The past five years have seen simply stunning business and stock market performance by US chip company Nvidia (NASDAQ: NVDA). During that time, the Nvidia share price has soared 1,486% and the company now has a market capitalization of $3.5trn.
Given that staggering performance, it may seem fanciful even to imagine that the share can do as well again over the years to come (possibly taking longer than five years this time around: as a long-term investor, I am in no hurry).
After all, that would imply a future market capitalization of around $55trn. That is far from anything the world has ever witnessed before.
I think it is unlikely to happen in the coming five or 10 years. But I do think it is possible, at least. Here is why.
Valuing high-growth companies is difficult
I like Nvidia’s highly profitable, proven business model. At the right price, I would be happy to invest.
The current price-to-earnings (P/E) ratio of 45 is higher than I am willing to pay, though. If earnings are static, the prospective P/E ratio after another 1,486% share price growth would be a bit over 700.
That strikes me as ludicrously frothy. But growth companies sometimes attract unbelievably high multiples. Palantir currently trades on a P/E ratio of 569, for example.
Nvidia has massive growth potential
What I think is less far-fetched is an explosion in Nvidia’s earnings per share (EPS). If that happens, then the share price could soar even without the P/E ratio growing (though, if the earnings growth is strong enough, the share may attract a richer valuation including a higher P/E ratio).
Nvidia’s EPS have been growing exponentially over the past few years. Over the past five years, for example, the basic EPS have grown by 2,700%.
It is tempting to dismiss that as an exceptional period of time that cannot be repeated in future. But what if it can – or even better?
After all, while demand for AI-related chips has soared, it could be that the first wave of AI chip purchase and use is just the tip of the iceberg. We have seen that sort of pattern with multiple technical innovations, from cars to iPhones.
A pathway to 1,486% share price growth, again
Nvidia has deep experience, proprietary technology, a large installed customer base, and huge ambition. Even if it manages to grow basic earnings per share by just half the rate it has done over the past five years, that would still mean growth of 1,350%.
In such a case, a 1,486% growth in the Nvidia share price would not stretch the P/E ratio too much from where it stands now – and that could be justified by growing investor confidence based on ongoing high earnings growth.
For now, though, there is a lot of speculation involved in such projections.
Nvidia is a well-run, proven business and I do see circumstances in which its share price could soar even from here.
But the current valuation does not offer me the margin of safety I would like as an investor. So, for now, I will not be investing.
