The stock market doesn’t always reflect the health of the wider economy, but the most valuable company is often a projection of the most important social and technological trends of the time.
In 2000, Microsoft’s $600bn valuation made it the most valuable company in the world. It did this by selling the operating system software to run the personal computers that were spreading to every home. By 2020, Apple sat top of the pile with a $2trn valuation. At this point, people were stuck at home scrolling through social media and Facetiming friends.
Last week, AI semiconductor company Nvidia briefly became the most valuable with its market cap hitting $3.34trn, leapfrogging both Apple and Microsoft. Over the past 18 months, Nvidia’s rise has been a story of two parts. Initially, its valuation was justifiably driven by its remarkable earnings growth. Now, it is the product of much more speculative valuation expansion.
The start of this cycle came with the release of ChatGPT at the end of 2022. At this point, OpenAI had already existed for seven years and released GPT 1 and 2. It also released the image generator DALLE-2. For anyone who had played with these tools, it was clear that AI was going to be hugely influential. However, it was ChatGPT that broke through public consciousness. Within two months of its release, it had more than 100mn users making it the fastest-growing consumer product of all time.
The day ChatGPT was released, the Investors’ Chronicle recommended buying Nvidia, arguing that the world had reached an “AI inflexion point”. This proved to be timely.
ChatGPT was trained using Nvidia’s graphics processing units (GPUs) in Microsoft’s cloud computing servers. After ChatGPT was released, the cloud computing giants Microsoft, Google and Amazon realised they were going to need a lot more GPUs to meet the incoming demand for generative AI and the only place to get them was Nvidia. Correspondingly, in 2023 Nvidia’s revenue rose 126 per cent to $60.9bn, while its earnings rose 581 per cent to $30bn.
This massive earnings growth drove up Nvidia’s share price 250 per cent in 2023. However, because its profits were growing so quickly it was getting cheaper relative to its forecasted earnings. In January 2024, valued at 25 times its forward earnings, Nvidia was cheaper than burrito maker Chipotle or energy drink company Monster.
Noticing its contracting valuation, Investors’ Chronicle recommended buying Nvidia again: “The scramble for Nvidia's hardware will accelerate in 2024, and its 25 times forward earnings multiple could soon look like a bargain”. This also proved correct.
However, Nvidia no longer looks like a bargain. Last quarter, its profits rose an impressive 21 per cent quarter-on-quarter, but this year its share price has risen 160 per cent. It is now worth 44 times its expected forward earnings.
We are now in the second part of the story, where it is being pushed up by investors who believe the AI hype but don’t know where else to put their money. No big listed software company has managed to use generative AI to meaningfully boost earnings, yet. Salesforce and Workday have both released generative AI products, but their growth rates are still falling as customers look to cut back on software expenditure.
Investors are turning away from them and investing in Nvidia instead. Total US retail activity has dropped to its lowest level since January 2020, while purchases of leveraged Nvidia ETF’s are hitting record highs, according to Vanda Research. In other words, individual investors are buying and selling less of every other company while taking out more highly risky bets on Nvidia. Not everyone thinks this consolidation is a problem. Melius Research analyst Ben Reitzes, who has raised his price target for Nvidia five times in the last six months, argues just because market value is transferring quickly away from the rest of the stock market, doesn't make it wrong. “Occasionally, like we saw with Apple and the iPhone, one company (or a very select few), creates an ecosystem that is good for developers, allowing it to generate an outsized share of profits” he argues.
We are at the stage where analysts are having to justify the ever-expanding valuation by painting increasingly speculative visions of the future. To lend credibility to their predictions, they reach back to business examples from the past. This is no criticism, as history is the only thing we have to refer to, but future innovation rarely looks like what came before.
Nvidia’s share price rise in the last six months shows the market is confident AI is here to stay and it is confident Nvidia will be a beneficiary. But that’s all it knows. It doesn’t know how much Nvidia will benefit. And it certainly doesn’t know which other companies are going to get lifted by the AI tide. For as long as this uncertainty remains, Nvidia’s earning multiple will keep expanding.
