When it comes to investing, I'm a big believer in a modified version of Newton's first law of motion -- an object in motion tends to stay in motion unless acted upon by an outside force. Over the last several years, NVIDIA Corporation (NVDA +1.67%) has been an object in motion and thus far there has been no outside force capable of diverting it from its course.
That said, investors should always be aware of the potential for disruption and of the potential for outside forces that could knock the company off its current trajectory. The stock performance over the last three years has been nothing short of phenomenal, racking up 700% gains in that time. Let's look at a few of the potential roadblocks that could interfere with NVIDIA's forward motion.
NVIDIA's GTX 1080 Ti -- The Fastest Gaming GPU Ever. Image Source: NVIDIA.
1. Competition in its core gaming market
NVIDIA has been the go-to graphics processing unit (GPU) in the gaming market for years. In terms of raw power, high-end gamers sought the unmatched performance of NVIDIA's GPUs. Advanced Micro Devices, Inc. (AMD 0.03%) has largely competed in the low end of the GPU market and provided better performance on a dollar-for-dollar basis. Investors shouldn't take it for granted that this will continue. AMD could make a breakthrough in its next generation graphics cards. Last year's Polaris GPU helped AMD steal market share from NVIDIA and investors and gamers both have great expectations for AMD's Vega lineup. If the company succeeds in taking even more share from NVIDIA, there could be a commensurate adjustment in the stock price.
Gaming revenue is the most significant source of revenue for NVIDIA and in the most recent quarter, it grew to over $1 billion, up 49% over the prior year quarter. It accounts for more than half of NVIDIA's sales. If AMD were able to develop a processor that steals share from the high end of the market, NVIDIA's stock would pay the price.
2. Somebody could build a better AI mousetrap
This has been the swan song for many a company over the years. It becomes the industry standard until something better comes along. NVIDIA has become the top choice for training artificial intelligence (AI) systems and has continued to innovate and further develop its GPUs for those applications. What the future holds in AI, however, is anybody's guess. Every company in the big tech arena is throwing everything they have at AI, which will likely result in revolutionary developments that we can't yet conceive. Several companies are already working on competing processors.
In its most recent quarter, NVIDIA's data center revenue, which it derives from AI sources, grew to $409 million, up 186% year over and year and currently represents 21% of the company's total revenue. Investors should be prepared for a day when GPUs may be obsolete for AI applications. I'm not saying it will happen, but it could.
3. Succession planning
The success at NVIDIA has largely been the result of the determination and innovation fostered by its founder and CEO Jensen Huang. His ability to recognize an opportunity and leverage it into a catalyst has been largely unappreciated. He relentlessly pursued AI before it was a household word. If for any reason he was unable to continue his leadership of the company, investors might lose faith and the stock could come crashing down.
4. What goes up, must come down
I'm not a big fan of judging a stock merely on valuation. Those types of calls tend to be short lived and not necessarily based on any potential future opportunities or operational execution. To me, this is a fool's game and one I'm not usually willing to play. That said, even with the recent tech sell-off, NVIDA's stock has risen nearly 700% in the last three years and currently trades at a hearty 49 times trailing earnings and an only slightly more reasonable forward multiple of 42 times. Any failure to execute, either real or perceived, and the market sell-off of NVIDIA's stock will likely be swift and brutal.
5. A lot riding on self-driving cars
NVIDIA has been pursuing the autonomous driving technology that has been garnering a significant number of headlines, though the underlying technology has much broader applications. It has also developed an unprecedented level of partnerships in its quest to conquer the self-driving challenge and garner the potential rewards. The company lists 25 automotive partners on its website, including Tesla, Inc., Toyota Motor Corporation, Honda Motor Co., Ltd., and Bayerische Motoren Werke AG, which goes by BMW -- to name a few.
Each of these companies is counting on NVIDIA's vision to provide an end-to-end solution, from software to hardware. Autonomous driving is still in its infancy and we don't yet know any of the potential consequences. If the technology were to begin making questionable decisions that resulted in lives being lost, a significant portion of NVIDIA's forward-looking strategy could be in jeopardy. In the most recent quarter NVIDIA's revenue from the auto category grew to $140 million, an increase of 24% over the prior year quarter and now represents 7% of the company's total revenue.
NVIDIA is a big player in self-driving cars. Image source: NVIDIA.
A word to the wise
NVIDIA has been a windfall for investors over the last several years. The company has been making all the right moves and there's no reason to think that won't continue. Still, it is always worth examining the risks and knowing both the bull case and the bear case for a company.
