Jen-Hsun Huang, president and chief executive officer of Nvidia Corp. Photographer: David Paul Morris/Bloomberg

At 17 times sales and 60 times earnings, the stock market values few companies as richly as Nvidia. Analyzing the reasons behind Nvidia’s valuation is important to understanding if there is more upside, and how much you have at risk if Nvidia disappoints. Bruce Pile, a Marketocracy manager who has a position in Nvidia explains why he paid the premium.

Ken Kam:  Bruce, it is not like you to pay such a rich premium for a stock. What makes Nvidia special?

Bruce Pile:  One’s first impression of Nvidia might be a computer chip maker. And if you think of them that way, you may marvel at the massive growth in their stock of late, especially with a 17 multiple on their sales and a 60 PE.

Doesn’t everyone already have a computer?

If you examine a 10 year stock chart, you see that NVDA traded against an upper resistance area of about $35 until mid 2015. At this point, the stock seems to have abruptly transitioned from a beeline growth from 2012 that approximates the computer gaming growth blossoming over that time. But as 2016 dawned, a new, much steeper beeline is taking hold to the astonishment of us all.

Kam: What is behind the steep price appreciation?

Pile: What the market seems to be eyeing now is not Nvidia the computer chip maker, but Nvidia the artificial intelligence (AI) processor.

It has been said that the best way to invest in the coming tsunami of AI is to find the masters of data. NVIDIA is the master of graphics processing, and much of what’s to come in AI is rapid, high volume processing of photos and images.

Kam: How big is the AI market?

Pile: It is claimed that the AI market less than 10 years out will be $59.8 billion. It is also estimated that of that $60 billion AI market,  NVDA figures the addressable market for their products in 8 years will be $39 billion. This compares to their average sales the last four years averaging only about $2 billion, less than half of which is AI.

Kam: How much of Nvidia’s sales are related to AI?

Pile: Most of their current sales are for gaming and their current AI revenue is just around $0.5 billion. This presents a massive growth runway to Nvidia if they only capture a modest AI market share. And they are positioned to capture more than just a modest share.

Kam: What kind of market share do they have now in AI?

Pile: They are already the AI processing leader. From the Chris Neiger piece linked above:

“According to Goldman Sachs’ Toshiya Hari, Nvidia already holds nearly 90% of the market for chips that are used for training tasks in machine learning.”

Kam: Since most of their sales are coming from gaming, what is the prognosis for that line of business?

Pile: Gaming has been a very fast growth story the last few years, but that’s old school now. “Gaming is the present, but AI is the future for Nvidia” claims Motley Fool writer Danny Vena. Over this last year, gaming revenue grew 25%, but the data center (AI) part of their business grew 109%. And that doesn’t even count the auto division, which is autonomous driving.

Kam: How long has their AI business been growing at more than 100%?

Pile: This 100%+ AI growth rate has been in place for them over many quarters now. And this looks to be just the taxi to the runway. On the recent conference call, founder and CEO Jensen Huang said: 

“we’re building the future of autonomous driving. We expect robotic taxis using our technology to hit the road in just a couple of years.”

Kam: With other stocks, I’ve seen you wait for temporary price drop before buying in. What’s different about Nvidia?

Pile: Because all this isn’t much of a secret, you are going to pay something like a 60 PE for this growth. Outside of a comet hitting earth, this will never be a cheap stock again.

My Take:  If you wait for a dip that never comes, you could miss out on a big move up all to save perhaps 10% on your entry price. However, before you pay a big premium, it is important to understand what the market already expects from the company.

Bruce Pile lays out good reasons why Nvidia is as richly priced as it is. In order to buy Nvidia now, you have to make a case that the market’s expectations are still too low. That argument is currently being hashed out in our forums.

I think there are people reading this who have the right background and experience to answer our questions but perhaps don’t know the investment implications of their knowledge. 

If you are following Nvidia, I invite you to collaborate with us. Click here to send me an email with your first and last name along with your preferred email address and I will set up a free account for you to access our forums. Read What Does The Wisdom Of The Crowds Say About Nvidia to see how this would work.

No one has all the answers. By collaborating we can answer the questions that will determine Nvidia’s success better than anyone else.

To be notified when I publish articles about Nvidia, and see my previous coverage, click here.

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