It might be tempting to think that after achieving impressive gains over the past several years, NVIDIA (NVDA 3.28%) is running out of steam. The stock has gained over 1,000% in the past three years, and is up 65% so far in 2018. However, those thinking that the company's gains are largely behind it need only to look at the broad base of potential opportunities to see that NVIDIA's growth trajectory is firmly on track.
Gaming is the company's bread and butter, accounting for more than half its revenue, yet much of NVIDIA's potential rests on several megatrends that have yet to be fully realized.
NVIDIA Quadro RTX 8000. Image source: NVIDIA.
Do you want to play a game?
NVIDIA pioneered the GPU in 1999, which solved the problem of boxy images by using parallel processing capabilities to render graphics -- and the company has been the leader in the field ever since. While there have been a number of contenders, NVIDIA's commitment to spending freely on research and development (R&D) has enabled it to stay ahead of the pack. The company invested 18% of its revenue into R&D last year, and is on track to spend a similar percentage this year.
Its latest innovation has been called the "holy grail" of graphics. It spent 10 years in development and has the ability to recreate how light behaves in the physical world. Ray tracing has been around for some time and has been widely used in movies and television, but the computational demands were simply too great to bring to gaming in real-time -- until now.
NVIDIA recently revealed that its ray tracing or RTX technology, which will render light and shadows in a much more realistic way, is a "revolution in gaming realism and performance" and will soon be available for gamers. This leap forward in technology keeps the company at the forefront of the gaming industry and will likely spur additional demand as gamers upgrade to its latest offering.
Hitchin' a ride
Investors have likely heard quite a bit about the market for self-driving cars, and while the technology is beginning to come to fruition, full-scale adoption will take years to achieve. That doesn't mean NVIDIA isn't positioning itself now to take advantage of that massive opportunity. The company has partnered with more than 370 companies across the automotive industry -- from leading automakers to Tier One suppliers, and from sensor companies to mapping services.
NVIDIA's Drive PX-2 AI platform is a supercomputer that compiles and processes the data from the numerous cameras, radar, lidar (light detection and ranging radar), and other sensors necessary for cars to drive autonomously. NVIDIA's strategy of creating the brains to process all this data as well as its broad positioning give the company the greatest opportunity to benefit from this trend.
Jensen Huang, NVIDIA's CEO, believes that driver-less taxis will begin coming to market sometime in 2019, and self-driving cars will be available for sale between 2020 and 2021. The company believes the addressable market will top $60 billion by 2035.
NVIDIA's DRIVE PX 2 self-driving computer. Image source: NVIDIA.
AI is just beginning
The biggest catalyst for NVIDIA's growth over the past several years was the result of the wide scale adoption of GPUs to power artificial intelligence (AI) systems. Researchers found that the parallel processing capability that made the GPU perfect for rendering images worked equally well at training deep learning AI systems.
This has led to significant growth in the company's data center segment, which houses chips used in AI. The segment has produced growth greater than 70% in each of the last nine quarters and now accounts for 24% of NVIDIA's total revenue.
While some people have been waiting for an inevitable slowdown, Huang said on the company's most recent conference call that, "industry after industry after industry" was finding ways to benefit from AI. That's an indication that the AI boom is far from over -- in fact, it's just begun. The AI market is expected to grow at a compound annual growth rate (CAGR) of 36.62%, topping $190 billion by 2025.
Show me the money
In its most recent quarter, NVIDIA grew revenue to $3.12 billion, up 40% year over year, while earnings per share of $1.76 grew 91%. This isn't a one-off, either. The company has produced revenue that has grown 44%, on average, in each of the past 10 quarters.
Data center revenue is also still thriving, recently up 83% year over year, showing that NVIDIA is still benefiting from the ongoing adoption of AI.
How much is too much?
For many investors, the decision about whether or not to invest in NVIDIA is one that has largely been made along party lines. You have those on the growth side of the aisle, who buy based on the massive opportunities that lie ahead. On the other side of the aisle are the value investors, who largely avoid the stock due to its frothy valuation.
Those looking for bargains will point out NVIDIA's sky high valuation as a reason to avoid the stock. From a price-to-earnings perspective, NVIDIA trades at 39 times trailing earnings, and an only slightly lower 34 times forward estimates.
That valuation may not seem all that unreasonable, however, when you consider that analysts expect NVIDIA's earnings per share to grow at more than 63% annually over the next five years. With the number of growth opportunities the company is pursuing, those estimates may end up being conservative.
In the coming years, NVIDIA's stock will likely not see the 1,000% gains it produced over the past three years, but with multiple catalysts still on the horizon -- I think NVIDIA stock is a buy.
