This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Key Points
- The AI industry is booming as tech giants continue to pour billions into Nvidia's cutting-edge hardware.
- Despite its size, the company's valuation remains reasonable, considering its incredible growth rate.
It's been three years since OpenAI's ChatGPT introduced the world to generative artificial intelligence (AI), and the booming industry shows no signs of slowing down as technology giants continue to pour billions into AI chips and other forms of infrastructure. With shares up by an eyewatering 1,300% over the last half-decade, Nvidia (NASDAQ: NVDA) is one of the most obvious beneficiaries of this megatrend.
That said, the iconic chipmaker now boasts a market cap of $4.83 trillion, which makes it comfortably the largest company on earth. For comparison, the entire nation of Germany had a gross domestic product (GDP) of just $4.66 trillion in 2024. And while that's not an apples-to-apples comparison, it does show the level of value we are dealing with. Nvidia's massive size is sure to leave investors wondering if further growth is even possible. Let's explore the pros and cons of the stock to decide what the next five years might have in store.
Business continues to boom
Perhaps the most surprising thing about Nvidia's $4.66 trillion price tag is that it isn't as expensive as it looks when you consider key factors like growth and profitability. Fiscal second-quarter earnings make the company look more like a fast-growing start-up than an established behemoth.
Revenue soared 56% year over year to $46.7 billion, driven by continued strength in the data center segment, where Nvidia sells its most advanced enterprise AI chips like Blackwell. With a gross margin of 72% the company manages to sell its cutting-edge hardware at a tremendous markup. For context, software specialist Microsoft only boasts a gross margin of 69%, despite typically not even selling physical products.
Nvidia maintains its incredible pricing power because of a strong economic moat built around its CUDA ecosystem of software and tools designed to work best with Nvidia hardware. This advantage makes it hard for clients to switch to competitors (like Advanced Micro Devices' MI350x Instinct series), even if they offer similar raw capabilities. Unsurprisingly, the company's bottom line continues to surge, with second-quarter net income jumping 59% year over year to $26.4 billion.
What are the challenges?
With a forward price-to-earnings (P/E) multiple of just 30, Nvidia stock is downright cheap when you look at its current fundamentals. For context, the Nasdaq-100 has an average forward P/E of 28, and few companies on the index can compare to Nvidia's explosive growth and strong moat. That being said, sometimes investors need to look past the numbers.
Even though Nvidia's valuation makes perfect sense compared to its profitability and growth, the company still feels too big for comfort. And there are some compelling reasons why. For starters, there are questions about the sustainability of the chip purchases fueling its growth.
According to The Wall Street Journal, tech giants including Alphabet, Meta Platforms, Microsoft, and Amazon spent a whopping $360 billion in capital expenditures over the last 12 months, with much of that going to Nvidia hardware to build out data centers. And while this might not be a traditional bubble, there is a real possibility that this level of spending could slow dramatically if generative AI doesn't turn out to be as profitable as expected. There are some early warning signs.
An August MIT study found that 95% of generative AI pilots fail to create meaningful value for companies. And the industry's frontrunner, OpenAI (a major customer for Nvidia), may have lost a whopping $11.5 billion in the most recent quarter because of the high costs of running its large language models (LLMs). With such dizzying losses, it may be a matter of time before shareholders revolt and companies start reevaluating the amount they are spending on AI hardware. If this happens, Nvidia's growth and margins could quickly come under pressure.
Where will Nvidia stock be in five years?
While Nvidia looks fairly valued compared to its explosive growth and profits, the company is overexposed to the generative AI industry, and that makes the stock riskier than its raw fundamentals might suggest. Potential investors may want to sit on the sidelines for now.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
