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As an investor, sometimes a stock is a dream. ai stock market Darling Nvidia (NASDAQ: NVDA) seems like a good example. If you had invested £10,000 in NVIDIA shares just five years ago, you would now have a stake worth over £200,000 thanks to a 1,940% increase in the price during that period!
(By the way, it would also earn dividends, although with the yield currently at 0.02%, I think what I'd be most excited about would be the price appreciation.)
But five years ago, NVIDIA was already a large and well-established company. Its revenue in 2019 was $11.7 billion and its net income was $4.1 billion.
So that huge price jump in NVIDIA stock was for a company that was already in the sights of many stock market investors.
I missed that incredible five-year run. But if I invested now, could I benefit from another?
Huge potential
At first glance, this might seem fantastic.
NVIDIA has a market capitalization of more than $2 trillion, higher than tech stocks like Alphabet and Amazon.
An additional 1,940% growth in the share price would mean a market capitalization well in excess of $40 trillion, far beyond anything seen before.
On the other hand, I think NVIDIA has enormous potential.
Despite the considerable market capitalization, its current price-earnings ratio (P/E0) is 72. But last year's earnings increased almost sevenfold. If they did that again, the potential P/E ratio at NVIDIA's current stock price would barely increase. be two digits.
I don't think profits will continue to grow at a similar rate to last year.
But I do expect long-term earnings growth from the chip giant. ai means that demand for chips has increased, and very few companies have the knowledge to meet it. NVIDIA does, which is why its business has been booming.
Attractive economy
Let's go back to those figures from five years ago.
They demonstrated an attractive feature of the business that has endured: high profitability. $4.1 billion versus $11.7 billion suggests a 35% net profit margin.
Last year was even better: the company achieved a net margin of 49%.
As sales grow, so should economies of scale. Not only that, but ai has seen demand for chips explode. Presenting its most recent quarterly results last month, NVIDIA's CEO said: “Accelerated computing and generative ai have reached the tipping point. Demand is increasing around the world”.
Stock valuation
Still, sometimes demand booms can fade in disappointing ways.
While customers are now spending money on chips to develop their ai capabilities, once initial demand is met, sales growth could fall sharply.
Scaling to meet growing demand could add fixed costs to NVIDIA's business. Other chip companies are also working hard to win new business, something that could ultimately impact profit margins across the industry.
I would be surprised to see NVIDIA stock grow 1,940% over the next five years. For now, its valuation is still too high to give me the margin of safety I like when investing, so I won't be buying its stock.
But if things go well, I think NVIDIA stock could rise in the coming years, although perhaps less dramatically. So I keep an eye out for any price drops that I think offer me an attractive buying opportunity.
