Nvidia (NVDA 1.69%) stock has been on a tear this year amid the arms race for artificial intelligence (AI) technology. The company is the leader in the market for graphics processing units (GPUs), which are required to do everything from playing video games to training computers to process information intelligently like a human.
While the company has had its ups and downs in recent years, there are a few reasons why Nvidia might be the perfect AI stock for a young investor.
1. Dominance in gaming
While AI chip demand is driving Nvidia's stock higher this year, many young people are probably familiar with the company as a gaming brand. This is a good starting point to understand what Nvidia is all about. It pioneered graphics processing technology in the 1990s for PC gaming long before it expanded the technology to other markets.
Gamers are also familiar with Nvidia's competitor Advanced Micro Devices, which makes the Ryzen series of desktop central processing units (CPUs) and Radeon family of GPUs. AMD also supplies custom GPUs for Sony's PlayStation and Microsoft's Xbox. Meanwhile, Nvidia provides custom chips for the Nintendo Switch, while dominating the discrete GPU market on PCs for many years.
Nvidia's focus on the PC has worked out very well for shareholders. Before Nvidia's data-center business took off, gaming was Nvidia's largest source of revenue and still represented 31% of the business last quarter. Quarterly gaming revenue more than doubled over the last five years, while the data-center segment grew even faster.
With an estimated 400 million new gamers expected to pick up the hobby by 2027, Nvidia's gaming business is still a major growth opportunity. As for AI, Nvidia is already bringing the technology to gaming with the Nvidia Avatar Cloud Engine, which will bring games closer to realism and potentially attract more gamers to Nvidia's GeForce family of gaming GPUs.
2. Superior growth from AI
Another AI stock that is a good option for a young investor is Microsoft. The software giant could be considered "safer" than Nvidia because it generally has less share-price volatility. Nvidia has been a bumpier ride in recent years for shareholders, but this hasn't kept it from outperforming Microsoft.
Strong growth from Nvidia's gaming and data-center segments has driven the stock up 650% over the last five years, compared to a 217% return from Microsoft.
Data by YCharts.
Over the next two years, analysts expect Microsoft to add about $65 billion to its revenue total, which should mostly come from growth in cloud services and AI solutions. Analysts expect Microsoft to grow earnings per share (EPS) by 14% per year over the next five years, but Nvidia could grow the bottom line by 21% per year.
Even though Nvidia stock is more expensive on a price-to-earnings basis, the expected growth could support further gains for investors.
In fact, it's possible analysts are underestimating the demand for Nvidia's AI chips right now. The company guided for revenue to nearly double year over year for the fiscal second quarter (Nvidia will report earnings results later in August). Nvidia could be entering a stretch of tremendous year-over-year revenue growth that could blow away the Street's estimates and support the stock's valuation.
Be prepared for bumps in the road
Nvidia's GPUs are known to control up to 95% of the AI chip market, but that will likely come down a little once AMD inevitably launches its own AI solutions. Obviously, companies would like to have AMD as a solid alternative to Nvidia to help mitigate the expensive prices that Nvidia can command for these advanced chips. But investors should expect Nvidia to hold a market-share lead in AI hardware similar to PC gaming chips, given the company's long-standing relationships with customers.
Nvidia will experience some bumps along the way. The demand cycle for GPUs has gone through soft periods, which have occasionally caused Nvidia to report financial results below expectations. The stock collapsed in 2018 and 2022 because of weak demand for data-center and gaming chips, but the long-term demand trends in these markets have supported outstanding returns to shareholders.
Buy and sell decisions in the stock market are most profitable over the long term when made with a business-focused mindset. A patient investor should do well with Nvidia over many years. Its dominance in gaming and the AI market, in addition to opportunities in self-driving car hardware systems, could drive the stock much higher over the next decade and beyond.
