Nvidia (NASDAQ:NVDA) shares are trading at a forward price-to-earnings (P/E) multiple of 17. That’s lower than the S&P 500.
The last time this happened was over a decade ago. So is this a rare chance to buy the stock at a discount, or time to worry?
Challenges: demand
Nvidia’s biggest customers include Amazon and Microsoft. Both companies have plans to invest heavily in artificial intelligence (AI) data centres.
Investors, however, have become sceptical about the wisdom of these plans. And the two companies’ share prices have been falling as a result.
That creates a strong incentive to think again. On top of this, there are questions about how strong the underlying demand really is. Amazon and Microsoft have deep pockets. But they’ll need to see returns on their investments sooner or later.
If a major customer decides to pull back on data centre spending, the implications for Nvidia could be huge. And that’s a major risk.
Demand, however, is only one half of the equation. There’s a danger Nvidia’s customers might even become competitors in the future.
Challenges: supply
A number of Nvidia’s customers – including Amazon and Microsoft – have been working on their own chips. And these are serious competitors.
In several cases, rival chips are more powerful and more efficient. But switching involves more than just buying different hardware.
Moving away from Nvidia’s architecture means rewriting code, retraining developers, and migrating software. That’s time-consuming and expensive.
That’s a big advantage. But a coalition involving Alphabet, Intel, Samsung, and others are working on an open-source alternative.
If this succeeds, it might be a real problem for Nvidia. At best, increased competition could threaten its ability to increase prices.
Nvidia shares are trading at lower multiples than before. But the competitive landscape has arguably never been tougher.
Expectations
Valuation multiples in general say more about what investors think about a business than anything else. Especially forward ones.
On the face of it, the market thinks Nvidia’s prospects are worse than the average S&P 500 company. I find that surprising. That’s not because I think it’s an obvious mistake. I’m not sure what to make of the evolving competitive landscape.
I’m surprised at how quickly the market has changed its mind. And that makes me think again about what’s going on. I don’t see the low multiple as investors saying the firm’s prospects are weak. I think it’s more a sign of uncertainty.
Nvidia’s story is becoming increasingly technical. And that makes it harder for non-specialist investors to assess accurately.
Risk
One of my favourite Warren Buffett sayings is that risk comes from not knowing what you’re doing. And that seems highly relevant here. Investors don’t have to know everything about a business to buy shares. Buffett’s investment in Apple is a good example.
The less they know, however, the greater the risk. And that means visible threats make it hard to buy shares at high multiples. That’s my assessment of what’s going on with Nvidia right now. And that’s why the stock doesn’t jump out at me as a buy.
For all I know, it might be an above-average business at a below-average price. But I have other ideas I’m more confident in.
