Share deep dive: Nvidia
Is Nvidia still a good buy after its meteoric rise?
Mentioned: NVIDIA Corp (NVDA)
As investors, it has been hard to avoid the story of Nvidia NVDA. has been In the last 2 years, from April 17 2022 to 2024, Nvidia has returned 227%. This compares to the S&P 500 return of 11%.
In this Investing Compass episode, we take a deep dive into what the company actually does, the risks it faces, and whether we think the company is still an opportunity.
A little about Nvidia
Nvidia designs and manufactures GPUs, which are Graphics Processing Units. They are a specialised electronic circuit that accelerate computer graphics. One of the main use cases for GPUs are gaming computers. Nvidia was an early leader and designer of GPUs, which were originally developed to offload graphic processing tasks on PCs and gaming consoles. They are the clear market leader in this space – they’ve got over 80% share according to Mercury research.
The other main use case is Artificial Intelligence.
GPUs are able to manage parallel workloads. Parallel processing has emerged as a near-requirement to accelerate AI workloads. Nvidia took an early lead in AI GPU hardware, but more important, developed a proprietary software platform, Cuda, and these tools allow AI developers to build their models with Nvidia. We believe Nvidia not only has a hardware lead, but benefits from high customer switching costs around Cuda, making it unlikely for another GPU vendor to emerge as a leader in AI training.
What are the risks?
Nvidia a very high Morningstar uncertainty rating. In our analysts’ view, they believe that the valuation will be tied to its ability to grow within the data centre and AI sectors. And this is great because it is a booming industry at the moment with a lot of research and funds flowing into its development. Being tied to one sector is always risk for businesses, especially ones that are emerging and we don’t have the full picture for. For better or worse, Nvidia is linked to this sector. We will just have to see how it unfolds, which is why it is given a very high uncertainty rating.
We do see a lot of competition. We see a host of tech leaders vying for Nvidia’s leading AI position. It is inevitable that companies like Amazon’s AWS, Microsoft, Google, and Meta Platforms will seek to reduce their reliance on Nvidia and diversify their semiconductor and software supplier base, including the development of in-house solutions as we mentioned.
And this isn’t in the future, they’ve already started to do this. Google’s TPUs and Amazon’s Trainium and Inferentia chips were designed with AI workloads in mind, while Microsoft and Meta have announced semiconductor design plans. There’s also existing semi conductor vendors that are joining the charge, like AMD. AMD is quickly expanding its GPU lineup to serve these cloud leaders. Intel also has AI accelerator products today and will likely remain focused on this opportunity.
So, the uncertainty rating is based on the uncertainty around this market. Nvidia dominates AI today and the sky is the limit for the company’s profitability if it can maintain this lead over the next decade. However, any semblance of the successful development of alternatives could meaningfully limit Nvidia’s upside.
Capital allocation
Nvidia is doing one thing really well – capital allocation. They’ve earned an exemplary capital allocation rating which is the highest rating that you can get.
When we speak about capital allocation, it refers to the way that management in a business spend their capital and is particularly important in the current environment. We can simplify this down to the three avenues for deploying capital – the balance sheet, investing in the business (internal and external) and shareholder distributions.
The capital allocation decisions that are made are based on the best utilisation of the capital to create value for shareholders as the owners of the company. And these decisions are never static, it will vary based on the company, the industry and market conditions.
The exemplary rating reflects a sound balance sheet, exceptional investments associated with the firm’s strategy and execution, and attractive and appropriate shareholder distribution policies.
Nvidia is in outstanding financial health. As of January 2024, the company held $26.0 billion in cash and investments, as compared with $9.7 billion in short-term and long-term debt. We think the firm generates sufficient cash flow and has ample resources to meet its debt obligations, capital expenditure requirements, potential acquisitions, and shareholder returns.
Nvidia has been perceptive. They’ve made almost psychic like investments in GPUs, networking semis, and software, as the company spent the past decade (if not longer) laying the groundwork to emerge as the clear leader in AI training GPUs and associated software and tools. Like many chipmakers, Nvidia’s hefty R&D budget enabled the company to remain on the cutting edge of GPU design.
Morningstar recently raised Nvidia’s fair value from $730 to $910 in March, and that was after the company’s tech showcase, called GTC. The keynote address introduced the company’s latest artificial intelligence graphics processor, or AI GPU, Blackwell, along with its associated platform and GPU clusters to enable AI workloads. You are able to read more about it here.
A $910 fair value puts Nvidia at a 3-star stock at 17 April 2024 – it last traded at around $874 and that is trading within a range that we consider fairly valued.
Ultimately, a good investment is acquiring a quality company at a great price, but also considering your financial goals. If you’re an investor that relies on sustainable dividends, Nvidia’s payout ratio has been volatile and negligible, to say the least. They are very focused on growing the business. The five-year average yield is 0.15%. The trailing 12-month dividend yield is 0.02%. If you’re an investor that has an outsized exposure to US tech, Nvidia may increase that exposure. If you are an investor that does not have a long-time horizon for Nvidia’s prospects to ride the AI wave to eventuate, this may not be the investment for you.
Listen to the full episode to understand the strengths of Nvidia, and further analysis from our analysts about the opportunities for the company.
You are able to find the podcast script below:
Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.
Mark LaMonica: Okay. Well, Shani, today we're going to talk about a stock that everyone is talking about. In the like 5% of the time that they're not talking about Taylor Swift.
Jayamanne: Yes.
LaMonica: And her new album. Although I saw an article, and yes, I'm a loser. This is how I read about Taylor Swift. I saw an article in the New York Times saying that there's a backlash because of her overexposure.
Jayamanne: Well, there you go.
LaMonica: Yeah. The New York Times said it has to be true. We had an exciting week.
Jayamanne: Yes. Did we?
LaMonica: I guess this happened a couple of weeks ago. We had a new joiner on the team.
Jayamanne: We do. Yes. So the team of two is now a team of three. And his name is Joseph. He's great.
LaMonica: And there we go. You just like him because he plays cricket.
Jayamanne: Yes. There's two against one now. I don't play. I just watch. But we can talk about it. I have someone to talk about cricket with now.
LaMonica: Does that mean you'll stop talking to me about it?
Jayamanne: Yes, probably.
LaMonica: So a win-win situation for everyone involved.
Jayamanne: Exactly. So why don't we talk about this stock?
LaMonica: Okay. So the stock is NVIDIA, which is how I would say it. But apparently it's also NVIDIA?
Jayamanne: Yes. It's a very common question. So common that the company has come out and told everyone how to pronounce it. And they said it was NVIDIA.
LaMonica: I don't understand why. This is the problem with these new names. Like they hire these naming consultants that come up with these ridiculous names and then people can't pronounce them.
Jayamanne: So before we started recording this podcast, this would have been a couple of podcasts recordings ago, Will said that we should have a segment where it was like what grinds Mark's gears. And he has 1 to 1.5 minutes at the beginning of the podcast where he just talks about something that is grinding his gears. So do you want to talk about naming consultants or NVIDIA today?
LaMonica: Okay. Well, the issue, okay. As an investor, to put this in investing context. So if a company that I own has a spin off, generally you get shares of that spin off as an existing shareholder. So then all of a sudden I have something in my portfolio and they're all obviously new companies and they bring in these naming consultants. And I don't know how to pronounce a lot of shares in my portfolio, which is just embarrassing because I come on here and I tell people they should know about the companies that they invest in. And I can't even talk about some of the companies in my portfolio because I don't know how to pronounce their names.
Jayamanne: Okay. Well, that wasn't quite one to 1 to 1.5 minutes, but we got there.
LaMonica: Okay. Well, there we go.
Jayamanne: (indiscernible)by any other name would smell as sweet Mark.
LaMonica: There we go.
Jayamanne: We'll have a lot of NVIDIA, NVIDIA in this podcast, but I guess what investors really want to know about NVIDIA is if it's still a good investment after its meteoric rise. Its performance has just been phenomenal.
LaMonica: And that is part of the reason why investors are obsessed with NVIDIA. So in the last two years from April 17th, 2022 to same date in 2024, the stock has returned 227%. And this compares to an S&P 500 return of 11%. So that's a lot more.
Jayamanne: A slight difference, but we always say on Investing Compass that chasing after returns almost always ends in tears. So this episode is going to be a share deep dive on NVIDIA and whether they're a quality business worth investing in and whether they are quality business worth investing in at the right price.
LaMonica: All right. So let's get started and we'll give a little rundown on NVIDIA. NVIDIA designs and manufactures GPUs and GPUs are graphics processing units. They are a specialized electric circuit that accelerate computer graphics. So one of the main use cases for GPUs are gaming computers.
Jayamanne: NVIDIA was an early leader and designer of GPUs, which were originally developed to offload graphic processing tasks on PCs and gaming consoles. They are a clear market leader in this space. They've got over 80% share according to Mercury Research.
LaMonica: But I think the reason that we're talking about this today is there's another use case for GPUs, and that is artificial intelligence. So this podcast is just full of buzzwords today, Shani.
Jayamanne: Exactly Mark. So NVIDIA, as we mentioned, is a market leader in GPUs. In fact, it has a wide economic moat thanks to their market leading products, which include GPUs, but also include hardware and software tools that are needed to enable the growth of AI. They have a huge grasp on this market, but our analysts imagine that over the long run, tech titans that use AI will develop and prefer in-house solutions to diversify away from NVIDIA. But this will only chip away their dominance. It won't get rid of it. So they enjoy a wide economic moat.
LaMonica: Now, did you say that deliberately chip away at their dominance?
Jayamanne: I don't think I did, but there we go.
LaMonica: You're not that funny. Okay. So let's talk a little bit about these GPUs. Basically, there's GPUs and they're able to handle parallel workloads. And then there's CPUs, central processing units, such as Intel's processors for PCs and servers or Apple's processors for its Macs and iPhones. They process the data of zeros and ones in a serial fashion. So the wheelhouse of GPUs has been the gaming market and NVIDIA's GPU graphics cards have long been considered best of breed.
Jayamanne: More important, parallel processing has emerged as a near requirement to accelerate AI workloads. NVIDIA took an early lead in AI GPU hardware, but more importantly, they developed a proprietary software platform, CUDA. And these tools allow AI developers to build their models with NVIDIA. We believe NVIDIA not only has a hardware lead, but benefits from high customer switching costs around CUDA. And that makes it unlikely for another GPU vendor to emerge as a leader in AI training.
LaMonica: And the CUDA platform is for AI tools. It enables developers to use NVIDIA's GPUs to build AI models. And a high switching cost means that there are a lot of barriers to entry for customers to switch. It's just too hard so they don't do it.
Jayamanne: So two sources of moat.
LaMonica: Yes. And as we mentioned, NVIDIA are market leaders in the GPU space and they have a wide economic moat. This moat is awarded for intangible assets associated with the GPU design and the associated software framework and tools required by developers to work with this GPUs.
Jayamanne: So we spoke a little about the risk that competitors pose. So let's delve into that a little more.
LaMonica: We do assign NVIDIA a very high Morningstar uncertainty rating. In our analysts view, they believe that the valuation will be tied to its ability to grow within the data center and AI sectors. And this is great because it's a booming industry at the moment with a lot of research and funds flowing into its development. But being tied to one sector is always risky for businesses, especially ones that are emerging and we don't have the full picture yet for it. So for better or worse, being linked to this sector has helped the share price but could be a risk in the future. We'll just have to see how it unfolds, which is why it's given a very high uncertainty rating.
Jayamanne: And we do see a lot of competition. We see a host of tech leaders vying for NVIDIA's leading AI position. It's inevitable that companies like Amazon's AWS, Microsoft, Google and Meta platforms will seek to reduce their reliance on NVIDIA and diversify their semiconductor and software supply base, including the development of in-house solutions as we mentioned.
LaMonica: And this isn't just in the future. They've already started to do this. Google's TPUs and Amazon's Trainium and Inferita chips were...
Jayamanne: Inferentia, I think that is, Mark.
LaMonica: Inferentia.
Jayamanne: You can go on about your naming consultants.
LaMonica: Well, these are all ridiculous names. But anyway, those chips were designed with AI workloads in mind. Well, Microsoft and Meta have announced semiconductor design plans. There's also existing semiconductor vendors that are joining the charge like AMD. AMD is quickly expanding its GPU lineup to serve these cloud leaders. Intel also has an AI accelerator product today and will likely remain focused on this opportunity.
Jayamanne: So the uncertainty rating is based on the uncertainty around this market. NVIDIA dominates AI today and the sky is the limit for the company's profitability. If it can maintain this lead over the next decade. However, any semblance of the successful development of alternatives could also meaningfully limit NVIDIA's upside.
LaMonica: Outside of the data center, NVIDIA's gaming business often faces boom or bust cycles, along with PC demand. And more recently, the sharp rise and fall of crypto trading and not just by will.
Jayamanne: NVIDIA also has invested heavily in autonomous driving. But again, squares off against many other chip makers and automakers for a piece of this pie with little guarantee of success.
LaMonica: We spoke a lot about where other companies are investing to try and compete with NVIDIA. Let's look inward, NVIDIA is doing one thing really well, capital allocation. They've earned an exemplary capital allocation rating, which is the highest rating you can get from a Morningstar analyst.
Jayamanne: When we speak about capital allocation, it refers to the way that management in a business spend their capital and is particularly important in the current environment. We can simplify this down to three avenues for deploying capital. The balance sheet, investing in the business, whether that's internal or external, and shareholder distributions.
LaMonica: The capital allocation decisions that are made are based on the best utilization of the capital to create value for shareholders as the owners of the company. And these decisions are never static. It will vary based on the company, the industry, and market conditions.
Jayamanne: The exemplary rating reflects a sound balance sheet, exceptional investments associated with the firm's strategy and execution, and attractive and appropriate shareholder distribution policies.
LaMonica: And NVIDIA is in outstanding financial health. As of January 2024, the company held $26 billion in cash and investments, as compared with $9.7 billion in short-term and long-term debt. We think the firm generates sufficient cash flow and has ample resources to meet its debt obligations, capital expenditure requirements, potential acquisitions, and shareholder returns.
Jayamanne: And NVIDIA has been perceptive. They've made almost psychic-like investments in GPUs, networking semis, and software. As the company spent the past decade, if not longer, laying the groundwork to emerge as a clear leader in AI training GPUs and associated software and tools. Like many chipmakers, NVIDIA's heavy R&D budget enabled the company to remain on the cutting edge of GPU design.
LaMonica: In terms of dividends, management initiated a quarterly dividend in the fourth quarter of fiscal 2013 to return excess cash to shareholders. And it currently has a stock buyback program. The firm returns cash to shareholders through ongoing cash dividends, which is $0.16 per share, which is frankly a rounding error compared to their price. And I'm sure the people that have gotten the 227% return in two years are really counting on those dividends, but they've also purchased shares.
Jayamanne: So let's move into the part that everyone always waits for, and that's a fair value.
LaMonica: So Morningstar recently raised NVIDIA's fair value from $730 to $910 in March. And that was after the company's tech showcase called GTC. The keynote address introduced the company's latest artificial intelligence graphics processor, or as you know now, AI GPU. And it's called Blackwell, a normal name, along with its associated platform and GPU clusters to enable AI workloads.
Jayamanne: As well as this, GTC showcased the efforts of the company's wide range of partners in areas such as robotics and automotive, amongst many others. Our analysts don't foresee these partners slowing their investments anytime soon, and that supports healthy growth estimates for NVIDIA in the years ahead.
LaMonica: So our analysts raised the fair value after taking a fresh look at our model assumptions, and they're more optimistic about future industry-wide capital expenditures, or CapEx, on AI GPUs in the decade ahead, both from large cloud computing vendors and enterprises. So as I said, Morningstar's fair value estimate is $910 per share, which implies an equity value of roughly $2.2 trillion. So for context, NVIDIA achieved 126% revenue growth in fiscal 2024, and our analysts anticipate another massive year with 91% growth to $116 billion in fiscal 2025. They model long-term mid-cycle revenue growth of roughly 10% per year for the business as a whole, resulting in a 28% compounded annual growth rate over the next decade.
Jayamanne: And a $910 fair value puts NVIDIA at a three-star stock on 17 April 2024, and last traded at around $874, and that is trading within a range that we consider fairly valued.
LaMonica: Ultimately, a good investment is acquiring a quality company at a great price, but also considering your financial goals. If you're an investor that relies on sustainable dividends, NVIDIA's payout rate has been volatile to say the least. They're very focused on growing the business. The five-year average yield is 0.15%. The trailing 12-month dividend yield is 0.02%. So as I said, a rounding error. If you're an investor that has an outsize exposure to U.S. tech, NVIDIA may increase that exposure. You're an investor that does not have a long time horizon for NVIDIA's prospects to ride the AI wave. This may not be the investment for you.
Jayamanne: It's important with all the decisions that you make, regardless of whether you have confidence in the thesis for the company's future, that you are still only investing in companies that align with the goals that you're trying to achieve.
LaMonica: And of course, just a warning that as Aussie investors, we need to also consider the impacts of currency as it will impact the total return that you will receive from an investment in NVIDIA. And maybe the best thing to do is, we've been told that AI can do everything, but maybe if it can send you back in time two years so that you can buy the share, maybe that is the best approach for investors. So anyway, thank you for us going through a podcast where we failed to pronounce most of the words correctly. We do really appreciate it. And of course, you can send critiques to my email address, which is in the show notes.
(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)
