Where Will Nvidia Be in 3 Years?

Once considered to be mainly a gaming-focused chip provider, Nvidia (NVDA 1.27%) has now positioned itself as an uncontested leader in the artificial intelligence (AI) space.

The company's GPUs have become the preferred choice for running the high-performance computing and AI workloads of Amazon, Alphabet, Microsoft, and many other major data centers across the world. A New Street Research report also claims that Nvidia's GPUs accounted for a 95% share of the machine learning (ML, a subsection of AI) market.

Celebrated hedge fund manager Stanley Druckenmiller considers Nvidia a solid buying opportunity for the next two to three years -- even after shares have gained nearly 228% so far in 2023. Could he and other Nvidia bulls be right? Let's find out.

The AI market opportunity

There is no doubt that Nvidia has emerged as a major beneficiary of the AI frenzy that has gripped the stock market after the launch of the next-generation chatbot ChatGPT. However, there is still a huge potential for future growth in this market.

Nvidia CEO Jensen Huang has predicted that data center operators will be spending nearly $1 trillion in the next four years on upgrading chips and other systems for AI workloads. He expects the bulk of this spending to come from cash-rich technology titans such as Amazon, Alphabet, Microsoft, and Meta Platforms.

Considering the significant capital expenditure budgets of these hyper-scalers, the market opportunity should be relatively resilient to economic upheavals. Furthermore, since Nvidia's AI chips are already sold out for 2024, the company is not likely to face significant challenges even in the case of a market downturn.

Besides focusing on hardware infrastructure that supports AI workloads, Nvidia has also made major strides in the AI software business. The company has guided for a long-term annual target addressable market of $1 trillion -- of which over $300 billion is attributed to AI software.

CUDA development environment

First introduced in 2006, Nvidia's Compute Unified Device Architecture (CUDA) software stack -- a parallel programming platform for general computing on GPUs -- has emerged as a major competitive advantage against other chip players. The CUDA software toolkit (comprising a huge array of developer tools, software libraries, and support for deep learning and AI applications) is used by over 4 million developers and has been downloaded over 40 million times.

Nvidia's hardware-software combination maintains a strong moat in the AI space. Since many of the advances in the field of AI can be attributed to the Nvidia chip+ CUDA combination, developers often prefer to stay with this ecosystem even in the presence of a lower-priced competing ecosystem. Furthermore, Nvidia also benefits from high switching costs (such as training costs, learning curve, and other expenses) that are involved for developers and companies changing chips and platforms.

Robust financials

Thanks to the jaw-dropping demand for the company's AI chips, analysts project that revenue for Nvidia's fiscal 2024 (ended Jan. 31, 2024) will rise by a whopping 100.5% year over year to $54 billion. Analysts also expect the company's adjusted earnings per share (EPS) to grow by 226.3% year over year to $10.90. These numbers highlight analysts' optimism about the company's growth potential in the current year.

Premium valuation is justified

Nvidia is currently trading at a price-to-sales ratio of 36.8 and price-to-earnings ratio of 116.7. Undoubtedly, the company is priced at a significant premium to the S&P 500, which trades at a P/S and P/E ratio of 2.4 and 24.4, respectively.

The S&P 500's blended earnings (combining the actual performance of companies that have reported results and estimates for those that are yet to report) are expected to grow by 4.1% year over year in the third quarter. By contrast, analysts expect Nvidia's third-quarter revenue and earnings (ending Oct. 31, 2023) to grow by a stunning 169.6% and 481.3%, respectively. Hence, considering the dramatic difference in the growth projections of Nvidia and the overall market, the company's premium valuation seems quite justified.

Analysts now expect Nvidia's fiscal 2027 (ending Jan. 31, 2027) revenue to be close to $112.2 billion. Multiplying this with the company's average three-year multiple of 24.9 gives us a market capitalization of $2.8 trillion. This implies that the company's share price can grow by nearly 134% in the next three years.

So is Nvidia a buy?

Nvidia has positioned itself as a force to be reckoned with in the accelerated computing market thanks to its superior AI chips and AI software offerings. With the AI market in its early stages of growth, Nvidia seems well-positioned to continue riding this wave in the coming years.