Artificial intelligence (AI) is being touted as the next great technological revolution, with some analysts predicting it will add trillions of dollars in economic growth to the world over the coming decade.
In order for AI to take off, it's going to need a lot of computer processing power created by some specific types of processing chips to generate that artificial intelligence. It just so happens that semiconductor company Nvidia (NVDA -0.01%) has a large market share in these high-performance graphics processing chips. The market is well aware of that and it's a big part of why Nvidia's stock price exploded in 2023 with 190% gains so far this year.
If you're still looking to buy Nvidia stock at this point, it's essential to ask whether there's any upside left in the stock at this elevated price. Basically, is it too late to buy Nvidia?
Let's look at what's ahead for investors to try to answer the question.
Price follows expectations
Nvidia was successful before the AI hype of 2023. The company is the world's leader in the design of discrete graphics processing units (GPUs), which were traditionally used for gaming but have found their way into data centers, cryptocurrency mining, autonomous driving, and other applications that require lots of computing power.
But the explosion of AI progress in 2023 with generative AI, ChatGPT, and new AI ambitions sparked a race among enterprises. Nvidia had already been developing chips with these applications in mind, giving the company an estimated market share as high as 80% to 95%. Nivida only fueled the hype in its most recent quarter when its guidance blew estimates away.
NVDA EPS long-term growth estimates data by YCharts.
Wall Street has steadily increased expectations for Nvidia as it digests AI's potential and the company's key role in the industry. You can see in the chart that long-term earnings growth estimates have virtually doubled over the past six months.
The bar is now set high for Nvidia
The simultaneous rise of both Nvidia's shares and analyst expectations is setting an increasingly higher bar. You can see that looking backward, the stock's price-to-earnings ratio (P/E) is a blistering 220 times trailing-12-month earnings, while lofty estimates have muted the forward P/E to a tamer (but still pricey) 54.
Investors should remember that the higher a valuation goes, the higher the bar is set. The broader stock market, which has grown by an average of 10% annually throughout its history, trades at a forward P/E of 20.
NVDA PE ratio (forward) data by YCharts.
Therefore, if Nvidia can consistently grow earnings by nearly 40% annually, the stock's valuation could make sense here. After all, the stock trades at a valuation 2.7 times as expensive as the S&P 500 but could grow earnings nearly four times faster.
But here's the problem...
Buying Nvidia stock here sounds fine if everything goes according to plan. But something seems off about assuming years of hypergrowth and success based on a single quarter of impressive guidance. That's a small sample size of accomplishment to base a ton of future expectations on, especially when this is not a small company -- it's now a trillion-dollar business!
There is a list of potential bumps in the road. AI's hype will send the competition sprinting to get a piece of the action. Other chip companies will undoubtedly try to dethrone Nvidia (they may or may not succeed).
And big tech companies with deep pockets could design chips to save on costs over time. There could be an economic downturn that stalls heavy investments into AI technology, or the industry could fail to live up to expectations.
A lot of things could go right, but the sky-high expectations Wall Street has placed on Nvidia's shoulders might make the stock a risky investment from here because a minor stumble could cause a painful resetting of expectations downward.
It might not be too late to buy Nvidia if you're looking a decade ahead, but investors should probably resist the temptation to chase share prices and let the dust settle. A market correction could easily create a better buying opportunity in the future.
