Five years ago, I was already well aware of chip firm Nvidia (NASDAQ: NVDA) and it crossed my mind from time to time to invest in it. I did not. What a missed opportunity! Over the past five years, the Nvidia stock price has soared by 1,471%.
I would still be happy to buy some Nvidia stock at the right price. After all, it benefits from having a large addressable market, installed customer base, and proprietary chip designs.
But the current price-to-earnings ratio is 47. I do not think that offers me sufficient margin of safety to account for risks like AI chip demand falling after the initial big installations are all completed. So, for now at least, I will not be buying any Nvidia shares for my portfolio.
What I am doing, however, is hunting for shares to buy in the hope they may have an incredible performance in the coming five years, like Nvidia stock has done in the past five.
Extraordinary returns rarely carry ordinary risks
One of the challenges in identifying such shares is that they can carry elevated risk.
For example, one approach is to go after growth companies in areas that seem to have a lot of potential. But such companies can often be loss-making for years or even decades before finally making money – if they do at all. More than a few burn all their cash and go bankrupt, leaving shareholders with nothing.
Consider renewable energy for example. It is a promising area – and some British companies have promising technology. But how have they done over the past five years?
ITM Power is down 72%, Ceres Power 84%, and AFC Energy 33%. The list goes on.
Nvidia stock has soared in five years, but it already had a highly successful, proven business five years ago. That is one thing I tend to look out for.
One alternative would be forgetting growth shares and going for turnaround stories.
The Rolls-Royce share price is up 681% in five years. That is impressive. Even better, though, is the 2,197% share price growth since October 2022. That even beats Nvidia stock’s five-year price gain!
But in autumn 2020, Rolls-Royce’s future was far from assured. It came good – but many turnaround stories never do. I tread very carefully when trying to assess whether a business can get back into good shape after a tough time.
Always the same approach
Rather than limit myself to loss-making growth shares or uncertain turnaround stories, though, I am open to buying all sorts of shares. But I look for a common theme. I like to invest in great companies at attractive prices.
Nvidia has the hallmarks of what I regard as a great company. It benefits from a large addressable market that is set to get even bigger over time. It also has specific assets that help it to compete successfully within that market, as I mentioned above.
The company also benefits from a proven model and indeed is massively profitable. It is always important to consider risks as well as possible drivers for a higher share price, though — and that is what puts me off buying Nvidia stock at its current level.
But I am applying those lessons when looking for other potential future stock market star performers!
