The term "cheaper" in investing can mean many different things. It could be that the stock price itself is cheaper, but this is a very narrow definition and honestly not incredibly helpful in the days of fractional shares. There are also connotations about future growth or by what metric a stock is valued.
For many people, artificial intelligence (AI) powerhouse Nvidia (NVDA 0.03%) looks incredibly expensive. But when compared to the largest company in the world, Microsoft (MSFT -1.00%), I'd suggest that it's cheaper. How? Looking at a particular metric is critical in assessing where a company is heading.
There are many ways to assess how expensive a stock is
First, let's get the obvious out of the way. From a dollar basis, Nvidia looks expensive, at around $870 per share. Microsoft is much cheaper, at around $425. However, the stock price is just an arbitrary figure. The stock price is determined by the number of shares outstanding and the company's total value. Either of these two could enact a stock split to change the number of shares and make the stock more or less expensive from a dollar standpoint. This is why looking at the stock price doesn't help investors.
Instead, utilizing a metric to measure how expensive a company is will be a much better measure. For example, the price-to-earnings ratio divides the stock price by how much earnings per share (EPS) the company has, giving a ratio that tells investors how much they must pay for a single dollar of earnings. This is an incredibly useful metric for mature businesses like Nvidia and Microsoft.
One of the best metrics to consider in today's environment is the forward price-to-earnings (P/E) ratio. It's the same as the regular price-to-earnings ratio, except it looks at forward earnings instead of trailing ones. This is critical as companies like Microsoft and Nvidia are rapidly growing and adapting to this new environment filled with AI technology. Because neither company has generated these forward earnings yet, investors must use Wall Street analyst projections to value the business.
This isn't an exact science and can lead to some errors. However, it gives a better picture of where a stock may be heading, which is far more important than where it has been.
Both Microsoft and Nvidia should be valued this way due to their rapid growth. Nvidia's graphics processing units (GPUs) are the best in the business for creating AI models, and companies need to buy thousands of them to create a computer powerful enough to crunch through AI calculations and training. This has shown up in a big way in Nvidia's financial results, like in the fourth quarter of fiscal year 2024 (ended Jan. 28) when its revenue rose 265% year over year to $22.1 billion, and EPS shot up 765%.
Microsoft is implementing OpenAI's ChatGPT into many of its products and charging a premium to use the service. Additionally, its cloud computing service, Azure, is growing in usage. This is due to many customers increasing their use due to developing AI models, something Azure has the computing power to do. Microsoft isn't growing as fast as Nvidia, but its revenue rose a respectable 18% year over year in the second quarter of fiscal year 2024 (ended Dec. 31, 2023), and EPS was up 33%.
Both companies are doing well. But how is Nvidia cheaper?
Nvidia is cheaper than Microsoft in one key way
Returning to the forward-facing mindset, Nvidia's stock trades at a cheaper level than Microsoft.
NVDA PE Ratio (Forward) data by YCharts
This means that if each company hits its earnings projections over the next 12 months, Nvidia will be cheaper from a more traditional trailing earnings perspective if the stock prices don't move.
Much of this disparity comes from the expectations for Nvidia to grow massively, as Wall Street analysts expect 81% revenue growth this year. Microsoft is expected to grow by 15% this year, but that's still not enough to surpass Nvidia.
So, despite many investors worrying about how expensive Nvidia is, it's cheaper than the stalwart Micorosft. As a result, I think investors should consider investing in Nvidia instead of Microsoft, as it doesn't have near the growth levels despite the hefty price tag.
