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Why Investors Shouldn't Underestimate NVIDIA

By John Ballard - May 1, 2021 at 7:27AM

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The chip specialist has a massive growth opportunity in software.

NVIDIA (NVDA -2.75%) is a leading supplier of chips for companies that need to process massive amounts of data with artificial intelligence (AI) workloads. Its graphics processors facilitate technologies that consumers engage with every day, including recommendation systems, AI-powered chatbots, and much more.

After a sharp price rise over the last year, the shares look expensive at a price-to-earnings ratio of 89, but based on recent growth and the announcements NVIDIA made at its investor day on April 12, it's difficult to call NVIDIA expensive. The stock could have legs over the next five years and beyond, as it starts to offer software solutions to enterprises. 

A side view of the Grace chip developed by NVIDIA.

NVIDIA Grace CPU. Image source: NVIDIA.

NVIDIA is leading the AI revolution

NVIDIA's revenue and earnings per share have grown significantly over the last five years, which has fueled a 1,600% rise in the share price during that time. Since fiscal 2017, NVIDIA's cash from operations has increased at an average annual rate of 37% per year. 

NVIDIA has long dominated the market for gaming graphics cards, and just recently, investors gave NVIDIA a big thumbs-up after it unveiled its Grace CPU, the company's first central processor designed for data centers. 

But what some investors might miss about NVIDIA's business is that it's not just high-powered chips that are fueling its growth. On top of chips, NVIDIA offers software and applications, which partly explains why profits are piling up. 

NVIDIA is building platforms combining software and hardware that basically make it easier for organizations to use AI. It's sort of like Microsoft transitioning from MS-DOS to Windows in the 1980s, ushering in a wave of new consumers wanting to use a PC. In a way, NVIDIA is positioning itself to be the Microsoft of the AI revolution.

Here are a few examples of what NVIDIA is offering:

  • NVIDIA recently unveiled NVIDIA AI Enterprise. This platform makes it easier and faster for companies to implement AI across their applications. NVIDIA developed AI Enterprise in partnership with VMware, a leading cloud infrastructure services provider that 70% of companies around the world use.
  • NVIDIA Jarvis is a software suite that provides organizations with the tools to use conversational AI, speech recognition, and text-to-speech capabilities. 
  • NVIDIA Omniverse is an interactive platform that allows graphics artists to collaborate virtually with other team members to create 3D objects. 

NVIDIA is widening its competitive moat with these platforms. Adding software tools on top of hardware leads to a much tighter relationship with customers than just selling them a chip. After all, there's always the risk that a competitor will make a better chip, as Advanced Micro Devices has demonstrated in taking market share from Intel.  

The chip-as-a-service has arrived

Our chips and systems market opportunity is profoundly greater with NVIDIA AI and NVIDIA Omniverse.
-- CEO Jensen Huang during NVIDIA's 2021 investor day. 

Looking at what NVIDIA is charging customers for AI Enterprise, it's clear why management believes its AI software platforms are a multi-billion-dollar opportunity. 

For AI Enterprise, NVIDIA will charge a license fee of $3,595 per CPU socket, and VMware has more than 300,000 enterprise customers. That's a potential market of 8 million CPUs per year. Plus, NVIDIA is offering a subscription service for $899 annually per license.  

Another big opportunity is NVIDIA DRIVE, which is the centerpiece of NVIDIA's push in the self-driving car market. Daimler's Mercedes-Benz reached a deal with NVIDIA last year to use the NVIDIA DRIVE AGX Orin chip to deploy autonomous capabilities across the Mercedes fleet starting in 2024. 

Like AI Enterprise, NVIDIA DRIVE could lead to a substantial amount of recurring revenue for NVIDIA. Mercedes will build next-generation cars that run on system software like a computer. The car will receive over-the-air updates, just like downloading a new update for your phone.

The important part of the deal is that NVIDIA has a revenue-sharing agreement with Mercedes-Benz, where it will earn revenue for every software sale. Car owners will be able to purchase new software features that improve the driving experience while keeping the car updated with the latest autonomous features. With millions of cars on the road, this opportunity could add up to something big over time.

NVDA Chart

NVDA data by YCharts

The opportunities are massive in AI software

The market for in-car services is currently estimated at $5 billion but could grow to be many times that, depending on how many of the 100 million cars currently on the road end up running on NVIDIA DRIVE. For perspective, NVIDIA's fiscal 2021 revenue totaled $16.7 billion. Of course, this is just the opportunity in transportation. Data center alone is a $100 billion opportunity, according to NVIDIA.

It's for these reasons that I wouldn't underestimate NVIDIA even at its current expensive-looking share price. NVIDIA AI is in every cloud, and it's positioning to be the technology backbone of every sector of the global economy. All of this points to further highs in the stock price over the long term.

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