Until recently, most people paid little attention to artificial intelligence (AI) because it worked behind the scenes. It was the enigmatic source of content recommendations, product suggestions, and personalized web experiences.
But ChatGPT recently thrust AI into the spotlight. The generative AI application allows users to interact directly with the technology, and its rapid adoption has whipped Wall Street into a frenzy. Many investors are buying AI stocks hand over fist.
For instance, the two wealthiest hedge fund managers in the world, Ken Griffin and Jim Simons, bought stock in Nvidia (NVDA -3.33%) in the first quarter. Griffin upped his stake in the chipmaker by 55%, making it his second largest holding (excluding options contracts), while Simons started a smaller position in the company. Given the financial success both money managers have achieved, investors would be wise to take a closer look at the stock.
Nvidia is synonymous with AI infrastructure
Nvidia reported mixed results in the first quarter. Revenue dropped 13% to $7.2 billion, but earnings under generally accepted accounting principles (GAAP) climbed 28% to $0.82 per diluted share.
However, the company stunned Wall Street with second-quarter guidance that implies 68% revenue growth, plus or minus 2 percentage points. Management attributes that forecast to a steep increase in demand for AI solutions, especially those related to generative AI and large language models.
Nvidia offers a broad slate of hardware products for 3D graphics and data center computing, including several types of semiconductors and high-performance networking solutions. But the company is best known for its graphics processing units (GPUs), chips designed to process lots of data very quickly. That makes GPUs very good at rendering realistic graphics and accelerating complex data center workloads like AI.
Nvidia dominates both markets. The company holds more than 90% market share in workstation graphics and supercomputer accelerators, and its GPUs are synonymous with AI infrastructure, according to Forrester Research. Indeed, the company has consistently achieved top results at the MLPerf Benchmarks, an event that measures the performance of AI computing products. But Nvidia is working to reinforce its strong competitive position by diversifying beyond hardware.
Nvidia is expanding into cloud software and services
Nvidia supplements its state-of-the-art chips with a growing body of subscription cloud software and services. For instance, its DGX Cloud provides businesses with on-demand access to AI supercomputing infrastructure. It works in conjunction with Nvidia AI Enterprise software to accelerate the development of AI applications across various industries, including retail and financial services, transportation, and healthcare.
Also, Nvidia AI Foundations is a suite of services that empower businesses to build generative AI applications for text, visual content, and biomolecular design.
Similarly, the company's Omniverse Cloud provides on-demand access to supercomputing hardware and software for 3D design and metaverse application development. Omniverse also includes tools to train and test autonomous machines (e.g., cars and robots) and build intelligent digital avatars.
Those subscription products are noteworthy for two reasons. First, they build on the brand authority Nvidia has cultivated with its hardware, and they extend its ability to monetize graphics and AI. Second, revenue from subscription software and services tends to be less cyclical than hardware revenue.
Nvidia stock looks expensive
Nvidia is an excellent business with a bright future, but it might not be a great investment at its current valuation. The company saw its share price skyrocket following its first-quarter earnings report, and the stock currently trades at 37.6 times sales, a significant premium compared to the three-year average multiple of 21.3. At that price, risk-averse investors should steer clear and risk-tolerant investors should be cautious.
As an Nvidia shareholder myself, I have no plans to sell, and I firmly believe the stock is worth owning over the coming decade. Management estimates its addressable market at $1 trillion, meaning the company has hardly scratched the surface of its potential, but that should change as demand for AI solutions continues to grow.
Even so, I believe investors will have far better buying opportunities in the future. Given its rich valuation, this growth stock will almost certainly be volatile, and it would be prudent to wait for the share price to pull back.
