When it comes to artificial intelligence (AI) stocks, few draw more attention than Nvidia (NVDA -0.01%). Its graphics processing units (GPUs) are the most popular to train AI models, making the stock a nearly perfect picks-and-shovels play for the AI revolution.
I say nearly perfect because every stock comes with a price tag, and Nvidia's is just too expensive for me. If you're curious about what Nvidia's current valuation implies, read on to find out.
Nvidia has a ways to go before looking like a $1 trillion company
Everyone knew Nvidia would benefit from an AI boost, which is why the stock price rose 47% from Feb. 22 to May 24, between Nvidia's quarterly reports for the fourth quarter of fiscal 2023 and the first quarter of fiscal 2024, despite Nvidia's revenue falling 21% in Q4. However, no one expected as massive a jump in demand, as Nvidia expects second-quarter revenue to be about $11 billion -- a 64% rise.
While that's a reason to celebrate, perhaps investors applauded it a little too much, as the stock is up about 30% since that guidance release.
With Nvidia hovering around a $1 trillion valuation, it's smart to look at the other companies with market caps over the illustrious trillion-dollar mark and see what kind of revenue and profits they generate.
NVDA Revenue (TTM) data by YCharts
From a revenue standpoint, Nvidia only generates an eighth of what Microsoft does. Even if you look at what Wall Street analysts think Nvidia's revenue will be by January 2025, $50.7 billion, it's still a far cry from other members of the $1 trillion market cap club.
Moving to the profit side, Nvidia is nearly tied with Amazon. However, Amazon makes up for its lack of profits with the highest revenue figure of any $1 trillion company. Once again, if you utilize 2025 earnings projections, Nvidia is only expected to generate $26 billion in profits. While that's much closer to Alphabet's current $58.6 billion in profits, it's under half its value despite using guidance that looks two years into the future.
Nvidia is clearly outclassed by other $1 trillion companies regarding revenue and profits. So that brings up the question, what is a reasonable price for Nvidia?
Even with impressive growth for three years, the stock is still highly valued
One factor Nvidia has going for it is its rapid growth rate. Although a weak PC market has dampened demand over the past year, AI has created a new wave of orders. Eventually, this rush will wear off, but by then, PC demand will likely have picked up again. This trend should allow Nvidia to continue growing its revenue fairly quickly, earning it a slight premium.
If we take a three-year mindset, allow Nvidia to return to peak profitability, and grow revenue by 50% this year, 30% the next, and 20% in the last year, that would give Nvidia revenue of $60 billion and profits of $24 billion. At Nvidia's current market cap, that would imply the stock is trading for 15 times sales and 41 times earnings.
That's an expensive valuation for a stock now, let alone one that can only achieve those numbers in three years by doubling its revenue.
If you adjust those metrics to a more reasonable 10 times sales and 27 times earnings, that would put Nvidia's stock price today at $261, a 34% downside, just to have a reasonable valuation in three years.
That's way too rich of a valuation for my liking, and even though Nvidia's products are great and the company will see significant growth due to AI demand, there isn't any room for the stock to grow. Because of that, I have to pass on Nvidia for now. But if its price comes back down to earth, I'd likely change my stance.
