Crossing the $3 trillion market cap, Nvidia had become the largest company in the world for a brief period. Even now, only Microsoft and Apple remain larger than it. As always price action is used to justify the valuation, and the all-time high triggered the very typical stock market FOMO (Fear Of Missing Out) feeling and many started thinking of buying Nvidia.
Looking at the performance of Nvidia, the stock has tripled in a year. The revenues, too, have tripled during the last one year, while the operating income has grown more than 10 times. On the face of it, one could say that the rise in the stock price is not without the strengthening of the fundamentals.
As is natural, Mr Market is projecting strong fundamentals for the future. The question is how sustainable are these increased revenues?
Nvidia sells GPUs (graphic processing units) which are considered the best-performing chips for Artificial Intelligence (AI). Earlier, Nvidia used to be considered as a niche player providing graphics cards for gaming computers. The question is how long will this extraordinary demand for Nvidia last?
Various estimates suggest that Microsoft (19 percent), Meta (13 percent), Amazon (6 percent), and Alphabet (6 percent) are the four largest customers of Nvidia.
Three of these companies are Cloud service providers, most likely, buying the Nvidia chips for their Cloud infrastructure. Of course, they could be using the computing power currently for their internal AI-training purposes. Meta is likely buying it mostly for AI-training and would eventually use it for inferencing.
Assuming that the above break-up applies to future revenues of Nvidia, one could estimate that around $100 billion is being invested in Cloud capex over the next couple of years by the large cloud service providers. Given the typical revenue-to-capex ratio for Cloud, one could estimate an incremental, recurring revenue of $120 billion revenue from cloud services for the Cloud service providers.
Nvidia is currently trading at 72 PE (TTM) and 49 PE (FWD). This definitely cannot be termed cheap. But what should one look at if one wants to benefit from the AI gold rush?
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The AI gold rush
Typically, in any gold rush the easy approach is to invest in the companies producing the picks and shovels. In the case of the AI gold rush, the picks and shovels are the AI chips and Nvidia is the one making those. However, given the overvaluation, it doesn’t make sense.
Alternatively, one could go downstream and explore the Cloud service providers. They would be selling the Cloud and AI computing power to their enterprise and mid-market or SME customers. Depending on which Cloud service companies look undervalued one could consider those.
Expanding this further, enterprise customers would need IT service providers to handhold them in their projects to use their data to get AI-based insights. This revenue would flow substantially to Indian IT service providers.
Now contrast the optimism for AI as far as Nvidia is concerned. Then consider the relatively less optimistic, but still positive, view of the Cloud service providers and their growth opportunities. Finally, consider the downright pessimistic value of the Indian IT service providers.
Logically, the customers of Nvidia are buying the AI chips with a view to sell the AI computing power to their customers who in turn will need significant support services from the Indian IT service providers if they want to benefit from their data and AI initiatives.
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How Indian IT companies can benefit
The demand for AI chips is a leading indicator, in our opinion, of demand for Cloud services, which would indicate demand for Indian IT service providers.
Over the next 3-5 years, the enterprise, mid-market and SME companies are likely to mine their data using AI for gold. While this indicates high demand for the companies providing the infrastructure for gold mining, i.e., Cloud service providers, and Nvidia, the AI-chip provider, it also indicates high demand for the gold diggers, i.e., the IT service providers. One could invest their time looking for mispriced opportunities in this segment.
Disclaimer: Please note that any mention of company names is not a recommendation to buy, sell or hold. Equity investments are subject to market risks. Past performance is no guarantee of future performance. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Global Investing has additional risks. One should invest based on the advice of their financial advisor based on their investment objectives, financial situation and risk profile. OmniScience Capital, its management and employees and its clients might be buying, selling or holding the mentioned companies.
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