Long-term investing is the key to generating sustainable returns in the stock market. Perhaps few will understand this better than Nvidia (NVDA 1.96%) shareholders, who have enjoyed total returns of more than 3,000% during the past five years despite challenges like the COVID-19 pandemic and rising interest rates, which crushed many stocks in the short term.
But what could the next half-decade have in store for this powerful technology leader?
The king of the AI opportunity
Since the release of OpenAI's ChatGPT in late 2022, the tech industry has scrambled to accumulate generative artificial intelligence (AI) hardware, such as Nvidia graphics processing units (GPUs), which provide the processing power necessary to run and train AI's complex algorithms. Nvidia's second-quarter earnings demonstrate how this new demand has transformed its operations.
NASDAQ: NVDA
Key Data Points
Revenue doubled year over year to $13.51 billion, driven by sales of high-end data center GPUs such as the H100. Profits jumped eightfold to $6.18 billion. And management aims to extend the company's dominance by accelerating the pace at which it releases new AI chips from biennially to annually, which will put even more pressure on its competition.
Nvidia is also expanding into new opportunities like custom chips, a $30 billion opportunity to serve clients with needs for their AI workloads that aren't as well-served by one-size-fits-all solutions.
All in all, the company looks capable of maintaining its 80% market share in the AI chip sector for the next five years and possibly beyond.
The valuation isn't as good as it looks
Though its market cap has more than doubled in 2024 alone, Nvidia stock may seem reasonably priced when measured against its bottom line. With a forward price-to-earnings (P/E) of about 49, the company's expected future earnings are valued at a premium to the NASDAQ 100's average of 29 -- no surprise considering the company's growth rate (first quarter earnings soared 628% year over year to $14.9 billion). But this situation is much more complicated than it looks on the surface.
Most of today's large tech companies built up their earnings over decades with businesses well integrated into the productive economy. But this is not necessarily the case for most of Nvidia's explosive growth since 2022. The chipmaker has become overreliant on the speculative AI industry, which currently isn't generating much in the way of either earnings or cash flow.
Image source: Getty Images.
According to Sequoia Capital, the AI industry has already spent $50 billion on Nvidia's AI chips, while generative AI start-ups have only earned $3 billion in revenue. In other words, so far, the AI boom has been based on the proverbial selling picks and shovels to miners instead of actually getting gold out of the ground. This is an unsustainable situation -- unless things change, eventually, those "miners" won't be able to afford their hardware expenses.
Bearing this uncomfortable fact in mind, Nvidia's stock isn't cheap, because its current valuation assumes demand for AI GPUs will remain elevated. And this is far from guaranteed.
Is Nvidia stock a buy?
Over the long term, Nvidia could sail through some of its biggest near-term challenges. While many consumer-facing AI businesses are losing money right now, they could eventually mature into profitable enterprises capable of sustaining enormous spending on Nvidia chips.
The industry could also diversify with contributions from AI use cases like self-driving cars and robotics, which would be great news for Nvidia shareholders.
But these are all what-if scenarios. And with Nvidia's stock currently priced for perfection, betting on this long-term thesis looks risky. It may make more sense to hold off until more information becomes available.
