To say that Nvidia (NASDAQ: NVDA) has been having a good run of it is putting things mildly. This week, the chipmaker became the world’s most valuable listed company. Nvidia stock is on fire – it is up 181% just since the start of the year. Over five years, it has soared 3,477%!
Opportunities for that sort of return might not come along very often. But, as the stock has shown, they do come along sometimes.
Perhaps, like me, readers missed out on the opportunity to invest in it before its dizzying share price ascent. Rather than dwelling on that, I have been thinking about what I should look for when scouring the market for what might turn out to be the brilliant opportunities of tomorrow.
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Big market potential
The rise of the stock has given me some useful food for thought.
Its huge price gain recently has been driven by the explosion of interest in artificial intelligence (AI). But even before that, it was making significant sales. AI has simply added to the already massive size of the market for semiconductors.
Its revenues last year were $60bn. To become the world’s most valuable company, I think it is important to operate in a market that not only has great potential but already has very high actual sales.
Barriers to entry – and competitive difference
Of course, such markets often attract a rash of competitors.
Here, I think, the Nvidia price reflects two advantages it has.
First, the barriers to entry in its industry are unusually high. Even with strong funding and a great team, setting up a chipmaker is a very slow process. It takes years if not decades to build the necessary research and manufacturing facilities then get them operational.
Secondly, it has what Warren Buffett calls a ‘moat’.
In other words, it has successfully differentiated itself even from other chipmakers. For example, it has proprietary chip designs that customers cannot get unless they buy from Nvidia. Creating such competitive differentiation can be an expensive business – but it can pay off in bucketloads.
Pricing power
Still, lots of companies have a strong competitive edge in a massive industry, but come nowhere near the current market capitalisation of the firm.
Chips are so fundamental to many of its clients’ businesses that it has pricing power. It can charge high prices – and customers are still willing to pay. That is good for earnings, which in turn has helped propel the the share price.
Last year, tbe company’s net income on that $60.9bn revenue was $29.8bn. In other words, its net profit margin is close to 50%.
Compare that to US retail giant Walmart. It has a number of competitive advantages in a market with huge demand. Its revenues last year were over 10 times Nvidia’s. But its net income, at $15.5bn, was barely half that of the chipmaker.
Walmart is a massively successful company, yet its market capitalisation is less than one sixth that of Nvidia’s. I think that is partly down to Walmart’s pricing power being far weaker than that of the chipmaker.
Looking to the future – now
By learning from the incredible jump in the Nvidia share price and some of what underpins it, I hope I can spot potential stock market success stories in their infancy.
I am doing that today!
