Summary
Nvidia is rated a sell. We love the company behind the stock as it is a success story of a well run business that maneuvered into profitable markets. At the current valuation we cannot justify buying at these prices. The current valuation gives the company no room for error for executing on growing at least 35% you. There are plenty of threats to Nvidia’s growth rate that its current valuation is unsustainable. This is evident with multiple insiders selling millions of dollars worth of stock.
Understanding the NVDA as a business
The first step to knowing if we should buy NVDA is knowing how NVDA makes money. Nvidia designs and sells graphics cards(GPUs). These graphics cards are used in PC gaming, crypto mining, and data centers. Their customers are anyone from individuals building a single computer to large companies buying millions of GPUs for their data center. Nvidia is not the manufacturer of these graphics cards, they are designers. They contract the manufacturing out to foundries that make the GPUs.
The company started mostly in the gaming industry however data centers has taken over as the largest source of revenue. This large increase in data center revenue is from the advancement of artificial intelligence (AI). Data centers are purchasing large amounts of graphics cards to be able to train their AI models. These AI models need large amounts of computing power to train the AI enough to be effective in a reasonable amount of time.
There are two other segments of Nvidia’s business which is professional visualization, and automotive/robotics. These segments are in the minority of the revenue for the company being less than a billion dollars combined.
AMD, and Intel are the two largest competitors to NVDA. AMD is the largest competitor in the GPU space and their rivalry within the gaming community runs deep. AMD is also trying to break into the data center business with their GPUs. Intel is most known for their central processing units (CPUs) and now they are trying to break into the GPU business. With the amount of success that NVDA is having and that the GPU industry is supply limited not demand limited there is projection that more competition will join the picture to compete with them to take market share.
NVDA operates with multiple moats to shield themselves from their competitors. The first moat is that they focused their designs on the high performance graphics cards that are used in the AI industry not just lower the graphics cards for gaming. This gives them first movers advantage to the foundries being set up for their designs and customers using them first. The first movers benefit is protected through another moat which is their software environment that these computer chips run through. If companies purchase NVIDIA graphics cards they can’t easily switch to another GPU because then they would need to switch the software in which they run the GPUs through would need to change too.
NVDA is a great company that has found a great way to make a lot of money. Let’s take a look to see if we can purchase this great company for a reasonable price.
Valuation Metrics
For preliminary metrics viewing I like to use the tool finviz. This website gives a good view of a lot of metrics in one place.
The important metrics from looking at the snapshot are:
- Currently NVDA trades at a P/E of 117 which is quite high.
- The projected forward P/E is 29 which is based on the projected growth of the company’s earnings.
- The earnings are projected to grow at 78.8% for the next 5 years.
- The current price to sales ratio is 37.
FAST Graphs Analysis
Using the FAST graphs tools we can look how NVDA’s share price has tracked its earnings. The black line represents the share price and the orange line filled in with green traces NVDA’s earnings trading at a P/E= the growth rate. Here we can see that NVDA’s share price has gotten ahead of its earnings and will need the share price to remain stagnant until the earnings catch up via growth. The estimates for future earnings are just that, estimates. Nvidia could always pull off greater growth than the analysts are estimating.
Bull Thesis
The bull thesis for investing in this company at its growth is enormous. The AI market has driven demand so high for their graphics cards that they can sustain this incredible growth rate over the next 5 years and beyond.
Another avenue of growth other than just AI is that the semiconductor industry will continue to grow worldwide as India and Africa become more developed. They will have demand for computer chips to fuel more advanced products going into those developing nations.
As well as more countries of the world developing and needing computer chips, products themselves will continue to develop. Shoes, shirts and all kinds of other ideas will advance to put computer chips in these products and that will stimulate growth for Nvidia.
With these avenues of growth and talented management Nvidia will defend its moat it has on the market. This increased growth more than defends the current valuation of $1.2 Trillion dollar valuation and it will grow into the largest company in the world.
Bear Thesis
The valuation of Nvidia is incredibly high. Nobody denies that Nvidia is an amazing company that produces a great product. The problem lies with how expensive the stock is compared to the company’s earnings. At a 37 Price to sales ratio that is one of the most expensive stocks on the market. History doesn’t favor companies that trade at that rich of an evaluation. This valuation depends on the growth rate it is expected to have over the next 5 years. At its current valuation it is trading like there will be no headwinds at all to achieve this growth and the market has totally bought in that AI will cause this growth.
For Nvidia to help us achieve our goal of a 15% yoy return rate on our investment.
The amount of demand that we see for Nvidia’s GPUs will indeed draw competition to the market and that’s a threat to Nvidia’s growth rate. AMD already has a strong rivalry with Nvidia in the gaming sector and there’s no doubt that they can catch up enough to take some market share in the AI industry as well. Not only AMD but Intel is making massive capital investments to threaten the market share of Nvidia. Apple and Tesla have already been working on ways they can make their own semiconductors and cut out companies like Nvidia and AMD. This paragraph isn’t meant to say that Nvidia will no longer be the biggest, most successful company in the industry; it’s the saying that it’s a threat to growth rate that the valuation depends on.
Another threat to Nvidia’s growth rate is the growing geopolitical tensions. The United States has banned chip sales to China from American companies. Approximately 25% of Nvidia’s sales are to China and that could be in jeopardy with the U.S. ramping up trade wars with China. The other big elephant in the room is that almost all computer chips worldwide are made on the island of Taiwan. China desperately wants to take over Taiwan and there could be war brewing. Military experts thinks its a matter of when not if China invades Taiwan. This will be devastating to Nvidia since all of their production will be ceased.
All of these things are threats to the growth rate that Nvidia has to achieve to maintain its sky high evaluation.
Sell Rating
Here at Basil Leaf Capital we are rating NVDA a sell. We have to agree with the bear thesis that the valuation is too high. For NVDA to return our goal of at least 15% yoy return in 5 years NVDA would need to be worth $2.8 Trillion. This would make it competing with Apple for the world’s largest company. This is an unreasonable expectation for this company based on current demand levels and current earnings. If the valuation comes down to a reasonable level we like Nvidia as company and would be more likely to invest.