If you want to bet on generative artificial intelligence (AI), there is still no better pick than Nvidia (NVDA 1.75%). The company dominates the market for cutting-edge AI data center chips. And unsurprisingly, shares have risen by a whopping 206% over the last 12 months alone. But can the bull run continue? Let's look at three reasons to continue buying Nvidia stock and one reason why it might be time to sell.
1. Spectacular performance
While Nvidia's parabolic stock price surge may look like a bubble, it isn't. The rally is justified by equally impressive operational results. Fourth-quarter revenue surged 265% year over year to a record of $22.1 billion, driven by sales of cutting-edge AI hardware. Profitability is also exploding, with net income jumping almost ninefold to $12.3 billion.
Nvidia is enjoying a windfall from selling graphics processing units (GPUs) like the h200, which data center clients use to train and run their AI algorithms. This hardware is remarkably expensive, with the h100 costing as much as $30,000 per chip. The strong demand and pricing power allowed Nvidia to boast a software-like gross margin of 76% -- up from 63.3% in the prior-year period.
2. Nvidia can keep the competition at bay
Nvidia's astronomical margins are catching the attention of rivals like Advanced Micro Devices, which want to compete for a slice of the AI chip market, and customers like Alphabet or Amazon, aiming to reduce their reliance on third-party hardware by creating in-house custom chips. However, Nvidia is positioned to handle both long-term threats.
Nvidia stays ahead of the competition through constant innovation and a faster product update cycle. While rivals are trying to match its current flagship, the h100, Nvidia is already launching its replacement, the h200, which features more memory and faster algorithm training speeds.
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The company is also tackling the $30 billion custom chip opportunity with a new segment designed to help clients build AI chips specialized for specific use cases. Nvidia's scale and design expertise could help it make custom chips more efficiently than its clients could do themselves.
3. Low valuation
With spectacular top and bottom-line growth coupled with a deep economic moat, Nvidia sounds like a company that deserves massive premium valuation. However, with a forward price-to-earnings (P/E) multiple of just 38, shares are only moderately higher than the Nasdaq-100 average of 33. And this looks like a shockingly good deal. So, why exactly is Nvidia stock still so cheap? There is one big risk.
The AI market might not meet expectations
While there are plenty of reasons for investors to buy Nvidia stock, there is one big reason to be more cautious: The AI market might not live up to expectations. According to the Washington Post, AI chatbots lose money with every customer search because of their high operating costs. And it is still unclear how companies plan to monetize them.
As the producer of picks and shovels in this "gold rush," Nvidia is currently shielded from the lack of profitability in consumer-facing AI applications. However, if companies keep losing money on AI, they may eventually scale back their spending on Nvidia's hardware. This challenge is likely the most daunting headwind Nvidia faces. But the good news is that its current valuation seems to already price in a possible slowdown.
