NVIDIA (NASDAQ:NVDA) stock has been running so hot lately that some have called it a bubble stock. In five short years, it has risen from $39.04 to $822 – an astonishing 2,000% return. Even more incredibly, a large portion of that growth has taken place since October of 2022. Since that date, it has risen 610%, making it one of the best performing stocks of the last year and a half.
The question is, “How long can this go on for?” While NVIDIA has seen a major explosion in earnings attributable to its new role as chip supplier to artificial intelligence (“AI”) developers, competitors want in on the action, and customers want to lower their costs. NVIDIA is so far ahead of its competitors in building AI accelerator chips (GPUs) that it maintains a de-facto monopoly on supplying such chips. The company had a massive head start by being the market leader in GPUs. It just so happened that AI workloads required the same massive amount of computing power that high end videogames did. As a result, NVDA became Silicon Valley’s chip supplier of choice.
NVIDIA’s stock price appreciation has been supported by earnings
Let’s get one thing right out of the way:
NVIDIA’s rally has not been driven by some unsustainable speculative frenzy. Yes, people have been buying the stock like mad, but the price actually hasn’t run ahead of earnings. Over the last year, at least, earnings have risen faster than the stock price has! In the last 12 months, NVIDIA’s revenue, earnings, and free cash flow grew at the following rates:
- Revenue: 126%.
- Diluted earnings per share: 561%.
- Free cash flow: 338%.
So, the business has really grown. The stock price has risen too: it’s up 250% in the trailing 12-month period. But earnings are up far more.
Nevertheless, its multiples are high
Despite the fact that NVIDIA is growing rapidly, some of its valuation multiples are a little high even if you assume continued high growth. For example, it trades at 68 times earnings and 33 times sales. Those are some steep multiples even if you assume that earnings will grow at 20% per year for the next five years. Granted, NVIDIA’s earnings growth rate has been orders of magnitude greater than 20% in the last 12 months. Still, the bigger you get, the more that base effects tend to curb your growth – or at least make continued growth more difficult.
We can see this phenomenon in action with Canada’s very own Shopify Inc (TSX:SHOP). During the COVID-19 lockdown period, both the stock and the company performed brilliantly. Shopify grew its revenue by 86% for the full year 2020, and its stock eventually went up by about the same amount. The stock seemed unstoppable! Alas, when 2022 came around, SHOP had big shoes to fill – namely, a series of ultra-high growth quarters, from which it was expected to grow even further. The fairly predictable result was that its revenue growth slowed down considerably. At one point, it went all the way down to 13%! The stock crashed and, despite seeing some subsequent revenue acceleration, remains down 51.5% from its all time high.
Foolish bottom line
Looking at the Shopify case study, we can see clearly that NVIDIA could run too hot. It happened to Shopify, after all. At the same time, SHOP got even more expensive than NVIDIA did (it traded at 50 times sales at one point), yet never grew revenue at anywhere near 125%. All things considered, I’d say that NVIDIA is too expensive for a truly conservative investor. If you want to take a risk with maybe 1% or 2% of your money, though, there are worse things you could buy.
