This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Nvidia (NASDAQ: NVDA) was the single best-performing stock in the S&P 500 (SP: .INX) in 2023, and it ranks as the fourth-best performing member of the index year to date in 2024. Its share price has increased 845% during that period due to strong earnings growth driven by tremendous demand for its graphics processing units (GPUs).
Nvidia is once again poised to generate market-beating returns for shareholders in 2025. The most obvious reason is its leadership in artificial intelligence (AI) accelerators, a market where spending is projected to grow at 29% annually through 2030, according to Grand View Research. But there are less obvious factors at play, too.
Read on to learn more.
Nvidia says demand for its Blackwell GPU is "staggering"
Forrester Research analysts led by Mike Gualtieri recently wrote, "Without Nvidia's GPUs, modern AI wouldn't be possible." There are two reasons for the company has become so dominant: (1) Nvidia GPUs are supported by an unmatched ecosystem of software development tools called CUDA, and (2) Nvidia GPUs consistently outperform rival chips at AI training and inference tasks.
Building on that second point, Nvidia is currently ramping up production of its next-generation Blackwell GPU, which offers up to 4 times faster AI training and 30 times faster AI inferencing versus the previous Hopper GPU architecture. CFO Colette Kress recently told analysts that "Blackwell demand is staggering." Indeed, the new chip is already sold out for 12 months.
Additionally, CEO Jensen Huang has said the Blackwell GPU architecture may be the most successful product in company history, and perhaps the history of the entire computing industry. That sets Nvidia shares up for market-beating returns as Blackwell sales hit the top line next year.
Nvidia expects gross margin to stabilise after the Blackwell ramp
Nvidia's gross margin peaked at 78.4% in the first quarter of fiscal 2025, which ended in April 2024. That figure has since contracted to 74.6%. Bears attribute that margin decline to an erosion in pricing power brought on by competition, overlooking the fact that Nvidia's operating margin is 18 percentage points above that of the next closest Magnificent Seven company.
Admittedly, Nvidia does face competition from other chipmakers and even some of its own customers. For instance, Amazon, Microsoft, and Alphabet have developed custom AI accelerators. But those competitors lack a software development ecosystem that rivals CUDA, something Nvidia has been building for nearly two decades. That ultimately makes competing chips much less useful to developers.
So, Nvidia shareholders have little to fear from competition in the near term. Indeed, CFO Colette Kress says Blackwell gross margins should be in the mid-70% range after the production ramp. In other words, while gross margin may drop a little more in the next quarter or two, it should rebound thereafter. That pokes a hole in the theory that Nvidia is in imminent danger of losing pricing power.
Indeed, Morgan Stanley analyst Joseph Moore recently commented, "The market tends to underestimate the difficulty of competing with Nvidia." That should become increasingly clear next year, and the stock could soar as investors fully appreciate Nvidia's dominance.
President-elect Trump wants to cut the corporate tax rate
President-elect Donald Trump has proposed lowering the federal corporate income tax rate to 15%. While a lower corporate tax rate has not always led to a boom in the broader stock market, it could move the needle for individual companies by boosting profit margins. In turn, excess capital could be returned to shareholders through stock buybacks and dividends.
Importantly, Nvidia repurchased about $26 billion worth of its stock during the 12-month period that ended in June 2024. Only three other companies in the S&P 500 allocated more to share buybacks during that period: Apple spent $96 billion, Alphabet spent $63 billion, and Meta Platforms spent $41 billion, according to S&P Global.
Nvidia could lean further into stock buybacks if the corporate tax rate was lowered. That would accelerate earnings-per-share growth by reducing the outstanding share count. So, a reduction in corporate taxes could result in Nvidia's earnings growing more quickly than Wall Street analysts anticipate, which could drive shares higher.
Admittedly, while the Trump administration could get legislation through Congress in 2025, any changes would not take effect until the next year. That means Nvidia would not see any benefit in 2025 even in the best case scenario. But the stock market is forward-looking, so if investors believe the tax rate will decline, the impact could be priced into the stock next year.
Nvidia stock is surprisingly inexpensive at its current valuation
Nvidia's market value has increased more than nine-fold since the beginning of 2023, but the company's stock still trades at a surprisingly reasonable valuation, especially in comparison to other AI companies.
Wall Street expects Nvidia's adjusted earnings to grow 50% over the next year, and the stock currently trades at 52.7 times adjusted earnings. Those numbers give a price-to-earnings-to-growth (PEG) ratio slightly above 1. Listed below are PEG ratios (calculated in exactly the same manner) for other popular AI stocks:
- Alphabet: 1.6
- Amazon: 1.7
- Apple: 3.5
- Meta Platforms: 1.8
- Microsoft: 3.9
- Palantir: 6.2
In general, PEG ratios below 1 are considered cheap, and values between 1 and 2 are seen as reasonable. In that context, Nvidia shares are remarkably inexpensive at their current share price of $138, which positions the stock for market-beating returns next year.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
