Inflation is on pace to be its highest in 40 years, driven by consumer demand and higher supply costs. Companies have seen raw-material prices soar over the last year, and not all of them are in the competitive position to pass those higher costs to customers.
Some investors can make the mistake of investing in value traps during periods like this. My preference is to look for companies experiencing robust demand for their products, even if the stocks have higher valuations. No investments are immune from a broad market sell-off, but companies experiencing lots of growth are in a stronger competitive position to outperform the market over time.
Inflation isn't going to stop the increasing amount of data that the world is gathering. This is driving accelerating demand for Nvidia's (NVDA -3.67%) advanced graphics processors designed for data centers.
Companies are racing to invest in high-performance computing systems needed to process large amounts of data in the fastest time possible. Let's dive deeper into Nvidia's business momentum and why the stock is running up my buy list.
Dominating the AI market
Companies are deploying Nvidia's graphics chips to run sophisticated artificial-intelligence (AI) applications and services. These are services that people engage with every day, such as image and speech recognition, natural language processing, chatbots, personalized recommendations, and cloud graphics and gaming.
Over the last three quarters, Nvidia's data center revenue has increased by 71%, 55%, and 35%, respectively. This acceleration entering the new year reflects a widening competitive position for Nvidia as an AI-chip leader.
Buying shares of Nvidia is basically making a bet on the growth of data, just as buying Intel in the 1990s was a bet on the growth of consumer PC sales. Chipzilla has made early investors a lot of money as it became the dominant supplier of CPUs. Nvidia is following a similar course in the graphics processing unit (GPU) market as it controls more than 80% of the market for AI processors used in the cloud and data centers, according to a 2021 report from Omdia.
Nvidia has solidified its lead with recent partnerships. It recently announced that Facebook parent Meta Platforms will deploy 6,000 A100 GPUs in its new AI supercomputer. Meta is expected to expand its usage to 16,000 chips later this year.
Block is using Nvidia GPUs to power its conversational AI for Square Assistant. Meanwhile, social-media leader Snap is using the company's chips to power its recommendation software. Strong demand from leading tech firms is ultimately powering explosive growth on Nvidia's bottom line.
The ultimate inflation beater -- expanding margins
Since Nvidia is the leader in AI processors and system software, it can price its products for healthy margins. As demand exploded over the last four years, Nvidia's non-GAAP (adjusted) operating profit margin improved from 37% to 47%. In fiscal 2022, the company generated $8.1 billion in free cash flow on $27 billion in revenue.
Management guided for fiscal first-quarter revenue to grow approximately 43% year over year to $8.1 billion, plus or minus 2%. It's possible Nvidia could beat those estimates since it has left sales on the table due to supply constraints. During the recent earnings call, CFO Colette Kress said supply is "improving every single day" and near-term guidance implies accelerating growth in the data center segment in the fiscal first quarter.
As supply improves, there will be more gamers and enterprise customers able to get their hands on a GPU, so Nvidia should be able to maintain strong revenue growth throughout the year. The market may not be anticipating this, given Nvidia's forward price-to-earnings (P/E) ratio has dropped to 40 based on this year's earnings estimates. That's more attractive than just a few months ago when the stock traded at a high forward P/E of 75.
In fact, Nvidia's forward P/E is attractive compared to slower-growing blue chips like Nike and Costco Wholesale. Nvidia's 83% earnings growth and 40 P/E is a relative bargain next to these stalwarts.
The post-earnings sell-off doesn't make sense relative to Nvidia's underlying business momentum. But of course, any time wars and inflation occur, many stocks get dumped no matter how good the business is performing. This is the time for retirement savers to take advantage of Wall Street's nervousness.
As the valuation comes down amid accelerating demand in the data center business, the stage is being set for better returns. Nvidia's surging growth and high margins make it an ideal stock to buy in this current high-inflation environment, where companies posting decelerating growth are experiencing the brunt of the market's wrath.