Here's Why Unstoppable Nvidia Stock Still Looks Reasonably Valued Right Now

There’s one thing I learned quickly about the investment business - the forces of nature do not apply. Gravity does not affect stocks, so what goes up does not necessarily come down. At least, not for a very long time. This holds especially true when it comes to a very hot sector that has caught the imagination of the investing public, such as artificial intelligence (AI). 

Of course, the poster child for the AI boom is semiconductor designer Nvidia (NVDA). Its stock has been on a tear since the start of 2023, and its momentum will be tough to stop. Ahead of its upcoming earnings report, let’s take a peek at Nvidia to see what, if anything, can slow this juggernaut down.

Why Nvidia Stock Looks Reasonably Valued Right Now

Here’s a question to consider: Is there any way a stock can still be considered a bargain if it has risen 220% in the past year? That’s just what Nvidia has done, leapfrogging both Alphabet (GOOGL) and Amazon (AMZN) this week to become the third-largest U.S.-listed company, with a market capitalization of $1.825 trillion.

NVDA shares have climbed 47% this year alone, adding roughly $560 billion to its market valuation since the start of 2024.

Surprisingly, the answer to that question may be “yes.”

Even after the extraordinary run-up in the stock price, Nvidia may still be reasonably valued. With earnings estimates rising almost as fast as the stock, the stock now trades at just 35 times this year’s expected profits. That is relatively modest for a company in the midst of a two-year growth spurt that is expected to quadruple its revenue.

There is no denying the current momentum in Nvidia’s business. In its most recent quarter, revenue rose 206% year on year to $18.1 billion. Generative AI and investments in large language models (LLMs) drove demand; data center revenue rose 279%, with cloud providers increasingly adopting Nvidia's Hopper-GPUs. Compute revenue jumped 324%, and its InfiniBand solution for high-performance computing saw a 155% pop in revenues.

And thanks to being a capital-light semiconductor designer that outsources manufacturing to Taiwan Semiconductor Manufacturing (TSM), the company’s operating margin climbed to an impressive 57%. That helped Nvidia's operating profit to rise an amazing 1,259% to $10.4 billion year-over-year.

One valuation metric that is often used to evaluate growth stocks is the price/earnings growth (PEG) ratio. This metric takes the P/E ratio and divides it by the growth rate over a certain period. Like the PE multiple, it can be historic or forward-looking. FactSet currently has Nvidia shares on a five-year forward PEG ratio of just 0.71, which is cheaper than other tech stocks, like Apple (AAPL).

Investors base Apple’s valuation on its strong brand and software ecosystem, which have given it a wide moat. This familiarity and comfort level translates to customers being happy to cough up a lot of money for newer, pricier iPhones.

Nvidia has a similar competitive advantage. While most investors know about Nvidia’s graphics processing units (GPUs), few appreciate that it has developed the proprietary software on which AI researchers across the world are trained.

The company launched its programming platform, CUDA, in 2007. It allows developers to use its GPUs for general purpose computing beyond just graphics design. The platform has libraries of computation templates, saving developers time and effort, and making CUDA the default platform in AI computing. Its strong following in the tech world will not be shaken anytime soon.

In addition, Nvidia’s 2020 acquisition of Mellanox Technologies gave it the cabling technology to connect multiple GPUs, which is essential to building supercomputers. Throw in CUDA, and Nvidia has a full-service AI offering for businesses.

What's Next for Nvidia Stock?

Nvidia does face some risk, though.

The need for continuous training and retraining of AI models should keep demand for Nvidia’s GPUs high. However, vast expansion of smaller AI models, along with the work of applying AI to specific tasks, known as inferencing, could lead to much of the spending shifting to other types of chips.

For Nvidia’s growth to maintain its current levels, its AI enterprise software needs to show clear productivity improvements in the workplace. If this happens – and I think this is likely – the scramble for Nvidia's hardware will continue through 2024 and beyond.

Forecasts are for a gross margin of about 73% to 74% from the 2024 fiscal year to the 2026 fiscal year. That’s much wider than the 59% in the 2023 fiscal year. Nvidia’s margin profile and scalable business model will drive significant free cash flow potential, which could reach $45 billion in the 2025 fiscal year and $55 billion in the 2026 fiscal year. For comparison, the 2023 fiscal year generated cash flow of around $5 billion.

With its expanding range of software, Nvidia should enjoy a bigger slice of the overall AI pie, even if its share of chip sales falls.

In a world racing to build a new AI computing infrastructure, it will be hard to stand in the way of the juggernaut that is Nvidia’s stock. Buy it on any general market weakness at under $750.