Chart of the Week: AI market leader is now surprisingly cheap
This AI beneficiary may still be one of the market’s most compelling bargains.
Mentioned: NVIDIA Corp (NVDA)
This week’s insights come directly from our US equity analyst Brian Colello on NVIDIA (NASDAQ:NVDA).
Contrary to popular belief, Nvidia now fits the profile of a growth-at-a-reasonable-price stock (GARP). The company emerged as the biggest AI beneficiary in 2023; as demand for its chips exploded, so did its stock price. Although Nvidia has continued to deliver strong earnings growth this year, its valuation has become more reasonable relative to our growth projections and fair value estimate.
Given the high likelihood of strong AI capital expenditures in the near term and medium term (and likely the long term too), we believe Nvidia’s growth prospects are underrated. The stock looks like a bargain, trading 30% below our $280 fair value estimate.
Nvidia: Price vs. Morningstar Fair Value Estimate
The drivers behind our fair value
Nvidia’s early pioneering in engineering Graphics Processing Units (GPU) have catapulted it front and centre of the AI boom. By combining both software and hardware solutions, Nvidia essentially made themselves irreplaceable for their customers.
Nvidia’s wide moat rating indicates confidence that they can continue to generate excess returns of invested capital over the next 20 years. There are no viable competitors in the current market that could threaten Nvidia’s position. While this can change as technology advances, we believe Nvidia has entrenched itself as the go to market leader.
Nvidia is currently trading at a sizeable discount to our $280 fair value. This implies there is further upside in valuation. Looking ahead, the key catalysts for Nvidia lie within its Data Centre segment, which is its growth engine. Further development of agentic and physical AI creates a long runway for AI spending in the near to medium term.
Risk and Uncertainty
While Nvidia is seen as the AI beneficiary, its earnings are now heavily influenced by changes in AI spending. We see the biggest risk to Nvidia is cuts to AI capital expenditure from its largest customers such as Google, Meta and Amazon which make up a large chunk of revenue. This risk is a key reason behind its Morningstar Uncertainty Rating of Very High.
While US tech giants are incentivised to build their own in-house solutions to reduce their spend at Nvidia, high switching costs remain a key concern. The entrenchment of both Nvidia’s software and hardware also increases their pricing power.
Bulls say
- Nvidia foresees $3 trillion-$4 trillion of annual AI infrastructure spending by 2030.
- Nvidia’s data center GPUs and Cuda software platform have established the company as the dominant vendor for AI model training and inference.
- Nvidia is expanding nicely in AI. It’s supplying industry-leading GPUs but also moving into networking, software, and services to tie these GPUs into even more powerful clusters.
Bears say
- Nvidia’s customers are a handful of the largest tech companies in the world, and they all have an incentive to eventually diversify away from Nvidia to some extent.
- AI infrastructure spending has been impressive, but revenue and use cases are less certain. This could cast doubt upon whether there is a good return on investment with AI, possibly leading to a spending downturn at some point.
- Geopolitics have entered the AI space, most notably limiting Nvidia’s AI opportunities in China.
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