Nvidia (NASDAQ:NVDA) shares have had a terrific 2023. Up 197% since the start of January, the stock is the top S&P 500 performer of this year – by some margin.
Earlier this week though, analysts at Goldman Sachs added Nvidia to their top conviction list. So should I look to buy the stock, even after a huge run-up?
The bull case
The rise of artificial intelligence (AI) as an investment theme has been a huge tailwind for Nvidia’s business. And its share price has responded.
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According to Goldman’s analysts though, things are just getting started. Businesses are investing heavily in AI and Nvidia’s competitive position means it stands to benefit.
As a result, demand for the company’s GPU chips is expected to grow sharply over the next few years. And supply issues unwinding should boost both revenues and profits.
Revenue estimates have Nvidia’s data centre business (which includes its GPU operations) reaching $70bn in 2025. That’s around a 50% growth rate from here.
Based on this, Goldman has set a $605 price target for the stock. That’s around 38% higher than its current price.
Valuing the shares
Nvidia’s profits are clearly set to grow. But the question for investors is how much of that is already priced into a stock that trades at a price-to-earnings (P/E) ratio of 106?
Suppose that Goldman’s predictions are accurate and data centre revenues reach around $70bn by 2025 and improving margins result in a 35% net margin?
That would mean $24.5bn in net income from the data centre business. Even if capital expenditures don’t increase at all, that should generate around $23bn in free cash.
A $605 share price implies a market-cap of $1.5trn. At that level, $23bn in free cash amounts to a 1.6% yield, which doesn’t look like a great return to me.
Even at today’s prices, Goldman’s projections still only imply a 2.1% annual return from its GPU business by 2025, as far as I can see. And that’s not enough to get me excited.
A stock to buy?
Nvidia is one the most obvious beneficiaries of the emergence of AI. It’s therefore no surprise Goldman’s analysts predict good things for the stock.
In my view though, the stock currently prices in all the forecast growth in the GPU business and more. So the shares aren’t on my list of stocks to buy right now.
I’m not saying it’s impossible for the business to grow into its valuation over time. There’s certainly more to the company than just its data centre operations.
The point is though, I don’t see how the forecast growth in Nvidia’s GPU business justifies a $605 price tag. I think it needs something else as well.
Whether or not the company can find that is something of an open question. But for me, I think there are better opportunities elsewhere.
