Chipmaker Nvidia (NVDA -1.92%) has become a Wall Street darling. It's soared by a whopping 215% year to date as it takes advantage of the opportunity in artificial intelligence (AI), which boosts demand for its cutting-edge hardware.
Despite rising competition and a seemingly high valuation, the tech giant still looks poised to outperform. Here's a deeper look.
Why Nvidia?
Since its founding in 1993, Nvidia has been on the cutting edge of computer hardware because of its focus on graphics processing units (GPUs). This type of chip was initially designed to handle computer graphics and image processing, especially for video games.
GPUs work using a method called parallel processing, which involves performing multiple calculations at the same time. Because of this, they quickly caught on in other computationally demanding applications, like cryptocurrency mining and -- most recently -- generative AI, where they help train complex language models on vast amounts of data. Nvidia's fiscal second-quarter earnings highlight the company's ongoing transition from video game hardware to enterprise-focused infrastructure.
While total revenue jumped 101% year over year to $13.51 billion, growth was driven by the company's data center segment, which saw revenue jump by 171% to $10.32 billion -- over 75% of the total. This business involves sales of Nvidia's most advanced AI chips, such as the h100 and a100, the latter of which trained OpenAI's ChatGPT. Investors can continue to expect demand for these products to rise as more companies build and scale proprietary generative AI applications.
Competition is rising
According to The New York Times, Nvidia controls a whopping 70% of the market for AI chips. This has a lot to do with its early mover advantage as the first company to specialize in this type of hardware. But that won't stop rivals from trying to take a slice out of this lucrative pie.
In August, Alphabet revealed several new AI tools, including custom-built chips designed to serve enterprise users on its Google Cloud platform. This development follows the June announcement of Advanced Micro Devices' new M1300x, an AI chip designed to train large language models.
Image source: Getty Images.
While Nvidia won't be the only game in town, its GPU business has a strong economic moat because of its brand recognition, community of developers familiar with its products, and partnerships with other tech companies. The company also spent $2 billion on research and development in the second quarter alone, helping it stay on the cutting edge of this rapidly developing industry.
The valuation is better than it looks
On the surface, Nvidia's current valuation looks scary. The stock's price-to-sales (P/S) multiple of 35 is much higher than the market average of 2.4, while its trailing price-to-earnings ratio (P/E) of 110 is significantly above the market average of 25. But these high numbers reflect how fast Wall Street expects Nvidia's growth to ramp up as it pivots to AI.
Looking at the company's forward P/E, which compares Nvidia's current market cap to expected earnings over the next 12 months, the valuation falls to just 29, which is a reasonable premium to pay for what arguably seems to be the hottest AI investment available right now.
