Not So Fundamental Valuations
For the past year or so, artificial intelligence or AI has been on the top of every list. How it is going to impact productivity. How it is going to change how we live our lives. How it is going to change everything. No company has taken advantage of the idea and profited from AI more than NVIDIA.
NVIDIA basically makes computer chips. I don’t think there is another company that has sold the dream of AI more blatantly, or more successfully, than NVIDIA. Yes, they are doing work in the space and their Generative AI seems to be moving forward. That being said, their stock price has gone from $225 a year ago to $870 today.
Fundamental analysis makes up the commonsense rules for investing. They are the simple measurements that help people understand the value of something.
Price/Earnings Ratio – The price of one share of a company divided by its earnings per share. A reasonable P/E ratio might be 15-20 times earnings. NVIDIA is trading at 73 times earnings.
Price/Book Ratio – The price of one share of a company divided by its book value per share or what it is worth on paper (assets minus liabilities). A good P/B ratio is under 1. NVIDIA has a P/B ration of over 45 times currently.
Price/Sales or Revenues Ratio – That is the share price divided by the sales (top line revenue) per share. An acceptable P/S ratio would be between 1-2 times. NVIDIA has a P/S of around 33 times.
To put this in perspective, below are comments made by Scott McNealy from 2002. Scott was the one of the co-founders of Sun Microsystems back in 1982. The company’s market cap peaked at around $200 billion, which was huge in 2000. It sold in 2010 for $7.4 billion.
Listen to what he says about the fact that Sun was trading at 10 times sales (less than one third of what NVIDIA is currently trading at):
‘At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?’— Scott McNealy, Business Week, 2002
NVIDIA has a market capitalization of just over $2 trillion U.S. The S&P 500, which is the largest 500 companies in the U.S., has a market capitalization of $43 trillion. That means that this one company represents over 4.5 per cent of the largest stock market in the world.
When you expand this to include the other Magnificent Seven stocks, it looks like this:
- Alphabet (GOOGL) $1.70 Trillion
- Amazon (AMZN) $1.85 Trillion
- Apple (AAPL) $2.78 Trillion
- Meta (META) $1.28 Trillion
- Microsoft (MFST) $3.09 Trillion
- NVIDIA (NVDA) $2.06 Trillion
- Tesla (TSLA) $0.45 Trillion
- TOTAL $13.21Trillion
This means that seven companies make up just under 31 per cent of the largest 500 public companies in the U.S. Put another way, 493 companies make up 69 per cent of the market.
They say history never repeats itself but just might rhyme. I would say that is food for thought. Maybe we should ask Mr. McNealy for his thoughts on the current market.
For a little more reading, here is an article from The New York Times: https://www.nytimes.com/2024/02/22/business/nvidia-price-to-sales-ratio.html
Les Consenheim is a portfolio manager with Raymond James Ltd -Consenheim Wealth Management and can be reached at 372-8117 or les.consenheim@raymondjames.ca Raymond James Ltd. is a member CIPF.
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