Over the long term, Nvidia (NASDAQ: NVDA) has been a brilliant share for some investors. Over the past five years, Nvidia stock has soared 1,356%.
The past year alone has seen Nvidia stock go up by 59%. It is now the largest listed company in the world, with a market capitalisation of $4.6trn.
Given that – and a price-to-earnings ratio of 47 – it might not look like much of a bargain. But I think it potentially could be, even at today’s price.
Ongoing value creation opportunities
Think about what it might take for Nvidia to command a higher value. I see a few possible avenues, which are not mutually exclusive.
One would be for revenues to rise because chip demand rises.
I can see that happening quite easily. AI has sent chip demand sharply higher and is still really only in the early stages of its roll out. Meanwhile demand for all sorts of other chips, like those for gaming and mobile phones, could move higher over time.
An additional driver for Nvidia could be taking more market share. It already has a dominant market position, so that might seem like a tough challenge.
But success can breed success. Nvidia’s existing scale gives it advantages such as a large installed user base and deep expertise, that could potentially help it get even bigger.
Another driver for Nvidia stock meriting a higher valuation could be higher profit margins.
The company’s margins are already high, but economies of scale and technological improvement could both help here. Last year’s net profit margin was 55.8%, more than double the 25.6% of just five years previously.
Flies in the ointment
Too much success does not only breed success, it can also breed jealousy – or monopoly lawsuits.
Will the market size for chips keep growing? I outlined the positive case above but it might turn out that AI does not prove its worth relative to the huge investments being made. That could mean chip demand and revenues fall in coming years. Over time, though, I would be surprised if the total chip market size does not grow.
Nvidia’s market share is high and there is a risk that that falls, hurting revenues. But the reason it is high currently is because it has a compelling competitive proposition. That could help it grow market share even further, I reckon, as customers want its proprietary chip designs.
I see a significant risk, both to market share and profitability, if a rival comes up with a product that offers better value.
By ‘better value’, I do not even mean a chip as powerful as Nvidia’s. I think it could be good enough for many clients if its capability was not quite as good as that offered by Nvidia, but the price was much, much lower. Nvidia could respond by cutting prices, but that would hurt its own profitability.
Given that Nvidia is almost printing money at this point, rivals are chomping at the bit. The industry has high barriers to entry but many are trying, including established players.
Nvidia stock could be a bargain even now, if it can grow sales and maintain or further grow its profit margins. Given the sizeable risks to that happening, though, I am not willing to invest right now.
