Ever since the rise of the internet decades ago, investors have been captivated by buzzy trends and innovations. However, none quite compared to the impact the internet had on corporate America. Enter the artificial intelligence (AI) revolution – a tech advancement that has left both professional and everyday investors in awe of its potential.
Analysts at PwC predict the AI sector could add a staggering $15.7 trillion to the global economy by the end of the decade. No company has capitalized more on the AI hype than Nvidia (NASDAQ: NVDA).
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Nvidia’s Meteoric Rise Unveiled
At the dawn of 2023, Nvidia was on the cusp of tech stardom with a market cap of $360 billion. Fast forward to August 28, 2024, and the company surged to an astounding $3.09 trillion. Nvidia briefly held the title of the most valuable publicly traded company in June after implementing a historic 10-for-1 stock split.
Nvidia’s H100 GPU became the darling of AI-accelerated data centers, solidifying its position as the go-to chip for generative AI solutions, large language model training, and rapid AI-driven decision-making. The overwhelming demand for Nvidia’s hardware granted the company formidable pricing power, with its H100 fetching prices ranging from $30,000 to $40,000, compared to AMD’s MI300X priced between $10,000 and $15,000.
Nvidia’s success doesn’t stop there. The CUDA software platform has played a vital role, enabling developers to maximize computing capabilities and build sophisticated LLMs. The company’s unrelenting performance streak, with six quarters of surpassing Wall Street projections, further cemented its dominance in the AI space.
However, beneath the accolades lies a worrying signal that Nvidia’s glory days might be ebbing.
Unearthing Trouble: Nvidia’s Margin Dilemma
While Nvidia resoundingly beat revenue and EPS estimates for the fiscal second quarter, a deeper look into its performance unveils a concerning downtrend. As headlines celebrate growth, the true pulse of Nvidia lies in its gross margin, a crucial metric dictating future trajectories.
Diving into adjusted gross margin, which eliminates acquisition-related expenses and stock compensation, Nvidia’s performance is laid bare. In the fiscal first quarter, the company boasted an unprecedented 78.35% adjusted gross margin. This meteoric 14-point rise over five quarters underscores Nvidia’s ability to command premium prices for its AI-GPUs.
Notwithstanding, Nvidia’s guidance for the second quarter hinted at a modest pullback, projecting an adjusted gross margin of 75.5% (+/- 50 basis points). True to projections, Nvidia’s fiscal Q2 results revealed an adjusted gross margin decline of 320 basis points, settling at 75.15%. While within the forecasted range, it slightly missed expectations.
Looking ahead, Nvidia’s fiscal Q3 outlook presents the looming potential for additional challenges
Challenges Ahead for Nvidia Amidst Gross Margin Contraction
Despite Nvidia’s adjusted gross margin forecast of 75% (+/- 50 basis points), there is no denying the looming challenges that the company is poised to face. While the current margin remains considerably higher than it was 18 months ago, a shift in the tide is becoming evident, and it is not in Nvidia’s favor.
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Increasing Pressure and Historical Context
Competition and history are aligning against Nvidia. The expansion of its H100 chip sales and the acknowledged demand for its next-gen Blackwell GPU architecture have fueled a notable portion of the adjusted gross margin growth. However, the threat lies in dwindling AI-GPU scarcity and the subsequent erosion of pricing leverage, as competitors like AMD ramp up their production efforts.
Furthermore, the impending likelihood of suppliers demanding a larger share of the pie adds to Nvidia’s woes. Taiwan Semiconductor’s significant CoWoS capacity expansion implies heightened production costs for Nvidia to sustain its operations effectively. The entrance of external rivals and the emergence of in-house AI-GPUs from Nvidia’s top clients only compound the pressure on the company.
The Weight of History
Over the past three decades, emerging technologies have invariably navigated early bubbles before reaching maturity. Artificial intelligence appears to be following this established trend, posing an additional obstacle for Nvidia to navigate. Despite securing substantial orders from key partners, the lack of a coherent strategy among businesses investing in AI, along with Meta Platforms’ prolonged monetization timeline for its AI ventures, add layers of uncertainty for Nvidia’s future prospects.
Given these challenges and Nvidia’s adjusted gross margin outlook, the prevailing sentiment indicates a peak in the company’s stock trajectory. Investor confidence may be wavering in light of these developments, signaling a potentially rocky road ahead for Nvidia.
Investment Considerations
As investors ponder the future of Nvidia, it is essential to weigh the emerging landscape carefully. While the Motley Fool Stock Advisor team excluded Nvidia from their list of top stock picks, other opportunities in the market may offer substantial returns in the foreseeable future.
Reflecting on the historical performance of stocks like Nvidia can provide valuable insights. For instance, an investment of $1,000 in Nvidia following a previous recommendation could have yielded a remarkable return of $769,685, underscoring the potential in strategic investment decisions.
Exploring alternative investment avenues through platforms like Stock Advisor can offer a roadmap to success, with a track record of outperforming the S&P 500 index significantly since its inception.
*Stock Advisor returns as of August 26, 2024
