The world has gone mad for AI. Setting aside what the latest AI models are actually good for, it is not surprising the Street is on the hunt for stocks with “AI exposure”. Unfortunately, this turns out to be a fairly short list at the moment, and at the top of that list is Nvidia.
Nvidia has largely captured all of the market for chips used for training AI models. and is doing fairly well with chips for inference. The company is incredibly well placed strategically. And that is reflected in the stock which is currently trading at 167x trailing twelve months earnings and 67x this year’s estimated EPS. Those are some big multiples, big enough to give many investors pause. True, they are unquestionably the leader in the hottest new market out there and there are no signs of anyone chipping into that dominance. On the other hand, this is a company which over its 40 year history has had numerous boom/bust swings. Their CEO has done an incredible job in getting them here, combining a deep technical understanding, a keen strategic mind and the eloquence to convince others of his Big Vision. But that eloquence has regularly gotten the Street overexcited about the numbers, often just ahead of a big inventory correction. There are no signs of a downturn out there, but to put it politely, this is a company that sometimes struggles to accurately forecast its end markets and effectively communicate its expectations to the market.
So what is Nvidia worth?
A big part of the disconnect right now is that for the first time Nvidia’s strong market position is based on software more than its hardware. For years, the company had to slog it out with AMD for leadership in the GPU Feeds and Speeds rat race. Nvidia has ended up winning most of those contests, but they always had some competition out there to let the air out of the balloon. The market for AI is different. Nvidia has been able to hold on to its lead because of its CUDA software. This is not exactly an operating system (OS), but its ubiquity and relative ease of use has ensured that it has become the de facto common software layer for much of the world where AI software meets silicon. AMD has never had anything to rival CUDA, and from what we can tell they are not even trying. And while there are many software libraries out there attempting to displace Nvidia, those are all owned or largely supported by software companies who do not really care enough about the intricacies of GPU firmware to create a true alternative. Maybe a few years of near monopoly will change that, but there does not seem to be anything on the horizon currently.
So if Nvidia’s software is their true competitive advantage, should they be viewed as a software company? This is just mildly outlandish, not totally outlandish, and worth considering. We ran some rough comparables for Nvidia stock in the graph below. Nvidia is already trading at more than double its large cap semis peers. It is also trading at a hefty premium to large cap, established software companies like Microsoft, Salesforce and Adobe. The closest multiple group are the new, high growth software companies like Snowflake and Datadogs. That is a lofty peer group. And while the Street expects Nvidia’s earnings to double over the next two years, Snowflake’s earnings are expected to double in a year. If Nvidia traded at Snowflake’s multiple, the stock would be worth ~$600, over double the current price of $291. The fact that we are even looking at a company like Snowflake for this discussion is reason enough to have some serious questions about Nvidia’s valuation.
A final way to think about Nvidia is think of other companies which monetize their unique software through the sale of hardware, which leads us to Apple. There is an investment banking MD shaking their head at us for even making the comparison as the two companies are very different. Nonetheless, conceptually they share that commonality of hardware prices with software differentiation. The problem is that even Apple trades at a discount to Nvidia, by almost 40%.
As much as we think Nvidia is executing incredibly well, it is really hard to be comfortable with the current share price.