Nvidia's (NVDA 2.94%) stock has been red hot for over a year now. Up an incredible 239% in 2023, it has continued to climb more than 45% so far in 2024 already. Investors aren't averse to paying a high premium for the stock given the potential that the company possesses.
For long-term investors, it's hard not to like Nvidia's growth prospects. Artificial intelligence (AI) is a huge opportunity for the business and its chips, which could prove to be essential for companies developing their own AI models and chatbots.
But there's a big concern that I see as the stock continues to rise, and one that could derail its progress: The expectations may be far too high.
Nvidia's PEG ratio suggests the stock is cheap
Nvidia's stock trades at nearly 100 times its trailing earnings. Even if you base it on the company's estimated future profits, the multiple is still a bit high at around 36. What investors can turn to in order to help normalize the company's earnings multiple is the price-to-earnings-growth ratio, or PEG.
The PEG multiple takes the price-to-earnings (P/E) ratio and divides it by the expected earnings growth for the business over the next five years. Nvidia's PEG ratio is less than 1, which implies that it's a good deal. If the PEG multiple is below 1, that indicates the company is expanding at a fast rate and the current P/E multiple may be justified, and that the stock is even cheap given the company's future growth prospects.
NASDAQ: NVDA
Key Data Points
How bullish is too bullish for Nvidia?
The problem with this conclusion, however, is that it depends heavily on analyst earnings estimates. According to analysts' expectations and data collected from Yahoo! Finance, Nvidia's growth rate will average 95% annually for five years. What this means is that if you believe Nvidia can double its revenue for five consecutive years, then yes, it's a good buy even at a P/E multiple of close to 100. The problem with that is it can create an extremely high bar for the company to have to hit.
Nvidia's growth rate has been more than doubling, however, and so it isn't outlandish to believe that it could maintain that high of a rate next year.
NVDA Revenue (Quarterly YoY Growth) data by YCharts
But how Nvidia will do in three or four years is more debatable. Previously, OpenAI CEO Sam Altman warned that people were effectively "begging to be disappointed" with AI's capabilities. If that turns out to be true, the risk is that the level of investment in AI that analysts and investors expect could way off base. And any drop in demand could make Nvidia's expensive stock vulnerable to a sell-off.
Should you invest in Nvidia's stock despite its high price?
Nvidia is a promising stock to own because it is a leading supplier of AI chips. But at its extremely elevated price tag, it's not a stock I would buy today. If you're willing to hang on for several years, it could still be a good buy. But with expectations set so high, there's a fair amount of risk starting to creep into the stock, which could set it up for a correction in the future.
Investors may want to consider buying other AI stocks that can provide them with potentially more upside.
