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- My Nvidia Valuation
Dear Investors,
Nvidia is the hottest company in the world at the moment because it is at the center of the change from general purpose computing to artificial intelligence (AI).
The question floating around investor’s minds is whether Nvidia is in a price bubble, that is about to pop, or not.
To help answer that question, we share our latest Nvidia valuation.
This week Nvidia released its second quarter (Q2) results of fiscal year 2025 (FY2025).
That’s a mouthful, so let me explain.
US companies release financial results four times per year, that’s why it’s called quarterly reporting. So far this year Nvidia has released two quarters of results (6 months), so it is half way through its fiscal year.
We’re in 2024, so why are they reporting for fiscal year 2025? A fiscal year is the time frame used in accounting for the 12-month period over which a company will report its financials. It often aligns with the calendar year, but it does not have to. Nvidia’s fiscal year 2024 ended on 28 January 2024. Therefore, its 2025 fiscal year began on 29 January 2024.
The stock market reaction
Investor waiting with baited breath for Nvidia’s results
This week it felt like the entire stock market was waiting with bated breath for Nvidia’s results and Nvidia did not disappoint.
Revenue was up 15% from Q1 and 122% from a year ago.
Operating profit was up 10% from Q1 and 156% from a year ago.
Net income was up 11% from Q1 and 152% from a year ago.
Besides profit being up, the outlook for the business was good and the financial results beat market expectations. But despite all the positivity, Nvidia’s stock price fell 6% the next day. Go figure!
That begs the question, is Nvidia overvalued?
Two valuation methods
In the world of investing there are two main methodologies to value companies, discounted cash flows and multiples.
The discounted cash flow (DCF) approach forecasts cash flows into the future, then discounts them for the time value of money and the risk inherent in the company. The discounted cash flows are then added up to determine the value of the company.
Multiples are a shorthand method of valuing a company. The most widely used multiple is the price-to-earnings (P/E) ratio. It is very simple to calculate, you take the share price and divide it by the earnings per share.
For example, if the P/E ratio is 10, that means you are paying for 10 years of net profit upfront. The higher the multiple, the more profit you are paying for upfront. Average companies trade at average multiples, but great companies like Nvidia trade on very high multiples because investors are expecting a lot of growth from them.
The S&P500 which is the index of the 500 largest US companies is currently trading on a P/E ratio of 29.
Nvidia’s P/E ratio is an eyewatering 55.4. That means you are paying for 55 years of profits upfront. Fifty-five years might be longer than an investing lifetime, so it is a high number, unless the company grows.
Our Nvidia valuation
In the case of a fast-growing company, multiples like the PE ratio can look absurd, so it’s better to use the discounted cash flow valuation method.
We calculated three discounted cash flow valuations for Nvidia – conservative, moderate and aggressive cases.
Let’s immediately throw out the conservative valuation. Nvidia is having such a growth spurt that it will never be conservatively valued. Here are the results of our valuation as well as the margin of safety (i.e. difference between the valuation and the share price).
Valuation | Margin of safety | |
|---|---|---|
Nvidia’s share price | $119.37 | |
Moderate case | $106.89 | -11.7% |
Aggressive case | $140.60 | 15.1% |
Nvidia’s share price on 30 August 2024 was $119.37, our moderate valuation was $106.89 and our aggressive valuation was $140.60.
Based on our moderate valuation, the margin of safety is -11.7%. This indicates that’s Nvidia is selling for more than its fair value. If you look at the aggressive valuation, the margin of safety is 15.1%, which means the share price is slightly lower than fair value.
Despite the use of spreadsheets, numbers and very technical sounding financial terms, valuation is not a science. It is a subjective estimate of the value of the company. A few percent up or down doesn’t really tell us much.
Nvidia’s largest product segment is data centers – that is the one where ludicrous growth has been occurring. Nvidia sells the Graphic Processing Unit (GPU) chips that are being used to implement artificial intelligence for … everything.
Nvidia leads the industry in this area and has new high-performance Blackwell GPUs coming out soon. So, for the next year or so, demand should remain high and revenues should continue to increase.
However, Semiconductors is a cyclical industry. At some point competition will catch up and many of the buyers will have what they need from Nvidia. When that happens revenue growth may slow down. Therein lies the risk with these valuations.
For Nvidia to maintain this valuation, profits have to keep growing into the future. If the cycle turns and profits drop, these valuations will prove to have been optimistic.
Conclusion
The solution to give you comfort that everything will be okay is… nothing.
Sorry, but that is the game of investing, you are valuing companies based on an uncertain future. That comes with risk. You often only find out years into the future whether you were right or wrong about your valuations.
To caveat our valuations, I would say Nvidia is trading near fair value if it continues to maintain this level of profitability for years to come. This is possible given their market leading status and the huge global demand for accelerated computing (AI). But nothing is guaranteed.
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