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Essential Knowledge for Nvidia Investors | The Motley Fool
By Jack Simpson
July 20, 2024
Investing in Nvidia (NVDA-2.61%) has been a rewarding venture for many, as the company’s stock has seen an impressive surge of around 160% this year. This growth is driven by the unprecedented demand for artificial intelligence (AI), making Nvidia one of the most sought-after stocks.
However, investing in Nvidia requires understanding three crucial factors that could potentially affect your perspective on its stock.
Primarily, it's important to note that, despite having some software products, Nvidia isn't a software company. Its principal product is graphics processing units (GPUs), which are instrumental in training AI models. Given their capacity to process multiple calculations simultaneously and be linked together by hundreds or even thousands, these GPUs are highly efficient at complex computing tasks, making them incredibly popular among users.
Nevertheless, like any other business sector, there are periods of turbulence in the chip industry too. The cyclical nature of this industry means that demand fluctuates based on secondary trends. For instance, Nvidia's last two cycles were tied to cryptocurrency; each cycle ended with significant revenue drawdowns.
Despite such challenges, Nvidia always emerged stronger after each cyclical downturn—an essential factor investors need to consider when assessing future risks associated with potential drawdowns.
The current massive demand for AI computing will eventually decline once fully built out, but predicting exactly when remains uncertain: next quarter? Next year? Or perhaps even further down the line?
In terms of valuation, given its recent run-up, it's no surprise that Nvidia carries a premium price tag. Currently valued at 47 times forward earnings, it is exceedingly expensive compared with the S&P 500, which trades at approximately 22.7 times forward earnings.
For a mature company like Nvidia experiencing rapid changes, the combined use of the price-to-earnings ratio and the forward P/E ratio can provide insight into expectations over the forthcoming year built into its stock price.
To achieve an earnings multiple of 30 times, Nvidia must grow its earnings by an impressive 151%. A daunting task, but not impossible given that the company previously grew its earnings per share by a staggering 629% in Q1 of FY 2025.
However, it's equally important to recognize that as comparison figures become tougher, growth rates won't appear as dazzling despite their rapid pace. Wall Street analysts project Nvidia's earnings to rise by around 60% over the next year; therefore, maintaining current growth for another two years is essential to justifying its valuation.
The question remains: is this level of sustained, robust growth feasible?
With AI being touted as a game-changing technology akin to the advent of the internet, it seems plausible. The potential applications for AI are just beginning to be discovered and will require even more computing power in the future.
Moreover, with an average lifespan of five years, a GPU used in a data center will eventually need replacement. This inevitable demand could further propel Nvidia’s growth trajectory.
As an investor, the high valuation might seem intimidating, but if you believe in prolonged growth extending over several years, Nvidia stock could still be worth your investment today.
Regardless—if you choose to invest through an index fund—you'll still have significant exposure to Nvidia since it comprises about 6.7% of the S&P500.
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