Fishing for chips – Is Nvidia a good catch?
Chipmaker Nvidia is now worth nearly as much as Amazon. Who’s Nvidia you ask? We’ve all heard of Apple, Amazon, Netflix, Microsoft etc but not many of us I suspect have heard of Nvidia. Yet its market capitalisation breached the US$1 trillion level last week, one of just nine companies ever to do so. Its market capitalisation has more than doubled in 2023.
Nvidia is riding the “AI” wave. The company designs semiconductor chips that (I read) are made of silicon slices that contain specific patterns. Just as you flip an electrical switch when turning on a light at home, these chips have billions of switches that process complex information simultaneously. And I thought finance was complex…These chips are integral to many AI functions, from OpenAI’s ChatGPT (which you should know about which I’ve written here before) to sophisticated image generation. In short, Nvidia sells the Graphic Processing Units (GPU’s) necessary to power these massive generative AI models. In perspective, to train a model like OpenAI’s GPT, Elon Musk said at the WSJ CEO Council that the number required would be a minimum of 30,000 – 50,000 H100s (one of their products). So, it’s understandably big business.
The Nvidia share price surged last week on the back of the company’s surprisingly strong first quarter financial results: revenue in the period increased 19% to US$ 7.2 billion with its data-centre income surging 80% to US$4.2 billion. Nvidia’s market capitalisation jumped nearly $200 billion the same day as the earnings release – the third biggest increase in any company’s market capitalisation in history! – with the company joining the esteemed US$1 trillion club as mentioned above. Why all the excitement?
Well at present there is a lot of noise, speculation etc in markets regarding all-things AI (notwithstanding AI has really been around since the 1950’s thanks to Alan Turing the famous English mathematician and computer scientist most notably behind the British code-cracking efforts in WW II). Open AI was really out of the gates with fanfare with its ChatGPT interactive intelligence bot. Sam Altman, Elon Musk and Microsoft are the big players. This early rush has been followed at scale with Bard (Google’s version of ChatGPT) as well as the, literally, thousands of others fighting out the micro spaces sometimes not doing much more than adding an “.ai” to their brands. There are currently more than 30,000 AI start-ups in the USA and the sector is growing ~40% pa.
To me, AI satisfies all the boxes of technology success, it’s just who wins which is the hard part. Remember for long periods Apple and Amazon were dead in the water, Microsoft had lost its way, and Tesla was needing Government help. Apple nearly went bust in the early 2000s before Steve Jobs returned and invented the iPod, then the iPhone and the iPad…we thought we would have Nokia phones forever!
And so back to Nvidia as its market cap reaches these incredible new heights: will its explosive growth continue, or is the AI craze merely temporary? As always, there are arguments to be made on both sides.
The bulls will say that big tech companies are racing to develop capabilities like those of Open AI. These types of generative AI require vastly higher amounts of computing power, especially as they become more sophisticated so if that were to prove accurate Nvidia may benefit from long periods of strong demand as many of the tech giants, including Google and Microsoft use Nvidia chips to power their increasing AI operations. Google plans to use generative AI in six of its products in the future. Each of these have over two billion users. But overall, 65,000 companies globally use the company’s chips for a wide range of functions. Tech companies tend to command high valuation ratios not just because of anticipated demand for what they are doing now but because of their development potential and product pipeline. Nvidia launched new products just days after last week’s results, spanning from robotics to gaming. One was its A100, a powerful GPU suited for machine learning. Another was a new supercomputer platform that Google, Microsoft, and Meta (Facebook, Instagram) are first in line for.
The bears though will point to the heightened expectation priced into these high valuation metrics and rightfully ask how do some of these fundamental valuations stack up to other giants? Checking on Bloomberg, at 131x, Nvidia’s last four quarters’ price to earnings (P/E) ratio is second-only to that of Amazon, at a staggering 137x. For some, Nvidia’s valuation seems unrealistic even in spite of the prospects of AI. Although, Nvidia has US$11 billion in projected revenue for the next quarter, it would still command significantly higher valuation multiples than those of its big tech peers. This might suggest the company is overvalued at current prices.
So, what do we make of all this? It’s important to view these tech developers in a historical context: we have had a lot of technology hypes, fails, work-in-progress and reincarnations over the decades: the Internet, Google Glass, the Metaverse, the Cloud, Cryptocurrencies, Blockchain, Autonomous, Drones, Minidisc, 3D Printers, Amiga, Google Wave, QR Codes, Amazon, Windows Vista, Lotus Notes, Myspace, Palm Pilot, Google+, Quantum Computing, to name just a few. The most recent in my mind is cryptocurrencies: in 2013 there were 66 of these things, in 2022 there were more than 10,000.
Our team at Hobson Wealth had a call with a US-based funds manager last week and he was at pains to say you just can’t pick the winners – and he’s a specialist! This is where an Exchange Traded Fund is actually a great vehicle as it contains a basket of lots of these companies doing lots of things. So maybe diversify rather than try to pick the winner.
So back to the start, is this AI stuff the real thing? Probably. Do we know who the winners are? To some extent no, but we know who the big names in the game are and Nvidia is certainly one of them.