As an investor, sometimes a share is the stuff of dreams. AI stock market darling NVIDIA (NASDAQ: NVDA) looks like a case in point. If I had invested £10,000 in NVIDIA stock just five years ago, I would now be sitting on a holding worth over £200,000 thanks to a 1,940% increase in the price over that period!
(I would also be earning dividends, by the way, although with the yield currently sitting at 0.02%, I think it is the price appreciation that I would be more excited about!)
But five years ago, NVIDIA was already a large, well-established company. Its 2019 revenues were $11.7bn and net income was $4.1bn.
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So that huge price jump in NVIDIA stock was for a company that was already in clear view of many stock market investors.
I missed that incredible five-year run. But if I invested now, might I benefit from another?
Massive potential
At first glance, that might seem fanciful.
NVIDIA has a market capitalisation of more than $2tn, higher than tech shares like Alphabet and Amazon.
A further 1,940% share price growth would mean a market capitalisation well in excess of $40tn, way beyond anything that has ever been seen before.
On the other hand, I think NVIDIA has huge potential.
Despite the hefty market cap, its current price-to-earnings (P/E0 ratio is 72. But earnings last year jumped almost seven times. If they did that again, the prospective P/E ratio at the current NVIDIA stock price would barely be in double digits.
I do not think earnings will keep growing at anything like last year’s rate.
But I do expect long-term earnings growth from the chip giant. AI means demand for chips has surged – and very few companies have the necessary know-how to meet it. NVIDIA does, which is why its business has been booming.
Attractive economics
Let us go back to those figures from five years ago.
They demonstrated an attractive feature of the business that has endured: high profitability. $4.1bn from $11.7bn suggests a net profit margin of 35%.
Last year was even better: the company achieved a net margin of 49%.
As sales grow, so should economies of scale. Not only that, but AI has seen demand for chips explode. Unveiling its most recent quarterly results last month, NVIDIA’s chief executive said, “Accelerated computing and generative AI have hit the tipping point. Demand is surging worldwide”.
Valuing the shares
Still, sometimes demand booms can fizzle out disappointingly.
While customers are splashing the cash now on chips to build their AI capabilities, once the initial demand is filled, sales growth could fall sharply.
Scaling to meet surging demand could add fixed costs to NVIDIA’s business. Other chip companies are also working hard to win new business, something that could ultimately hurt profit margins across the industry.
I would be surprised to see NVIDIA stock grow 1,940% in the coming five years. For now, its valuation is still too high to give me the margin of safety I like when investing, so will not be buying its shares.
But, if things go right, I do think NVIDIA stock could rise in coming years albeit perhaps less dramatically. So I am keeping my eyes out for any price fall I think offers me an attractive buying opportunity.
