AI has transformed demand for computer chips and the most obvious beneficiary of that has been Nvidia (NASDAQ: NVDA). With a stock market capitalization of $3.4trn, Nvidia might not seem like an obvious bargain.
But what if it is really worth that much – or potentially a lot more? I have been keen to add some Nvidia stock to my portfolio, but I do not want to overpay. After all, Nvidia has shot up 1,499% in five years!
So, here is what I am doing.
High-growth companies and fast-growing industries
For some companies in which I have invested in the past, from Reckitt to Burberry, I have benefited as an investor from a market being mature. Sales of detergent or pricy trenchcoats may grow over time, but they are unlikely to shoot up year after year.
That is because those firms operate in mature markets. On top of that, as they are large and long-established, it is hard for them to grow by gaining substantial market share. So, market maturity has helped me as an investor because it has made it easier for me to judge what I think the total size of a market for a product or service may be – and how much of it the company in question looks likely to have in future.
Chips, by contrast, are different. Even before AI, this was still a fast-growing industry – and AI has added fuel to that fire. On top of that, Nvidia is something of a rarity. It is already a large company and generated $130bn in revenues last year. But it is not mature – rather, it continues to grow at a breathtaking pace. Its first-quarter revenue was 69% higher than in the same three months of last year.
Nvidia is very hard to value
Those factors mean that it is hard to tell what Nvidia is worth. Clearly that is not only my opinion: the fact that Nvidia stock is 47% higher than in April suggests that the wider market is wrestling with the same problem.
Could it be a value trap? It is possible. For example, chip demand could fall after the surge of recent years and settle down again at a much lower level. A lower cost rival could eat badly into Nvidia’s market share. Trade disputes could see sales volumes fall.
With a price-to-earnings (P/E) ratio of 46, just a few things like that going wrong could mean today’s Nvidia stock price ends up looking like a value trap.
On the other hand, think about those first-quarter growth rates. If Nvidia keeps doing as well, let alone better, its earnings could soar. In that case, the prospective P/E ratio based on today’s share price could be low and the current share price a long-term bargain.
I see multiple possible drivers for such an increase, such as more widespread adoption of AI and Nvidia launching even more advanced proprietary chip designs.
So, I reckon the company could turn out to be either a massive bargain at today’s price, or a massive value trap.
The price does not offer me enough margin of safety for my comfort if the stock is indeed a value trap. So, I will wait for a more attractive valuation before buying.
