Since the dawn of this year, the iconic Dow Jones Industrial Average, benchmark S&P 500, and growth-powered Nasdaq Composite have navigated past the 2022 bear market blues, surging to unprecedented record highs. While megacap stocks have borne the brunt of this ascent, it’s the Wall Street darling of the moment – artificial intelligence (AI) – that is propelling this extraordinary rally.
AI, the software and systems replacing humans in executing tasks, owes its mojo to machine learning. This technological wizardry enables software and systems to learn and adapt, amping up their efficiency or acquiring new skills over time.
The allure of AI stocks boils down to one simple fact: AI finds applications across the spectrum of sectors and industries. The pundits at PwC prognosticate that by 2030, artificial intelligence could inject a staggering $15.7 trillion into the global gross domestic product (GDP).
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The Nvidia Phenomenon: Scaling the Heights on AI
Amid the AI evolution, no entity has capitalized as lucratively as Nvidia (NASDAQ: NVDA).
Entering 2023’s stage, Nvidia flaunted a $360 billion market cap sculpted mainly by its supremacy in graphics processing units (GPUs) for gaming and cryptocurrency mining. By March 4, 2024’s closing bell, Nvidia’s market cap had ballooned to $2.13 trillion, only rivaled by Apple and Microsoft in the quest to reign as the largest publicly traded company.
Nvidia’s stratospheric stock surge mirrors its dominance as the backbone for high-compute data centers. The A100 and H100 GPUs are projected to drive most GPU deployments in business-operated AI-accelerated data centers this year.
Riding high on exorbitant demand, Nvidia revels in its premium pricing leverage for these first-rate GPUs. Even with Taiwan Semiconductor Manufacturing expanding its chip-on-wafer-on-substrate capacity to boost A100 and H100 GPU production, Nvidia thrives on elevated prices for its limited A100 and H100 supply.
However, if Nvidia’s uptrend rings too sweet, history suggests an ominous echo.
A Cautionary Tune: Nvidia and AI in the Bubble Ecosystem
Wall Street’s tryst with next-big-thing investments is a recurrent saga, dangling a carrot of promise to eager investors. Over the past three decades, over six major investment fads were predicted to be the game-changer. Despite sending their stocks skyrocketing initially, all followed a path back to earth.
- The internet revolutionized businesses, yet the dot-com bust from 1999 to 2002 was a plunge precipitated by lofty e-commerce expectations.
- Genome decoding reshaped health
- Housing boomed in the mid-2000s but imploded due to risky financial practices.
- China stocks surged but stumbled from poor controls.
- The 3D printing craze faded by the mid-2010s.
- Cannabis stocks floundered due to regulatory hurdles.
- Electric vehicle growth was hampered by infrastructure gaps.
- Blockchain’s banking potential hit roadblocks.
- Metaverse hype overshadowed sluggish sales.
Every one of these instances epitomized investors’ optimism outstripping the realities of innovation. You may be tempted to believe that the current phenomenon is different; however, history often rhymes rather than repeats.
Challenges Facing Nvidia in the AI Revolution
When it comes to artificial intelligence, history suggests it’s not so bright. Most businesses are still grappling with how to leverage AI effectively to enhance sales and ramp up profits. This uncertain terrain resembles a deja vu scenario where the next big thing investment trend may falter, reminiscent of past disappointments over the last three decades.
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Navigating Stormy Weather in the AI Infrastructure
Despite Nvidia’s historical prowess, several headwinds loom on the horizon for the company in the current year. One significant challenge for this AI infrastructure giant is the production surge of its A100 and H100 GPUs, potentially denting its gross margin. The escalation in costs indicates a shift from GPU scarcity, which bolstered margins previously. With increased production, Nvidia risks diluting its pricing power by mitigating GPU scarcity.
Rivalry is intensifying for Nvidia as it faces challenges from multiple fronts. Traditional adversaries like Advanced Micro Devices and Intel are rolling out AI-GPUs to compete head-on with Nvidia’s chips in the high-compute data center arena.
However, the more pressing concern arises from the competition within Nvidia’s own clientele. The top four revenue-contributing customers – Microsoft, Meta Platforms, Amazon, and Alphabet – are collectively developing their AI chips. This move could potentially diminish their dependency on Nvidia’s A100 and H100 GPUs.
External Pressures and Valuation Conundrum
External factors are not favoring Nvidia either, with U.S. regulators restraining exports of high-compute AI chips to China. This limitation on shipping top-tier AI-GPUs to the second-largest economy globally could translate into significant revenue losses for Nvidia each quarter.
Furthermore, Nvidia’s current valuation may raise some eyebrows among investors. While its price-to-earnings-growth (PEG) ratio reflects a reasonable pricing, the company’s valuation stands at 38 times trailing-12-month (TTM) sales. Except for brief instances during the dot-com peaks of Amazon and Cisco Systems at around 40 and 38 times TTM sales, there hasn’t been a market leader historically valued at such a lofty premium to sales. Is Nvidia potentially the bubble stock of this century?
Final Thoughts
As investors ponder whether to pour funds into Nvidia, it becomes essential to weigh these challenges. The murky waters ahead for the AI pioneer suggest turbulent times with multiple adversaries and wavering market conditions. Will Nvidia navigate these stormy waters and emerge stronger, or will it prove to be a turbulent ride for investors?
