After suffering through the worst market downturn in over a decade, investors are cautiously optimistic that 2023 will turn out differently. And thus far, anyway, there are reasons to be hopeful. Each major stock market index has rebounded by 20% or more from their troughs reached late last year. This has some pundits announcing the start of the next bull market, though not everyone agrees.
Helping to fuel the market recovery are extraordinary advances in artificial intelligence (AI). The next generation of large language models have been trained on increasingly large amounts of data, and the generative AI that results can create original content and handle tasks previously conducted by humans. While estimates vary, experts agree that the resulting productivity gains could add trillions of dollars to the economy by the end of the decade, which could ultimately drive stock prices higher.
These potential gains have investors scrambling to find the stocks best positioned to profit from the AI boom, and arguably no company is better situated than Nvidia (NVDA 6.98%).
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The opportunity is vast
The debut of ChatGPT last year helped illustrate the many ways generative AI could increase productivity. Drafting emails, compiling research, and writing code were just a few examples, with more being unearthed with each passing day.
These AI systems require incredible computational horsepower to train and run the growing mounds of data, and that's where Nvidia comes in. Researchers had already discovered that the parallel processing capability of the company's graphics processing units (GPUs) -- which allow the chip to carry out a multitude of mathematical computations simultaneously -- was perfect for the unique demands of AI.
Nvidia leaned into its expertise, creating ever faster and more robust chips better suited to AI, speeding up the process. What once took months can now be accomplished in days or even hours.
Just this week, Nvidia announced that the latest generation of its AI processor -- the GH200 Grace Hopper Superchip -- can now process 5 terabytes (trillion bytes) of data per second, up from 4 terabytes for the previous version.
Advanced AI chips have become table stakes in the data center industry as more workloads move to the cloud. At an industry conference this week, Nvidia CEO Jensen Huang said that a $100 million center outfitted with dated technology could be replaced for just $8 million, resulting in 20 times less power consumption. This gives existing facilities a compelling reason to upgrade to the latest processors.
Evidence is mounting
When Nvidia reported its fiscal 2024 first-quarter results, it was the first clear sign that the AI revolution had begun. Revenue of $7.2 billion climbed 19% year over year, while its data center segment hit a record of $4.3 billion.
It was the company's guidance, however, that turned heads on Wall Street. Nvidia's outlook called for revenue of $11 billion at the midpoint of its guidance, an increase of 64% year over year and 53% sequentially. It was also more than 50% higher than analysts' consensus estimates at the time, which called for revenue of roughly $7 billion.
This provides a glimpse of what could be coming, and Nvidia will likely be the biggest winner of the AI revolution.
The elephant in the room
It's important to acknowledge the biggest argument cited by bears regarding Nvidia: its valuation. And they have a good point. The stock has nearly tripled so far this year, and is currently selling for 53 times forward earnings and 18 times next year's sales, which is lofty no matter how you slice it.
Here's the thing. While that valuation certainly seems outrageous at first glance, it needs to be put into context. The adoption of AI is increasing at an unprecedented pace, and how far it has to go remains to be seen.
Wedbush analyst Dan Ives says, "This is the start of the fourth industrial revolution," which will spark a bull rally that could run for years. He estimates that AI could represent 8% to 10% of IT budgets next year, compared to 1% in 2023. As the gold standard for AI processing, Nvidia chips will continue to experience strong and growing demand.
Estimates regarding the impact of AI in the coming years vary greatly, but the figures are all astronomical. Conservative estimates by investment banks Morgan Stanley and Goldman Sachs suggest productivity gains will add $6 trillion and $7 trillion, respectively, to the economy by the end of the decade. Cathie Wood's Ark Investment Management offers a much more robust prediction, suggesting AI software will generate $14 trillion by 2030.
Based on what we know right now, Nvidia's valuation is undoubtedly egregious. However, if the impact of AI is anywhere near what experts suggest, Nvidia's processors are the key to the next generation of AI, and the sky could be the limit.
That's why, despite its elevated valuation, I believe Nvidia stock is a buy.
