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Good morning The Atlanta Fed’s third quarter GDP estimate, which seemed impossibly high, keeps climbing. Yesterday it rose to 5.9 percent. One factor: a 0.5 percentage point increase from sold-out concerts by Taylor Swift and Beyoncé and the Barbenheimer phenomenon, according to estimates by Bloomberg Economics. We’re awaiting Jay Powell’s comments on this in Jackson Hole today. Email us at [email protected] and [email protected].
Nvidia’s rating has been reconsidered
A week or two ago I wrote an article suggesting that Nvidia’s rating might be overstated. After the company’s second quarter earnings report on Wednesday afternoon and yesterday’s market reaction, I feel half vindicated.
The results report was an absolute monster. The results were miles above expectations and so was the outlook. The company expects sales of $16 billion in the third quarter; In the same period last year, sales were $5.9 billion. The company grows like wildfire. But the stock reacted yesterday with a rise of a full tenth of a percent. That suggests that all the good news was already priced in, or in other words, that the shares could be near a valuation ceiling for now.
I only feel half vindicated because Nvidia’s growth is so strong that I have to reconsider my argument that the stock is gripped by irrational exuberance, much like Cisco stock was in 1999 and 2000. Cisco stock has skyrocketed so much that despite 23 years of great performance, it still hasn’t reached the highs of the time. But Cisco has never grown the way Nvidia is growing now, so Nvidia’s valuation may make more sense than I thought.
A little rough calculation makes the evaluation picture clearer. Let’s say the company earned $3.25 in net income per share on a GAAP basis for the quarter. In view of the sales forecast, this seems entirely possible. Applying that to the year, the company makes $13 per year. At current prices, that translates to a forward price-to-earnings multiple of 36. Apple is up 27 and growing sales in the low single digits. The S&P 500 sits at 20. Relative to its growth, one could argue that Nvidia is cheaper than Apple or even the market. This week’s earnings report showed that while Nvidia’s rating is high, it’s absolutely great not Dotcom crazy. (Of course, one could argue that Apple is overvalued, or that big tech companies are overvalued, or that the entire market is overvalued; maybe it is, but what we’re talking about here is relative Evaluation.)
The scale of Nvidia’s growth is undeniable. How about its stability?
It may seem that Nvidia’s competitive position in AI chips is unassailable, and not just because they’re better able to handle the high parallel processing that AI requires. Its “full-stack” products, which integrate chip design, hardware, and software, are the only turnkey solution for companies looking to quickly add AI capabilities. As rival chipmakers like Intel and AMD catch up in parallel-processing chips, Nvidia’s installed base will represent an insurmountable competitive advantage — much like Intel’s position in personal computing years ago with its x86 processor.
A conversation with Gartner AI analyst Chirag Dekate convinced me that there is a different perspective. In a way, Nvidia’s main competitors aren’t other chipmakers, but the major computing platforms: Amazon Web Services, Microsoft Azure, and Google Cloud. These companies plan to use AI both in their own services and to sell AI capabilities to customers.
Crucially, the platform companies are competing on cost, and the opportunity for them to deploy low-cost AI capacity and services is by leveraging the computing infrastructure already in place. In other words, their appeal is to offer customers a variety of options, including both Nvidia’s ready-to-use, highly specialized products and their own technology that can handle AI work and any other type of computing work that they and their customers do customers do. And the platform’s own purpose-built AI infrastructure could potentially provide more computing power for the corporate budget.
“If a platform uses Nvidia across the board, its cost advantage could disappear. The only way they can gain cost advantage over time is by driving costs down from the infrastructure tiers and exploring alternative avenues to efficiencies,” Dekate says. He believes Nvidia alternatives will offer companies more flexibility and potentially better value for money as early as next year. The market for AI chips is still open. “Winners aren’t announced after the first inning,” he says.
With that in mind, the question is less whether Nvidia currently looks grossly overvalued compared to its peers or the broader market. I no longer believe that is the case. The question is how it will look in, say, two years. The answer depends on how AI services will be delivered in 2025. If you can predict this with certainty, by all means drop me an email.
A good read
They really don’t want to be in the “quantitative ejection seat.”
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