At first glance, it might seem as if Nvidia (NASDAQ: NVDA) is defying gravity. Its rise to a $4.3trn market capitalisation has been relentless. So far this year, Nvidia stock has moved up 32%. Over five years, it has grown by a stunning 1,357%.
Stellar financial performance
But on closer examination, Nvidia stock might not be defying gravity so much as reflecting the stunning business performance of the chip firm. Five years ago, for example, Nvidia’s second quarter revenue was a record $3.9bn, up 50% in a year. Net income was $622m.
Those were already very strong numbers. Five years on though, and last quarter’s revenue was $46.7bn, while net income was a whopping $26.4bn. In other words, over the past five years, Nvidia’s net income (using the second quarter numbers) grew 4,244%.
Set against that, the five-year growth in Nvidia stock of 1.357% looks surprisingly small! On a price-to-earnings basis, that means Nvidia is actually significantly cheaper now than it was five years ago.
Could there be more to come?
Why has the valuation effectively got cheaper? Five years ago, investors were really excited about Nvidia’s potential as artificial intelligence (AI) investment expanded.
Now that has become a reality – as reflected in Nvidia’s incredible performance not only in terms of revenue but also net income. Net income growth has far surpassed revenue growth, demonstrating how economies of scale and pricing power have helped Nvidia improve its profitability.
Clearly, a surging Nvidia stock price shows that many investors remain excited about the company’s growth prospects as AI investment continues. I reckon the share could well keep moving upwards even from its already lofty price.
A changing landscape
But the relatively cheaper valuation now compared to five years ago may suggest that investors recognise there could be limits to how much customers are willing or able to spend on chips for AI.
We are already seeing vast spend by tech giants. There may not be many other firms who think it makes sense to spend at that level, or can afford to. There are also risks now that there were less obvious or absent five years ago, from US export controls to tariff disputes.
In a sense, even though it is going gangbusters, Nvidia’s growth runway may indeed now be smaller in relative terms than it was five years ago.
I’m waiting for a better price
Still, in absolute not relative terms, Nvidia still has a lot of space to grow. Its most recent quarter showed 56% year-on-year revenue growth, to $47bn. Achieving that sort of growth from an already high base is extraordinary.
The company has a lot of proprietary products, a large installed user base and sizeable pricing power. At the right price, I would be happy to buy Nvidia stock for my portfolio.
But I also always like a margin of safety when I invest. Currently, Nvidia’s price-to-earnings ratio is 50. Given the risks I mentioned above, I think that is too high for my comfort level.
So for now, Nvidia remains on my watchlist and will not be investing.
