Go back two years and the US stock market was littered with tech juggernauts that surged to wild market capitalisations amid extraordinary government stimulus and good narratives. Everyone thought that the story-stock market died when the Federal Reserve started raising interest rates, but chipmaker Nvidia Corp has defied that logic to become the market’s ultimate story stock — that rare bird that’s capable of riding a good yarn to retina-burning valuations even amid tight monetary policy and a potentially looming recession.
Nvidia, of course, has become the darling of the generative artificial intelligence boom that started with the launch of OpenAI’s ChatGPT in November. With its 25% post-earnings surge on Thursday, the stock is now up 161% this year on the promise that the company’s chips will power the future of AI. So what kind of sorcery is this? And why are investors willing to pay 186 times current earnings to get a piece of it?
Right on cue, it’s out this year with its next-generation H100 graphics processing units, or GPUs, in hot pursuit of the AI business. Its GPUs have some competitors (Advanced Micro Devices Inc is one), but investors mostly seem happy to ignore the perceived threat for now because Nvidia’s market share is so dominant. And as Sanford C Berstein semiconductor analyst Stacy Rasgon pointed out on the Odd Lots podcast this month, Nvidia has also built a hard-to-replicate software ecoystem around its technology that gives it a “moat” that’s even harder to breach.
Because of that position, investors haven’t really fretted about whether a particular hype cycle pans out as long as there’s another one right behind it. As long as companies are investing in computationally intensive technology, Nvidia’s addressable market can continue to expand. Maybe that’s why billionaires Stanley Druckenmiller and David Tepper are among those recently building or expanding their Nvidia positions, as Bloomberg’s Amanda Albright reported this month.
Which brings us to the AI frenzy.
Nvidia’s latest stock pop came after the company projected $11 billion in sales for the quarter ending in July, shocking analysts who had penciled in about $7.18 billion for the quarter. The episode sent the Nasdaq 100 up about 2.3%, mostly because of Nvidia’s large and growing weighting in the index. Not only did it account for about 60% of the index’s gains on Thursday, but it’s now the single-biggest contributor to the year-to-date rally.
Meanwhile, Nvidia Chief Executive Officer Jensen Huang has fanned the hysteria with his compelling description of the opportunity. As he described it on Wednesday’s earnings conference call, the world’s $1 trillion in installed data center infrastructure was already primed for extensive
upgrades to accelerate computing and significantly cut energy and costs “by an order of magnitude.” Against this background, along came the generative AI wave, and suddenly companies had all the more incentive to make the move. In Huang’s words: "We’re seeing incredible orders to retool the world’s data centers. ... You’re seeing the beginning of call it a 10-year transition to basically recycle or reclaim the world’s data centers and build it out as accelerated computing."
All of this deserves some healthy skepticism. At current multiples, Nvidia has left even the bubbly valuations of 2021 in the dust. As my colleague John Authers has pointed out, Nvidia’s success brings back bad memories of Cisco Systems Inc., a company that surged to extraordinary levels in the dot-com bubble on the promise that its routers offered exposure to the limitless upside of the booming internet. The internet flourished, but Cisco is now worth less than it was at its 2000 peak. Even if Nvidia’s total addressable market is now vastly larger than previously suspected, it will still have to contend with the near-term threat of recession (which could prompt its top customers to curb capital expenditures) and the longer -term threat of new competition, including from the likes of Microsoft Corp and Alphabet Inc potentially making their own chips. “They’re buying Nvidia’s chips and they’re also investing in R&D to make their own chips,” Bloomberg Intelligence’s Mandeep Singh said Wednesday on Bloomberg Television. “So clearly that is a threat.”
But unlike the favorites of the pandemic bubble, Nvidia isn’t a one-trick pony. Peloton Interactive Inc and Zoom Video Communications Inc had essentially one good story to tell, and when the pandemic waned and life normalised, their valuations cratered. Nvidia has a lot riding on the future of generative AI, and its stock will fall meaningfully from current altitudes if reality doesn’t deliver. But eventually, odds are that it would find another hype cycle to ride anew, potentially to even greater heights.
Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
