INTRO: Nvidia is one of the most underrated mega
cap companies in the world.
While Nvidia is extremely popular within gaming and tech circles, the average person is not
so familiar with the company.
This is quite surprising because unlike some other background mega cap companies like TSMC
and ASML, much of Nvidia’s customer base is everyday people.
Despite this, Nvidia was able to race towards a trillion dollar valuation under the radar.
At the peak, Nvidia boasted a valuation of $867 billion.
But, it looks like becoming a trillion dollar company just wasn’t in the cards for Nvidia
at the time given that their stock has gotten obliterated.
In fact, since their peak in November, Nvidia has sold off a painful 55% which correlates
to a market cap loss of $480 billion.
By now, this is probably not even that surprising given how bad the overall market is doing.
But, like all the other companies that have sold off this much, Nvidia does have it’s
own set of shortfalls and concerns.
So, here’s why Nvidia is down $480 billion and why it may be long journey back to the
top.
SEASONAL: One of the biggest shortfalls of Nvidia’s
business is that they’ve somehow become a seasonal business.
Now, this might sound a bit surprising given that demand for their GPUs is rather constant
from companies and everyday people.
But, there’s also a third demographic that you need to consider which is of course miners.
If you’re not familiar with cryptocurrency mining, it’s basically a super computationally
intense process that validates crypto transactions.
The people who validate these transactions are called miners and they get paid for each
block of transactions that they validate.
Now, miners don’t have to do anything manually, but given the high computational requirements
to mine, they’re forced to buy extremely powerful hardware.
And as you guess, one of their top choices is Nvidia GPUs.
In the early days, miners didn’t really influence the overall GPU market all the much
as they were a pretty small community.
But, as cryptocurrency becomes larger and more people jump on board, it’s only natural
that the mining community has also gotten quite large.
If miners were simply buying gpus on a regular basis, this wouldn’t really be a problem.
But, the interest in mining is highly correlated with the bitcoin market cycles which have
thus far been highly seasonal.
For example, let’s take a look at the 2017 Bitcoin cycle and compare it to Nvidia’s
net income.
As we can see, Ethereum which is what people were predominantly mining with Nvidia gpus
peaked in early 2018.
This momentum along with the release of Nvidia’s 2000 series of gpus carried the company throughout
much of 2018.
But as the hype surrounding the new gpus settled down and miners flocked the scene, Nvidia’s
net income got obliterated.
Within just two quarters, Nvidia’ net income crashed 68% from $1.23 billion to $394 million.
It wasn’t till the last quarter of 2020 when Bitcoin returned to its all time high
that Nvidia’s net income also recovered.
Since then, Nvidia’s income has only gone up, but as we saw in 2018, it’s takes about
a year for the crypto cycle to reflect in Nvidia’s bottom line.
Also, Nvidia is supposed to release the 4000 series of gpus this year similar to the 2000
series in 2018, so that should help hold up their income for some time.
But as we get into the end of this year and especially the beginning of next year, the
weak crypto market will likely weigh down on Nvidia’s income quite substantially.
PERMANENT SEPARATION: Even if the crypto markets do recover within
the nest 12 months, it’s going to be difficult for Nvidia to maintain their current numbers
because Nvidia and miners are slowly parting ways.
From Nvidia’s side, they’ve been limiting the performance of their GPUs if they’re
used for mining.
The goal with this limit is to mitigate the demand from miners and make more gpus available
for everyone else.
Now of course, hackers have figured out ways to bypass these limits, but that’s besides
the point.
The point is that Nvidia is finally taking action to limit the number of GPUs that are
sold to miners.
This was something that Nvidia was previously extremely reluctant to do for obvious reasons.
However, Nvidia has been switching their stance likely because they've realized that in the
long term, they will lose the mining demographic no matter what.
And when that happens, they want to ensure that they have a strong core of gamers that
are still loyal to the brand.
But wait a minute, why will Nvidia lose out on the mining demographic in the first place?
Well, the answer boils down to two reasons starting with ASICs.
ASICs or application-specific integrated circuits are hardware that are specifically built for
a given computational purpose which in our case is mining.
In the early days, mining ASICs weren’t that prevalent given that there wasn’t much
demand for them.
But, nowadays, full on companies like Bitmain have built on just selling mining ASICs.
And given that mining ASICs are specifically built for mining, they’re way better than
Nvidia’s gaming GPUs for mining.
Now, Nvidia has launched mining specific hardware, so they might make a targetted move into the
crypto market.
But, the days of using gaming gpus for mining are definitely coming to an end.
Something else to consider is that much of the crypto market is trying move away from
mining altogether due to how wasteful the process is.
Afterall, to mine, you have to buy loads of expensive hardware and constantly burn mountains
of electricity to keep them running.
So, cryptos like Ethereum are trying to switch to a proof of stake model from a proof of
work model.
Both of these models are rather complex, but all you need to know is that the new method
does not require super powerful hardware.
The founder of ethereum, Vitalik Buterin, has already been trying to make this switch
for years, and he may be trying for years to come as well.
But at this point, it seems like a transition to proof of stake not just for etherem but
cryptocurrencies as a whole is ineveitable.
And as crypto and Nvidia sever their ties, there’s no question that Nvidia’s financials
will take a hit.
Now, it might seem like I’m overstating Nvidia’s dependence on mining, but this
is not the case.
In fact, the SEC just fined Nvidia for not disclosing how dependent they were on cypromining
to investors.
Considering this, declining demand from miners is by far the biggest threat for Nvidia.
UNSUSTAINABLE PRICES: Another major threat for Nvidia’s business
is their unsustainable price increases.
Over the past several years, Nvidia has enjoyed extremely strong pricing power due to overwhelming
demand.
For one, miners are willing to pay way more for Nvidia’s gpus than gamers because it’s
an investment for them, not just entertainment.
And secondly, the supply shortage and more specifically the chip shortage has made it
imposible for Nvidia to keep up with demand.
This deadly combination has led to gpus selling for unreal amounts on secondary markets.
Take the RTX 3090 for example.
The RTX 3090 launched with a sticker price of $1500.
This itself is super expensive until you take a look at how much these gpus are selling
for on secondary markets.
This listing for example comes in at an eyewatering $4800 or over 3 times the launch price.
Now, given that this is the resale market, Nvidia doesn’t actually make anything from
these ludicrous resale prices.
However, this has allowed Nvidia to substantially raise the launch prices of their new gpus.
For example, in 2017, Nvidia’s flagship GPU, the GTX 1080 TI, launched for $700.
Last year, Nvidia launched the 3000 series equivalent, the 3080 TI, for $1200.
This means that Nvidia was able to raise prices by 71% within a matter of 4 years, and that’s
not even considering their new additions.
You see, Nvidia had so much demand that they decided to launch even higher end consumer
gpus called the 3090 and 3090 ti.
And the launch price of the 3090 ti is a whopping $2000.
This means that Nvidia’s flagship consumer gpu has risen from $700 to $2000 within 5
years.
Clearly, gpu prices have gotten way out of hand and they’ve been like this for years
at this point.
But, eventually, things will cool down like they always do and Nvidia will lose pricing
power.
I mean, even Apple had to reduce the launch price of their iPhones with the iPhone 11.
And Apple had only raised the launch price of their iphone by $100.
Nvidia is over here raising prices $500, so it’s no wonder that investors are worried
about Nvidia's pricing power in the future.
UNSUSTAINABLE VALUATION: It’s not just Nvidia’s customers that
have been willing to pay any price for their gpus.
Till recently, Nvidia’s investors were also willing to pay any price for Nvidia stock.
In fact, I don’t think it’s a stretch to say that Nvidia had the richest valuation
on the entire stock market.
For example, if we take a look at their PE ratio or their price to earnings ratio, they
were floating at 70 to 80 for much of 2020 and 2021.
For perspective, Apple is trading at a pe ratio in the mid 20s and Micorosft is trading
at a pe ratio in the high 20s.
Now, this is not actually that bad when you compare it to Tesla which peaked at a PE ratio
over 1000.
But, here’s the key difference.
Tesla was barely profitable with a net margin of just 2.29% while Nvidia was at peak profitability
with a net margin of over 30%.
This means that Tesla’s PE ratio was super skewed due to low profits while Nvidia’s
PE ratio wasn’t skewed at all.
And this becomes super clear when we compare the price to sales ratio of the two companies.
Tesla’s PS ratio peaked at 23.75 while Nvidia’s PS ratio ran all the way to 26.62.
Also, let’s not forget that Tesla is the most hyped stock on the market.
But somehow, Nvidia was even more richly valued despite having far inferior growth prospects.
Also, the recent sell off hasn’t made their valuation that much better.
Nvidia still has a PE ratio of nearly 50 and a market cap of $460 billion.
And thus far, Nvidia has only been reporting stellar quarters.
Imagine if Nvidia has just one quarter of stagnation or even a decline.
Their current valuation would just become even less justified causing investors to sell
off the stock even further.
And don’t think that just because Nvidia has already dropped 50% means that they can’t
drop much further because they definitely can.
If mining demand doesn’t recover and the overall market continues to sell off, Nvidia
can easily sell off 80-90% like it did during the dotcom bust and the 2008 financial recession.
Really, you don’t even have to look that far to realize how much Nvidia can drop.
Just take a look at Netflix or PayPal right now.
FUTURE OF NVIDIA: At the end of the day, Nvidia has been propped
up by a several factors for several years now.
First you had the 2017 bitcoin bull run, then there was the 2021 bitcoin bull run, and now
you have the supply shortage.
All of these factors have given Nvidia an unprecedented amount of pricing power and
leverage which Nvidia has cleverly used to maximize profits.
But, as these temporary boosts start to fade away, the short term future of Nvidia is becoming
more and more uncertain.
Combine this with the fact that Nvidia was already one of the richest valuations on the
market, and it becomes clear that Nvidia’s 50% sell off could just be the beginning of
something much more painful.
This isn’t to say that Nvidia is screwed in the long term by any means though.
Nvidia produces the best gpus in the world and they’ve diversified into several sectors
from machine learning to artificial intelligence.
So, Nvidia is by no means going anywhere.
But, it’s very likely that we start to see declines in Nvidia’s financials as the GPU
market finally cools down and miners move away from gaming gpus.
But if we look past that, I think it’s just a matter of time until their dominant position
and massive investments pay off and Nvidia reaches a trillion dollar valuation.
But that’s just what I think.
Do you guys have an Nvidia gpu?
Comment that down below.
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