(Bloomberg) — The rise of Nvidia Corp. since the start of 2023 has been so sudden and strong that even bullish investors are concerned about how much room the stocks have left to run.

That’s what a gain of almost 550% since the start of last year will do for even the strongest bull cases. While Nvidia’s earnings and revenue growth are real and sentiment on Wall Street remains overwhelmingly optimistic, run-ups of this magnitude tend to represent years of earnings growth yet to materialize. The stock has become one of the largest in the world, adding $2 trillion in value in the past fifteen months.

A move like this “brings out many years of future returns in a very short period of time,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. The fundamentals take a back seat and trading becomes fraught, he added.

Shares fell 0.8% on Tuesday.

While Nvidia’s lead in artificial intelligence chips seems formidable, there are reasons for caution beyond the basic math of stock gains. Here are some of the main arguments:

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Nvidia is benefiting from an arms race among companies rushing to increase computing power to run AI workloads. The chipmaker’s revenue doubled in the last fiscal year and is expected to rise another 81% this year, according to data compiled by Bloomberg.

While there are few signs of demand slowing, the semiconductor industry is notorious for boom and bust cycles. Over the five decades of its existence, the chip industry has consistently struggled to match the introduction of long-term manufacturing capacity with short-term demand fluctuations, creating surpluses and periods of shortages.

High-end chips like Nvidia’s processors take well over a quarter to make and must be ordered from manufacturers months in advance. That makes forecasting a precarious game that companies don’t always get right.

Read more: Nvidia ‘Bubble’ Talk Spreads to ESG Investors Who Got High Marks

By the end of 2023, four companies — Microsoft Corp., Meta Platforms Inc., Amazon.com Inc. and Alphabet Inc. – accounting for more than a third of Nvidia’s revenue. A slowdown in purchases by these large data center owners would result in a revenue hit for Nvidia and a recalibration of growth estimates that would likely roil the stock.

“Right now, there is demand for Nvidia, in terms of Microsoft, Alphabet and Amazon all looking to build out their AI infrastructure,” said Jeffrey Muhlenkamp, ​​portfolio manager at Muhlenkamp & Co., who is not targeting Nvidia due to valuation concerns. “If they can’t turn that around and make those investments profitable, there won’t be a second round of spending.”

Bulls argue that this is just the first wave of purchases for AI chips and that the next surge in spending will come from other sectors such as drugmakers, shipbuilders and carmakers, as well as governments.

Competition

With Nvidia’s profits approaching $30 billion in fiscal 2024, the competition is rushing to get a piece of the action. Nvidia’s closest competitor Advanced Micro Devices Inc. launched its AI accelerator late last year and predicts revenues of as much as $3.5 billion from that space this year. Intel Corp. has its own line of AI chips, and customers including Microsoft and Amazon’s AWS have their own in-house chip design efforts.

“Nvidia’s margins are so high that it’s just begging for competition,” said Logan Purk, the Edward Jones analyst who cut his rating on Nvidia in November to deter a purchase. “Nvidia has done a fantastic job of establishing a moat, especially with its software business, but everyone wants a piece of this space.”

Read more: Nvidia wants to expand AI dominance with new Blackwell chips

Last week, Nvidia Chief Executive Officer Jensen Huang unveiled a new chip design – the successor to the company’s all-conquering H100 product. When asked about his competition, Huang emphasized that he doesn’t just offer chips, but also networks and all the software needed to quickly deploy AI data centers. Huang characterized Nvidia’s competition as a mountain to climb, and analysts largely agreed.

Price promotion

Nvidia’s booming profits have kept the stock market’s valuation in check, but its price-to-earnings ratio is on the rise again. According to Bloomberg data, the stock trades at 37 times expected earnings over the next 12 months, compared to about 25 times at the start of the year.

Many comparisons have been made between the rise of Nvidia and the dot-com era, when stocks like Cisco Systems Inc. rose on the basis of a similar proposition: buy the pickaxe makers in a gold rush.

One of the biggest lessons from that crisis was that while an investor may be right about which companies will prevail, the price at which you pay for a stock is even more important.

Cisco’s annual profits have more than quadrupled since the stock peaked in 2000, but shares are still down nearly 40%.

“Anytime there’s a fad and people get excited, expectations are always so high that they’re inevitably going to disappoint,” says Brad Lamensdorf, co-manager of the AdvisorShares Ranger Equity Bear ETF.

—With help from Ian King and Subrat Patnaik.

(Updates to open the market.)

©2024 BloombergLP

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