If you're looking for the poster child of the artificial intelligence investment trend, look no further than Nvidia (NVDA +2.59%). Nvidia has seen a business explosion, and its stock has followed suit, as it has nearly tripled this year. But Wall Street analysts don't think the party is over either. The average analyst has a one-year $625 price target on the stock, indicating about 46% upside.
That's a fantastic gain for any stock to make in one year, which intrigues many investors (including myself). So, is it time to pile in on Nvidia? Or are there other considerations? Let's find out.
Nvidia's GPUs are needed in large quantities for AI
Nvidia is a critical component supplier in the AI world. Its graphics processing units (GPUs) are used in AI supercomputers to process mountains of information quickly. Nvidia has known about AI's potential for some time and tailored its product development for this day. As a result, Nvidia's GPUs are best-in-class for hardware used in AI.
Compounding the general demand for Nvidia's products is the need to buy hundreds or thousands of them at a time. Unlike some products in supercomputers, GPUs are clustered to increase their computing power, which requires customers to buy many at once.
This has been the driving force behind Nvidia's jaw-dropping quarters. Nvidia reported a 101% revenue increase in second-quarter fiscal year 2024 (ending July 30) and projected 170% revenue growth in the third quarter. Because of the strong demand, Nvidia can charge a massive premium on its products, which has significantly boosted its gross profit margin.
NVDA Gross Profit Margin (Quarterly) data by YCharts
Because Nvidia already has most of its operating expenses in place, this allowed its profit margin to soar as well, increasing to a company-record 46% in Q2. As this demand continues over the next year, expect Nvidia to produce eye-popping numbers.
But how long will this party last?
The government is restricting Nvidia's China exports
It's unknown how large the market's appetite is for Nvidia's GPUs. Nvidia is known as a cyclical company, as demand for its products rises and falls quite often. This happened most recently in 2021 when the cryptocurrency market crashed, as GPUs are also used in that industry.
NASDAQ: NVDA
Key Data Points
If there is a sizable market for AI supercomputers, Nvidia will enjoy these business gains for some time. But, if there isn't a second demand wave after the initial one has subsided, it could be a rocky time for Nvidia investors.
There are also other factors to consider, like geopolitics. The Biden administration restricted the export of some chips used in AI to China for some time, but it recently expanded this restriction to A800 and H800 Nvidia chips. The restriction of these two products alone caused a Citi analyst to drop its price target from $630 to $575, which still represents a significant upside.
Furthermore, Nvidia's stock is expensive. It trades for 103 times trailing and 39 times forward earnings, indicating analysts think Nvidia's profits will grow by 161% over the next year.
NVDA PE Ratio data by YCharts
That's a high bar to clear, and Nvidia must sustain its gains forever to stay valued at that level.
I think that's quite high for any company, which makes me concerned with Nvidia's long-term (three- to five-year) prospects. However, there's a real possibility that these gains could be permanent, so I think investors can devote a small portion of their portfolios to the stock.
Nvidia is too remarkable a company to miss, but that doesn't necessarily translate to an outstanding stock performance, either.
