This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Stock splits can be exciting for retail investors, particularly those whose brokerages might not offer them the option of purchasing fractional shares. I have lost count of the number of non-finance people suddenly asking me about Nvidia (NASDAQ: NVDA) stock now that it's trading for "just" $130 a share.
But while splits can make a stock appear cheaper, they have no impact on a company's valuations -- how the market prices it relative to sales, earnings, etc. -- nor on its market cap, which is the value of all its outstanding shares combined. In the case of Nvidia, that market cap is $3.2 trillion, making it the third-largest company in the world today, just a hair behind the one that makes iPhones.
Is Nvidia stock still a buy at its current lofty market cap? Here are two reasons to continue hitting the buy button and one reason to consider jumping ship.
Reason No. 1 to buy: The artificial intelligence industry is just getting started
It has only been around two years since OpenAI took the world by storm with ChatGPT, a generative artificial intelligence (AI) chatbot capable of producing high-quality responses to user queries based on training data. Analysts are feverishly optimistic about the AI industry's potential, with Bloomberg Intelligence estimating it could be worth $1.3 trillion by 2032.
If that forecast proves close to accurate, this will be an incredible opportunity for Nvidia, which is the leading maker of the specific types of powerful graphics processing units (GPUs) needed to run and train these advanced algorithms. Currently, it holds a market share of more than 80% in that hot niche, where demand is outstripping supply.
While Nvidia will face growing competition from rival chipmakers such as Advanced Micro Devices (NASDAQ: AMD) and Intel, it's protecting its market share via software solutions like CUDA (Compute Unified Device Architecture), a computing platform and programming interface that's bespoke for use with its hardware, and by constantly improving its offerings. According to CEO Jensen Huang, the company will henceforth release a new family of updated AI chips every single year (up from its prior pace of once every two years), making it even harder for rivals to keep up.
Reason No. 2 to buy: Nvidia isn't overvalued relative to fundamentals
The second bullish fact about Nvidia is its valuation. Despite rising by over 3,000% in the last five years, shares are still reasonably priced relative to the company's remarkable growth rate.
With a forward price-to-earnings (P/E) multiple of just 48, Nvidia's shares are not much more expensive than other popular AI hardware stocks like AMD, which has a P/E of 47. To put this in context, in the first quarter, AMD's sales grew by just 2% year over year, while Nvidia's exploded by 262%.
This valuation suggests Nvidia's stock could have more room to run if the AI industry lives up to analysts' expectations. But hold your horses -- there is one big risk factor new investors should be aware of.
A reason to sell: Its uncanny resemblance to Cisco Systems
Cisco Systems (NASDAQ: CSCO) is a computer hardware company that sold the routers and switches needed to build out the internet in the late 1990s. It was the "picks and shovels" way for investors to bet on what the smart money saw as a transformative new industry. And by the peak of the dot-com bubble in 2000, Cisco's market cap had hit $500 billion. Then the bubble burst, and it dropped by a staggering 88% within two years. The stock still hasn't recovered to its previous highs.
Investors should take this as a cautionary tale, because Nvidia occupies a similar role in the AI space today, and any hit to its growth rate or pricing power could lead to a rapid collapse in its valuation, just like what happened to Cisco. While Nvidia investors have a lot to be excited about, they should also be aware of the potential risks this company faces before buying the stock, especially at its current valuation.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
