Image source: Getty Images
With a market capitalisation north of $4.2trn, chip company Nvidia (NASDAQ: NVDA) might not seem like an obvious bargain at first glance. Nvidia stock sells for 56 times earnings. Again, that does not necessarily sound like a screaming bargain.
But Nvidia is no ordinary stock.
The company recently became the most valuable listed business in history. The Nvidia stock price has risen 1,602% over the past five years. That is the sort of performance that many stock market investors dream of.
However, am I too late to the party? Or could buying Nvidia stock for my portfolio even now potentially turn out to be a bargain when looking back a few years from now?
Dramatic business improvement
One of the difficulties in valuing Nvidia, whether one sees it as too pricy or a bargain, is the speed at which its business has grown in recent years.
Last year, for example, revenues were $131trn. Five years before, they had been $11trn.
Could it be that this is an exponential growth machine, so that even the current revenues might look comparatively small a few years from now? Or might it be that the recent years have seen a one-off boom in AI-led chip demand? And once that demand is fulfilled, will it fall away meaning Nvidia’s revenues start getting much smaller?
The answer to that question is critical, I reckon.
If revenues fall significantly, earnings almost definitely will too. If earnings fall, the current Nvidia stock price could be too pricy.
However, while revenue growth over the past five years has been incredible, earnings have been growing even faster. Last year’s net income of $73bn compared to $3bn five years before.
If AI heralds a permanent shift in chip demand and we are only in the early stages, that could be brilliant news for Nvidia. Economies of scale could mean that earnings growth outpace revenue growth, as happened in recent years. In that case, the current Nvidia stock price could yet turn out to be a bargain.
Risky, but potentially rewarding
What will happen? We do not know.
What is clear, however, is that Nvidia has significant strengths that could help it keep doing well if chip demand remains buoyant. They include proprietary chip designs, a world-class workforce, strong brand, and established relationships with a large roster of existing clients.
Those things all strike me as strengths and help explain why, at the right valuation, I would certainly be happy to add Nvidia to my portfolio.
The question I wrestle with is whether the current valuation feels right to me. It does not, which is why I will not be adding Nvidia stock to my portfolio for now.
For the reasons I outlined above, I see a strong case for the share to keep soaring in coming years. But that largely depends on the outlook for chip demand. That remains uncertain.
Tariff disputes and growing competition could also eat into Nvidia’s profitability. I do not think those risks are properly reflected in the current share price.
