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Good morning! The Atlanta Fed’s estimate of third-quarter GDP keeps rising and reached 5.9 per cent yesterday. This increase is attributed to sold-out concerts by Taylor Swift and Beyoncé, as well as the Barbenheimer phenomenon, according to Bloomberg Economics estimates. We’re eagerly waiting for Jay Powell’s comments on this at Jackson Hole today. Feel free to email us at [email protected] and [email protected].
Rethinking Nvidia’s Valuation
A week or two ago, I wrote an article suggesting that Nvidia’s valuation might be too high. However, after the company’s impressive second-quarter earnings report and the subsequent market response, I now feel partially vindicated.
The earnings report was outstanding, surpassing expectations, and the outlook was equally positive. Nvidia expects to generate $16bn in revenues in the third quarter, compared to $5.9bn in the same period last year. The company is experiencing tremendous growth. Despite this, the stock only rose by 0.1% yesterday. This indicates that the positive news had already been priced in, suggesting that the shares may have reached a valuation ceiling, at least for now.
I feel partially vindicated because Nvidia’s growth is so remarkable that I must reconsider my argument that the stock is driven by irrational exuberance, similar to Cisco shares in 1999-2000. Cisco’s stock became overinflated and has still not reached its previous highs, despite 23 years of strong performance. However, Nvidia’s growth trajectory is much stronger, which may justify its current valuation.
Taking a closer look at the numbers, assuming the company earns $3.25 in net income per share this quarter, on a GAAP basis, it seems highly likely given the revenue guidance. Annualizing this figure, Nvidia would be earning $13 per share per year. With the current price, that translates to a forward price/earnings ratio of 36. In comparison, Apple’s ratio is 27, even though its revenue growth is in the low single digits. The S&P 500 ratio is 20. Considering Nvidia’s growth, one could argue that it is cheaper than Apple or even the overall market. This week’s earnings report showed that while Nvidia’s valuation is high, it is not in the realm of dotcom-crazy.
The extent of Nvidia’s growth is undeniable. But what about its stability? It may appear that Nvidia’s dominance in AI chips is unassailable, not just because they excel in the heavy parallel processing required by AI, but also because their “full-stack” products offer a comprehensive solution for companies wishing to quickly incorporate AI capabilities. By the time competing chipmakers like Intel and AMD catch up with parallel-processing chips, Nvidia’s established presence will create an insurmountable competitive advantage, similar to Intel’s position in personal computing with its x86 processor.
However, a conversation with Gartner AI analyst Chirag Dekate has made me consider an alternative perspective. Nvidia’s primary competitors may not be other chipmakers, but rather the major computing platforms: Amazon Web Services, Microsoft Azure, and Google Cloud. These companies aim to utilize AI in their own services and also offer AI capabilities to customers.
The crucial factor here is cost. The platform companies compete on cost, and they achieve low-cost AI capacity and services by utilizing their existing computing infrastructure. In other words, their incentive is to provide customers with a range of options, including Nvidia’s specialized products and their own in-house technology, which can handle AI and other types of computing work. The platforms’ purpose-built AI infrastructure could potentially offer superior cost-effectiveness.
Dekate notes, “If a platform solely relies on Nvidia, their cost advantage may decline. They can only maintain a cost advantage over time by exploring alternative pathways to efficiency within the infrastructure layers.” He believes that Nvidia alternatives will offer enterprises more flexibility and potentially better price-performance trade-offs as early as next year. The AI chip market is still up for grabs, and it’s too early to declare winners.
Considering this perspective, the key question is not whether Nvidia is currently overvalued compared to peers or the broader market. I no longer believe it is. The real question is how Nvidia will fare in the next two years. The answer depends on how AI services are delivered in 2025. If you have any confident forecasts, feel free to email me.
One Good Read
You definitely don’t want to find yourself in the “quantitative eject seat.”
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