Nvidia’s Journey: Evaluating the Stock Amidst Competition and Growth Potential

Nvidia stock (NASDAQ:NVDA) has generated more value in the last three years than the combined market cap of 250 S&P 500 companies, amounting to a staggering $3 trillion. However, the important question is: what’s next for Nvidia? Should you buy, sell, or hold? Alternatively, might there be better options, such as robotics surgery firm Intuitive Surgery, which could increase its stock (ISRG) value tenfold?

In our recent analyses, we’ve presented various scenarios: Nvidia may reach $300 versus the possibility of Nvidia dropping to $40.

Tracking Nvidia’s Performance

Nvidia’s stock grew over 10 times, jumping from about $13 in early January 2021 to roughly $140 today. For comparison, the S&P 500 has seen a 50% increase during this same four-year span. This journey has not been smooth; returns fluctuated significantly with a surge of 125% in 2021, a drop of 50% in 2022, followed by a remarkable 239% rebound in 2023. The stock’s 2022 underperformance stands out, especially considering the benchmark index’s decline of 19% that year. Meanwhile, the Trefis High Quality (HQ) Portfolio, comprising 30 stocks, has consistently outperformed the S&P 500 each year during this period. What accounts for this? The HQ Portfolio has offered better returns with less risk, providing a steadier performance than the broader market.

Let’s examine some critical attributes to consider regarding Nvidia’s place in your investment strategy.

Three Key Facts About Nvidia

1. Nvidia is a key player in the AI sector. The competition in artificial intelligence is intense.
2. AI is essential for competitive success. Enterprises across diverse sectors, from apparel to pharmaceuticals, need AI to outperform their rivals, making customers less sensitive to price changes.
3. Rapid growth can lead to significant fluctuations. Tracking Nvidia’s stock may feel like a wild ride.

So, what should your approach be?

Recommendation: Consider adding Nvidia to your portfolio in a way that allows for visions of a 5x return while being prepared for a possible 50% drop at any moment. Accepting short-term volatility is necessary in pursuit of long-term gains. Although this rationale seems straightforward, implementing it effectively presents challenges.

Let’s dive into some pros and cons.

Start with the Challenges

Competition is intensifying. AMD, for example, has reinforced its focus on AI-targeted GPUs and claims superiority with its new Instinct MI300X chip in certain areas. Intel is also stepping up as a competitor, promoting more affordable AI chips. Additionally, major tech companies like Google, one of Nvidia’s prominent clients, are developing their own AI and machine learning hardware. This increased competition may threaten the rapid revenue growth and high margins Nvidia currently enjoys, which have recently hovered above 50%.

Moreover, the fundamental economics of the AI GPU market face struggles, as many of Nvidia’s clients remain unprofitable. For instance, large language models are costly to develop, and returns can take time. A report from venture capital firm Sequoia estimates the AI sector spent $50 billion on Nvidia chips last year, potentially exceeding $100 billion when accounting for ancillary expenses. These investments have only yielded about $3 billion in revenue, with few services beyond ChatGPT gaining substantial user bases. This situation may indicate we’re in an AI “FOMO phase,” where companies invest in AI primarily to keep pace with competitors. As shareholders push for more returns, capital expenditure could decline, impacting companies like Nvidia.

On a different note, AI implementations progress in two major stages. The first stage involves training AI models with powerful computational processes, while the second revolves around deploying these models in real-world scenarios, which typically requires less processing power. As the AI journey began around two years ago, most companies are still in the training phase. Demand may decrease as the industry shifts to less intensive processing needs.

The Positive Aspects

Nvidia has established itself as a leader in the AI market and aims to maintain that advantage. The company has developed an extensive ecosystem surrounding its AI processors, including proprietary programming languages and software, which can encourage customer commitment as they scale their AI investments. Its software solutions, such as CUDA, cuDNN, and TensorRT, enhance performance and ease the AI development process, making transitions to competing platforms more challenging and costly. As companies invest time and resources into training and integrating AI tools, switching to competitors becomes less feasible. This ecosystem might secure Nvidia’s margins and facilitate growth in software-related revenues in the long run.

The initial AI models launched by actors like OpenAI in 2022 were predominantly focused on text. Now, models are becoming more advanced and capable of handling various data types, including speech, images, and video. This trend increases the demand for GPU shipments and processing power. Unlike a decade ago, where software development lagged behind advancements in hardware performance, today’s AI landscape demands significant computing power due to the complex needs of machine learning. This heightened demand could sustain strong support for Nvidia’s business.

A shift in U.S. monetary policy could also bolster Nvidia’s prospects. With the Federal Reserve’s 50 basis point cut—its first in nearly four years—bringing the federal funds rate to 4.75%-5%, there’s potential for further reductions. Lower rates generally favor growth sectors like technology by enhancing the present value of future earnings. This reduction in rates could particularly aid Nvidia, as it would lessen financing costs for large data center builders, potentially increasing capital spending in this sphere and benefiting companies like Nvidia that sell GPUs for servers. Additionally, despite the mixed economics surrounding AI investments, lower interest rates could make these projects financially more viable. Explore our analysis of other investment opportunities driven by the Fed’s next moves.

[1] Returns as of 10/25/2024
[2] Cumulative total returns since the end of 2016

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The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Nasdaq, Inc.