heart of a thriving AI ecosystem.

Finally, one should note that from its inception, NVDA’s mission was clear: Champion GPUs. This laser focus contrasts with companies like AMD, which only delved deep into the GPU domain in 2006 after acquiring a graphics company named ATI. Before this, AMD’s business centered around memory chips, CPUs, and motherboards, essentially competing with the likes of Intel (INTC). Interestingly, before acquiring ATI, AMD was a client of NVDA.

Considering this historical backdrop, it’s evident why NVDA boasts a more robust foundation in the GPU and AI sectors than AMD.

How Far Behind is AMD?

Gaming

NVDA and AMD are titans in the gaming GPU market, yet they employ different strategies. NVDA markets its GeForce products primarily as premium, high-performance gaming GPUs, targeting the high-end market. In contrast, under its Radeon brand, AMD zeroes in on the mid-tier gaming CPU segment, offering competitively priced solutions for budget-conscious gamers.

The branding and marketing position has a significant impact on financial outcomes. NVDA typically boasts higher gross margins than AMD. However, during downturns, NVDA experiences a more profound sales decline than AMD, given pricing dynamics, where NVDA’s premium customers fall back onto AMD’s mid-tier processors when money is tight.

Strategically, NVDA’s focus on the upper-tier market has led to customer churn, especially those facing competitive dynamics. For example, Sony (SONY) dropped NVDA’s processors from PlayStation consoles in 2020 and started using AMD’s Oberon, a custom-made GPU designed by AMD. Still, NVDA has strong brand recognition among individual gamers, OEMs, and Cloud Gaming Service providers loyal to the GeForce brand.

Moreover, looking at the innovation timelines of both companies reveals that NVDA maintains a lead, outpacing AMD by approximately 12 to 24 months. Here are a few examples highlighting this trend:

Ray Tracing:

• NVDA launched ray tracing, a tech that simulates the real-world behavior of light, within its Turning architecture in 2018
• AMD debuted its take, RDNA 2 Ray Accelerators in the RDNA 2 architecture in 2020

Variable Rate Shading:

• NVDA rolled out VRS, a technique that bolsters game performance by dynamically adjusting shading rates in 2018.
• AMD presented its version of VRS in 2020

Deep Learning Super Sampling (DLSS)

• NVDA introduced DLSS in 2018, a technique that improves game image quality by upscaling lower-resolution images using AI
• AMD followed NVDA’s DLSS, releasing FidelityFX Super Resolution in 2021

These examples illustrate AMD’s pattern of playing catch-up to NVDA in the gaming GPU vertical.

Data Centre and AI

In the AI and Data Center landscape, AMD trails NVDA by nearly a decade in specific metrics. NVDA launched its CUDA platform in 2006, laying the foundation for a dynamic AI ecosystem of developers, libraries, and applications, becoming the industry’s benchmark.

On the other hand, AMD introduced ROCm, its answer to CUDA, a decade later. This ten-year interval allowed CUDA to cultivate an expansive ecosystem, drawing a rich array of libraries, developers, and tools. This considerable head start inevitably positioned NVDA as the undisputed leader in the GPU-accelerated computing realm.

Regarding hardware, NVDA sells the most powerful AI training GPUs, the H100. AMD has plans to roll out the RDNA 4 architecture and the accompanying Instinct MI GPU in 2024, which will introduce new AI computing enhancements. By then, NVDA will likely introduce its new GPU.

Autonomous Driving

NVIDIA is currently ahead of AMD in the autonomous driving market. It has been working in the sector for longer than AMD. It has a broader range of products and solutions than AMD, such as Drive AGX Xavier, Driver Orin, and Driver Hyperion platforms.

As for partnerships, I am unaware of any auto manufacturer working exclusively with one chip supplier or another. But from my understanding, NVIDIA currently has closer relationships with a broader range of auto companies, including Mercedes-Benz (OTCPK:MBGAF), BMW (OTCPK:BMWYY), and Volvo (OTCPK:VLVLY), while AMD is working closer with the likes of Waymo, Cruise, and perhaps Ford (F) (which is also an NVDA customer).

Summary

Nvidia Corporation, with its early advantage and strategic focus on GPU innovation, seems poised to continue its leadership. Advanced Micro Devices, while having made strides, often finds itself in a catch-up mode. The key point now is to assess whether AMD provides an investment opportunity at a relatively attractive value compared to NVDA.

In my view, NVDA’s first-mover advantage in AI has created a wide competitive moat that is hard to penetrate. History seems to be repeating itself in autonomous driving, with NVDA having multiple platforms standing ready for wider adoption of Autonomous Driving.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of NVDA 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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