Artificial intelligence

Nvidia AI Chip Dominance Is Uncertain At 76 Times Profits

Nvidia’s stock surged 4,000% in five years, holding a 90% AI chip market share with a 57% profit margin.

TakeAway Points:

  • Nvidia’s stock has surged 4,000% in five years, driven by a 90% market share in AI chips and a 57% profit margin on $80 billion revenue.
  • Despite high valuations at 76 times trailing earnings, analysts project long-term earnings growth of 43%, but with significant uncertainty compared to Microsoft and Apple.
  • Broader AI sector ETFs lag behind Nvidia’s performance; BOTZ fell 4.7% over three months while SMH gained 19.7%, highlighting concentrated investor interest in Nvidia.

Nvidia Dominates Market

Nvidia Corp. has become a focal point in the stock market, with its shares surging 4,000% over the past five years. This remarkable growth has positioned Nvidia among the top three most valuable companies globally, alongside Microsoft Corp. and Apple Inc. Nvidia’s dominance in the AI chip market is evident, holding a 90% market share. 

The company boasts a profit margin of 57% on $80 billion in revenue, the highest among companies with similar profitability in the S&P 500 Index. Over the past five years, Nvidia has achieved an annual sales growth rate of 64%, the highest among S&P 500 companies.

Despite its impressive performance, Nvidia’s valuation is a point of contention. The company’s stock trades at 76 times one-year trailing operating earnings, more than three times the S&P 500’s valuation and twice that of Microsoft and Apple. Investors are betting on Nvidia’s future growth, with analysts projecting a long-term earnings growth rate of 43% per year. 

This growth rate suggests that Nvidia’s operating earnings per share could rise to $80 in four years from $19 today, resulting in a long-term price/earnings ratio of 18, comparable to Microsoft and Apple.

However, the variability of Nvidia’s long-term growth estimates is significantly higher than that of Microsoft and Apple, indicating greater uncertainty about its future. The standard deviation of Nvidia’s growth estimates is three times that of Microsoft and four times that of Apple. This highlights the risk of relying on future earnings to justify Nvidia’s current stock price, especially given the uncertainty surrounding the AI market.

Result in AI Sector 

Nvidia’s success has not uniformly benefited the broader AI sector. While Nvidia has propelled the stock market rally in the first half of 2024, some AI-related exchange-traded funds (ETFs) have lagged. The Global X Robotics & Artificial Intelligence ETF (BOTZ) has fallen by 4.7% over the past three months, while the VanEck Semiconductor ETF (SMH) has advanced 19.7% in the same period. For the year, BOTZ is up 7.9%, compared to a 51.5% gain for SMH and an 18.7% gain for the Technology Select Sector SPDR Fund (XLK).

Todd Rosenbluth, head of research at VettaFi, noted, “Nvidia’s astronomical returns in the first half of 2024 are a catalyst for all of the funds, but [for] the AI-themed ETFs, it’s happening to a lesser degree.” Nvidia’s stock, which has jumped 155% in 2024, is a significant component of many AI-related ETFs. However, the performance of other components, particularly robotic and industrial-automation companies traded on foreign stock exchanges, has been sluggish.

Dan Faggella, founder and head of research at Emerj Artificial Intelligence Research, explained, “Stock prices are based on opinions and dollars moving in the physical world, but money flows are overwhelmingly centered around Nvidia, despite all the other startups that have tried to come up. There’s really nobody standing in its [Nvidia’s] way right now.” He added that smaller AI players face “scale production” and “reliability” problems, making it difficult for them to compete with Nvidia.

Possible Risks

The high expectations for Nvidia’s future growth come with significant risks. The variability in analysts’ growth estimates underscores the uncertainty surrounding Nvidia’s role in the AI market. If consensus growth forecasts prove too optimistic, Nvidia’s stock could reprice, with substantial room for correction. 

Comparisons to Cisco Systems Inc. are instructive. In the 1990s, Cisco’s routers powered the booming internet, making it the most valuable business in the world. However, when the internet bubble burst in 2000, Cisco’s fortunes quickly turned, and its valuation plummeted.

Parmy Olson, a Bloomberg Opinion colleague, sees “signs of discontent” with AI, including businesses cutting back on new AI tools. Daniel Ives, an analyst at Wedbush Securities, wrote, “Nvidia’s GPU chips are in essence the new gold or oil in the tech sector.” However, the path of both commodities is notoriously difficult to predict.

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