Did Microsoft Just Give a Big Hint That Nvidia's Remarkable Run Could Soon Be Over?

There's no question which stock is most likely at this point to be the S&P 500's best performer of 2023. Nvidia's (NVDA 2.67%) share price has close to tripled year to date. The No. 2 S&P 500 stock -- Meta Platforms -- trails well behind with a gain of roughly 150%.

It's also no secret what has been the biggest catalyst for Nvidia. The surging interest in generative AI has fueled tremendous demand for the company's graphics processing units (GPUs). Microsoft (MSFT 1.71%) ranks as one of several tech giants that have been buying GPUs hand over fist. But did Microsoft just give a big hint that Nvidia's remarkable run could soon be over?

Supply and demand

Microsoft Chief Technology Officer Kevin Scott was interviewed by Nilay Patel with The Verge in May. At the time, he told Patel that being in charge of Microsoft's GPUs was "a terrible job." The problem, according to Scott, was that people within the company would get angry with him because they couldn't get enough GPUs. This dynamic didn't affect only Microsoft -- and it helped create a massive tailwind for Nvidia that showed up in its stock price.

Last week, Scott spoke with Patel again at the Code Conference held in Dana Point, California. He referred to how things were in May, stating, "Demand was far exceeding the supply of GPU capacity that the whole ecosystem could produce." 

However, it's a different story now. Scott said, "That is resolving. It's still tight, but it's getting better every week, and we've got more good news ahead of us than bad on that front, which is great."

Nvidia's increased supply might be just part of the good news. Microsoft is also reportedly working on its own AI chip, something that Amazon and Alphabet have also done. 

When asked about this, Scott wouldn't directly address the reports. He did respond with an interesting comment, though. Scott told Patel, "I'm not confirming anything, but I will say that we've got a pretty substantial silicon investment that we've had for years. And the thing that we will do is we'll make sure that we're making the best choices for how we build these systems, using whatever options we have available."

Economics 101

College students in Economics 101 class will almost certainly learn about the basic principles of supply and demand. When supply can't keep up with demand, prices rise. But when supply increases and/or demand decreases, prices fall.

Microsoft's Scott definitely seemed to confirm that Nvidia's GPU supply is increasing. There's also at least a possibility that alternative AI chips could reduce the demand for Nvidia's GPUs going forward. This does not mean that GPUs won't remain the gold standard for AI apps. However, it could contribute to reducing the tailwind that has helped Nvidia in a huge way this year.

If there were a Stock Valuation 101 college class, it would no doubt highlight the relationship between stock prices and projected future cash flows. When expectations of future cash flows change for any reason, it's likely to affect the stock price. Based on Microsoft's CTO's recent comments, the expectations for Nvidia's future cash flows perhaps shouldn't be as lofty as they have been. 

Keep in mind that Nvidia's shares currently trade at over 33 times trailing-12-month sales and nearly 41 times forward earnings. Those valuation metrics reflect an enormous amount of growth baked into the share price. If the company's actual growth fails to meet expectations, the stock will almost certainly fall.

Two other key considerations

So can we safely assume that Nvidia's remarkable run could be near its end? Not necessarily. There are two other key considerations.

First, investors shouldn't be surprised that the supply situation for GPUs is improving. Nvidia CFO Colette Kress said in the company's August quarterly conference call that Nvidia "expect[s] supply to increase each quarter through next year."

Second, it could take a while for the supply demand imbalance to be resolved. Don't bank on new AI chips from other companies to reduce the demand for Nvidia's GPUs.

My personal view is that Nvidia is probably headed for a significant pullback sooner or later. I'm not convinced that its current valuation is sustainable. However, I also think the stock will continue to be a big winner over the long term.