There are just 6 public companies in the whole world with a valuation over $1 trillion.
Apple, Microsoft, Saudi Aramco, Google Amazon.
Recently, Nvidia has joined that 1 trillion dollar club as well.
What does it actually have to deserve a valuation over 1 trillion?
Is that even a fair valuation?
We will take a closer look at that in this episode.
This is not a stock recommendation episode.
But an episode to show what are all the things that we need to consider in a valuation of a company with example.
Hello Everyone, my name is Vijay Mohan. You are watching - Investment Insights.
Nvidia is not something that came into being in recent times.
It was started in 1993 by a Taiwanese American, Jensen Huang.
He is still the CEO of the company. He is a very interesting person. We need a separate episode just on him. But that is for another day.
When Intel was focusing on CPU (Central Processing Unit),
Nvidia focused on GPU (Graphic Processing Unit).
CPU is like a Ferrari car. It can go very fast. But it cannot carry huge loads of data.
GPU is like a truck. It can take huge loads of data.
But it is not as fast a CPU. Though it is not as fast as a CPU, it has another trick under its sleeve.
Parallel Processing. It can process not just one truck load of data, but many truck loads of data in parallel.
So in short, a GPU is faster than a CPU in processing huge amounts of data.
Nvidia originally focused on GPU's to serve the graphics data in the video game. market.
As the GPU's grew stronger, gaming industry expanded aggressively as well.
Supplying GPU's for video games is the primary market for Nvidia.
They did not focus just on the hardware GPU, but also on the software called CUDA to effectively use a GPU.
They have developing and enhancing this CUDA software since 2006.
With the help of CUDA software, any developers can write programs to use the GPU effectively for their purpose.
Because of this advantage, many university professors started using GPU for their computational research.
This was a big bonus for Nvidia.
Knowing the power of their GPU's in deep learning, they heavily invested in CUDA software.
CUDA software is one of the important reason that Nvidia is a leader in the deep learning market Today.
They started a separate processor line up specifically for deep learning, and they provided their hardware and software for all research related to deep learning.
Today we are seeing the benefit of all those investments made in the past many years.
Today for machine learning, Nvidia processor is the default choice.
Crypto market came into main stream in 2017.
When everyone started crypto mining, the hardware that is required to mine is, GPU with parallel processing power.
That made Nvidia's revenue to shoot up after 2017.
Nvidia's revenue is coming from 4 main segments.
Data center, Gaming, Professional Visualization and then Automotive and embedded.
The orange bar in the chart is the revenue from data center. We can see that it is growing aggressively every quarter.
A direct impact from deep learning growth.
It was at 1 billion 4 years back. Now it is over 4 billions.
Out of the 7 billion total revenue, 4 billion has come just from data center segment.
Nvidia has given a guidance of 11 billion dollars for next quarter.
Out of that 11 billion, 8 billion is expected to come from data center.
That is, data center's revenue is going from 4 billion to 8 billion in just one quarter.
100% growth in a quarter. Mind blowing right?
A revenue guidance like this makes us wonder whether we are underestimating the growth of AI.
Though the revenue from other segments slowed down in 2022, it has started coming up in recent quarters.
If a management itself has projected a revenue growth of over 50%, then we can imagine the demand they are facing in the market.
Interesting times. We can see from this chart. Nvidia is a good business with revenue growing aggressively.
We should definitely own a business like this. There is no doubt about it. But at what cost?
Today its value is over 1 trillion.
Is this business that good to spend 1 trillion on it?
To find that out, we should take a look at its financial numbers closely.
Nvidia's revenue for the past one year is, $25.88 billions.
If its value Today is 1 trillion, then its price to sales ratio is 38.64.
My goodness. Even Tesla did not command a sales multiple like this during its peak times.
This is definitely expensive. How about Price to Earnings (P/E) ratio?
Last one year earnings is $4.8 billion.
P/E ratio is 208.
S&P500's average P/E ratio will be close to 18.
This one is more than 10 times over that.
This is super expensive without a doubt.
A value investor would stop right here. But how about a growth investor?
They will start with, what is the sales and earnings ratio given by market historically for nvidia.
Let's take a look at the data for the past 4 years. Nvidia's fiscal year is from February to January.
The fiscal year that ended in Jan 2020 has a revenue of 10.9 billions.
It has grown to 26.97 billions for Jan 2023 fiscal year.
That means, the revenue has increased 150% in the last 4 years.
We can see that the price to sales ratio has ranged from 13 to 23.
On average, it was at 20.
Today it is at 39. More than double.
Price to earnings was around 75 on average. Now it is as 208.
It is more than double as well.
A price to sales of 20 and a price to earnings of 75 themselves are super expensive.
if the current value is more than double of that, then we do not need any other proof beyond that. Nvidia is a super expensive stock. Right?
Don't jump to a conclusion yet. This data is history. This has already happened.
A growth investor has to take the future growth under consideration as well.
It is very hard to predict the future. But market tries to predict it, based on what it knows as of Today.
It is bit difficult to believe that. But analysts make their income from this kind of prediction.
Let's try to believe in that as well.
What is the guidance given by nvidia for the next quarter? 11 billion dollars.
After that, if we assume that they do not have any further revenue growth, then they will end up a total revenue of 44 billion dollars for 12 months.
Now the price to sales ratio is 22.73.
As this is future estimation, we can this as forward price to sales ratio.
It is not far from the historical average 20.
How about forward P/E ratio?
The earnings margin expectation for next 12 months is 45%.
That is, net income will be 45% of the total revenue. This is the expectation of analysts covering Nvidia.
So the net income will be, 19.8 billions.
P/E ratio: 50.51. It is less than the historical average.
So considering the future revenue projection, today's sales and earnings ratio do not look that expensive.
They look very reasonable as they are closer to the historical averages.
This is the base case.
In this calculation, out revenue expectation for next year is 44 billion. How about the following year?
Nvidia's CEO Jensen is saying that the data centers today that run with CPU's are worth 1 trillion dollars.
To help deep learning, all those data centers need to upgrade their hardware to GPU's.
It is a 1 trillion dollar market.
So when the transition to GPU happens, a big chunk of that money will come to Nvidia is his expectation.
Well, he has to say that as the CEO of the company. We are not expecting him to say that his business has no scope right?
We do not have to go that far to 1 trillion. But Nvidia's revenue grows at a rate of 25% every year, its revenue will cross 100 billion in next 5 years.
If we assume that the price stays the same for the next 5 years,
then the price to sales ratio will be 9.31.
P/E ratio: 20.69.
So what price of nvidia will make its sales and earnings ratio to go close to its historical average?
It has to go to 2.5 trillion dollars.
That is, Today's price has to go up by 150%.
Is it possible? How can we say that it is impossible? It is totally possible.
That is the analysts consensus estimate as well.
We can call this as bull case.
There is a red bull case as well.
To project that, we should drink the same kool-aid that folks in ARK office drink, but mixed with a red bull. Let's do that.
"Your estimation of 25% growth is very conservative.
"Actual AI demand is going to be lot more than that.
"Just last week, mcKinsey has published a report regarding that.
"AI is going to bring many trillion dollars into the economy.
"Nvidia's revenue growth will be at least 50% every year."
What if that happens?
Then the revenue of Nvidia will go to more than 200 billions in 5 years.
To maintain the same sales and earnings multiple, price has to go up by 6 times.
All this sounds good, but what if the AI growth does not pan out like we are expecting?
Then that will hurt Nvidia's revenue.
If the revenue does not grow, then the market will start cutting down its sales multiple premium.
Price to sales ratio will go down from 20 to 2 or 3.
Then the stock price could go down even by 80%.
In fact, when we look at the history of Nvidia's revenue, it is doubling in certain years and is flat in some years.
To match that, its stock price is very volatile as well.
This is very common in semiconductor industry.
Because it is a cyclical industry, it does really great during boom times.
But goes bust during recession times.
In short, Nvidia's future looks bright.
But the expectation from the market on it is even brighter.
Even when there is a. little bit doubt on that expectation, that will hurt the stock price pretty bad.
So Nvidia's stock holders ride will not be smooth at all. It will be very bumpy.
If you are expecting a smooth ride, do not go near Nvidia.
There is no reason to invest by taking that much risk and paying a huge premium.
You can now see what are all different things we need to consider in a company's valuation.
It also comes with 1000 ifs and buts.
Not just that. Check the comments for this episode. You will see many mentioning that I did not capture this or that.
Valuation is that much personal.
Remember the story of a boy taking a gem stone and asking for its value to different people? This is very similar to that story.
Folks who can appreciate the value of the gem, will see its value.
Other will just see it as a stone.
So how does Nvidia look to you? a gem or a stone?
If you see it as a gem, invest in it. If you see it as a stone, then throw it away.
If you are not sure whether it is a gem or a stone,
then it is better to invest in the index that has Nvidia as well. That will be the simplest solution.
We will soon meet again in another episode. Thank You.