Nvidia's (NVDA 2.24%) rise in the last year to become the most valuable semiconductor business -- and among the world's most valuable businesses, period -- is well documented. In a word, it's because of AI.
But what of the financials at work propelling the stock higher? Nvidia has been clobbering the competition in one key metric. The question now is how long this situation will last.
Nvidia's ROIC soars
As calculated by research firm New Constructs, Nvidia's return on invested capital (ROIC) soared in the last 12 months -- even far above that of very well-run and disciplined peers in the semiconductor industry like Taiwan Semiconductor Manufacturing (TSM), Broadcom, and Qualcomm. Nvidia's ROIC just topped 50%, nearly 14 percentage points higher than second-place TSM at 36%, which is also an exceptionally good ROIC.
For the record, New Constructs calculates ROIC as net operating profit after tax (NOPAT) divided by average invested capital.
Image source: The Motley Fool.
What exactly does ROIC tell us?
ROIC is a useful metric in assessing a company's investment decisions. A high ROIC indicates the business is allocating capital (accessed via both debt and equity) to projects that are generating a high rate of profitable return. In the chart above, weighted average cost of capital (WACC) indicates the cost to Nvidia and its peers to access this capital for investment.
In this case here, Nvidia's investments in recent years were in computing systems and related software used in generative AI. Starting in late 2022 with the viral hit that ChatGPT became, all sorts of companies are in line to purchase Nvidia's AI systems.
CEO Jensen Huang and Nvidia's top team have indicated its data center sales -- primarily driven by those AI systems -- will continue to grow every quarter into calendar year 2024. This could mean that, with much of the research and development expense on these systems already complete, Nvidia's ROIC could actually continue to chug higher well into next year.
How high can Nvidia fly?
Huang and the top team have been putting their own AI to work to accelerate new system development. Huang has said what previously took two years between major product announcements has been shrunk down to as little as just six months. Maybe, just maybe, Nvidia's elevated ROIC can run hotter for longer than in times past.
That being said, Nvidia has a long history of spiking ROIC, followed by more prolonged periods of more average returns on invested capital. It would be wise for investors to assume ROIC to moderate, perhaps by the end of 2024. These periods of moderating ROIC tend to correspond with a semiconductor industry slump, which has caused Nvidia's stock price to fall.
Data by YCharts.
It appears Nvidia is earning its sky-high stock returns right now, but what becomes unclear is for just how long it can sustain these record levels that far exceed the semiconductor industry competition. Investors who don't already own Nvidia will likely be best served taking a cautious approach to Nvidia stock right now.
