If there was a poster child for the advent of artificial intelligence (AI), there's a strong argument it should be Nvidia (NVDA 6.18%). The stock generated blistering gains of 239% in 2023 and was already up 72% so far this year (as of the market close on Monday), regularly notching new all-time highs.
The company, best known for its graphics processing units (GPUs), has adapted its technology to run AI systems and has essentially cornered the market. Rivals are scrambling to invent a better mousetrap, but thus far, none has been forthcoming.
This has investors in a quandary. After clocking 483% gains in roughly 14 months, is Nvidia stock still a buy? Let's dig into the evidence to see what it reveals.
Image source: Getty Images.
How Nvidia became the gold standard
It's easy to dismiss Nvidia's recent run as a delightful happenstance, but it was actually years in the making. More than a decade ago, CEO Jensen Huang focused on technology that wasn't discussed much outside academic circles -- AI.
Back in 2009, researcher Geoffrey Hinton, widely acknowledged as the "Godfather of AI," used Nvidia processors to train a deep learning neural network, laying the ground for much of the AI research that followed. After achieving astonishing results, Hinton sang the praises of Nvidia GPUs to his colleagues, who soon began using the processors for AI, and the rest, as they say, is history.
Since then, Nvidia has become the gold standard for machine learning, an established branch of AI, controlling an estimated 95% of the market, according to market intelligence company CB Insights (via BBC). This extends to data centers, where much of the AI processing is done, as Nvidia controls a dominant 95% share of that market as well, according to CFRA analyst Angelo Zino.
Because Nvidia was so entrenched in the existing AI market, this paved the way for a groundswell of GPU demand when generative AI broke out early last year.
Nvidia's growth is off the charts
It's this rapid and accelerating demand for AI that has supercharged Nvidia's growth. For its fiscal 2024 fourth quarter, ended Jan. 28, Nvidia generated record revenue of $22.1 billion, which soared 265% year over year. Profit was also robust, as adjusted earnings per share (EPS) of $5.16 surged 486%. This marked the third successive quarter of triple-digit year-over-year growth.
If that wasn't enough, management expects the company's growth spurt to continue. For its fiscal 2025 first quarter, Nvidia is guiding for record revenue of $24 billion, up 234% year over year and 9% sequentially. This illustrates that the adoption of generative AI continues to accelerate, and there could be more to come.
Is Nvidia stock simply too expensive?
I might as well address the elephant in the room, as it encapsulates the debate that rages on Wall Street: Is Nvidia stock simply too expensive? The answer to that question, quite frankly, is "it depends." Investors have their preferences when it comes to valuation metrics, but truth be told, there isn't one that's the be-all and end-all -- and each has its limitations.
For example, based on its price-to-earnings ratio of 71, the stock appears wildly expensive, more than double the value of the S&P 500. Furthermore, at 35 times sales, the stock also appears ridiculously expensive, as a reasonable price-to-sales ratio is generally considered to be between 1 and 2. These are the two most commonly used valuation metrics, which would suggest the stock is too expensive.
Unfortunately, neither of these backward-looking metrics factors in Nvidia's relentless and ongoing triple-digit growth. For that, we turn to the price/earnings-to-growth ratio, which values Nvidia at less than 1, the standard for an undervalued stock.
A vast and growing opportunity
Despite its rapid adoption, it's important to remember that generative AI is still in its infancy. These next-generation AI systems appeared just over a year ago, and the number of use cases is growing exponentially.
While estimates vary wildly regarding the potential size of the AI market, the generative AI market alone could add between $2.6 trillion and $4.4 trillion in economic value annually, according to global management consulting firm McKinsey & Company.
It's unlikely that Nvidia can keep up its relentless pace of growth indefinitely, and the days of easy comps are in the rearview mirror. Furthermore, a rival could create a processor that's better equipped to handle the rigors of AI -- and a host competitors are working to achieve that goal.
That said, given Nvidia's entrenched position, the breadth of the opportunity, and reasonable valuation, investors would do well to at least consider owning a piece of this runaway train.
