How NVIDIA And The Magnificent Seven Are Transforming Markets
The rise of NVIDIA is nothing short of extraordinary, recently reaching the status of the most valuable company with an intra-week high of $140 per share and a market cap of $3.3 trillion. This surge has generated buzz from AI enthusiasts to conventional market watchers alike.
The Dual Perspectives On NVIDIA “Gold Rush”
The magnitude of NVIDIA's growth is unprecedented, with Bloomberg headlines declaring, "NVIDIA Is Now a 591,078 Percent Rally from Its 1999 IPO." Ives, highlighted this transformation by stating, "The focus on NVIDIA’s GPU [graphic processing unit] chips will be its new golden goose or oil well where all tech companies will eventually follow as the fourth industrial revolution clearly appears to be upon us."
He emphasised the significance of this shift in the trajectory of artificial intelligence (AI) development, characterising NVIDIA's CEO, Jensen Huang, as the "Godfather of AI." This title underscores Huang’s instrumental role within NVIDIA and his broader influence on shaping the global AI landscape (Benzinga) (The UBJ - United Business Journal).
It echoes an attitude that runs through the entire sector. A key element of NVIDIA’s soaring share price isn’t really a component at all: it’s the collection of chips inside the green-bracket ticker tape that represents the ‘AI revolution’ and powers everything from machine learning models to space simulations. And the question at its core – is this stock rocket/ticker tape an explosion that portends a mother of all bubbles? Or a new world of fundamentals?
Two contrasting statistics provide a finer-grained picture. On the one hand, Microsoft and LinkedIn’s 2024 Work Trend Index shows that 75 per cent of ‘knowledge workers’ worldwide are now employing AI, and 78 per cent of these are smuggling it into their workplace. This is a sizable, under-the-radar, enterprise-level market, which underscores growing market potential for AI in the future.
However, as the Wall Street Journal noted in an April article on the finances of generative AI startups, large language models have cost approximately $50 billion to train on NVIDIA chips, whereas only $3 billion in revenue has been derived from generative AI to date. In the words of Sonny Huang of Sequoia: ‘AI is a field of dreams. The amount of money it takes to build this stuff has vastly exceeded the amount of money coming out so far.’
NVIDIA's Staggering Revenue Growth
It’s not that the AI startup world has escaped the harsh economics of revenue diversity. Even aside from GameStop, NVIDIA’s revenue performance is off the charts: in 2023, the company reported $60 billion in revenue, and it’s growing at more than 250 per cent. This is not about some wild capital-gains fairytale – this is one of the single greatest revenue growth stories of, well, ever.
But ordinary valuation metrics are another matter – NVIDIA currently trades at a price-earnings (PE) ratio of 77, compared with an average of about 30 over the preceding 10 years for the median stock in the S&P 500, which seems extravagant but has implications that are tame compared to extreme spikes of the past: Tesla’s P/E ratio topped 1,200 in December 2020, and Cisco’s PE in the dot-com bubble peaked at 200 in 1999.
Market Dynamics and the Magnificent Seven
Investors have ploughed their money elsewhere; the market power of NVIDIA is a big part of the reason why the S&P 500 and NASDAQ indices have turned north so forcefully this year. NVIDIA accounts for more than one-third of the S&P 500’s market cap gains this year and for more than half of the NASDAQ’s gains. The concentration of the wealth blown off the top of the equity market of the US has never been seen before.
The market cap of the Magnificent Seven (the top seven companies in the S&P 500) now accounts for 28 per cent of the market capitalisation of the S&P 500, which was only marginally beat during the dot-com bubble at the turn of the millennium.
That concentration also hides weakness. The S&P is up 15 per cent this year, but an equal-weighted version is down 0.5 per cent, with just 48 of its 500 stocks today above their 50-day moving average. This is the worst market breadth during a rally since 2002, according to Bloomberg.
The Debate: Bubble Or Sustainable Growth?
Financial analysts and investors are currently debating whether NVIDIA’s valuation reflects sustainable revenue growth or a bubble that will burst, and Mike Green’s argument concerning the power of passive investing, with ‘demand self-reinforcing to turn flows into a reflexive loop for mega-cap stocks’, helps explain why.
His thesis makes us wonder what will happen when these inflows become outflows – perhaps due to shrinking demographics and/or demotions – since the weights of the constituent stocks of index-linked ETFs adjust automatically in response to stock price fluctuations.
Comparing NVIDIA To Bitcoin
Curiously, though, one sees some resemblance between NVIDIA and Bitcoin: not only do they have similar returns and volatilities, over the course of a decade NVIDIA has been a serious contender as one of only a few assets that can match, let alone beat, Bitcoin’s returns, and for much shorter periods of time as well.
However, unlike the mysterious digital currency, NVIDIA is a fixture in retirement accounts. Given current valuations, 60-40 portfolios have approximately 4 per cent exposure to NVIDIA with S&P index funds clocking in at a staggering 7 per cent holdings of NVIDIA stock.
A Financialized Economy's Bet On NVIDIA
Powered by its leading-edge GPUs, the company’s phenomenal rise reflects – on the one hand – the potential promise of the new market environment. Its GPUs are at the heart of the AI revolution, driving exceptional growth in revenue. Yet it also exemplifies the risks of the new market environment. Fortunately for long-term shareholders, it also verges on mania.
Judged by conventional financial metrics and leverage levels, the market environment exhibits many of the hallmarks of earlier peaks. P/Es are elevated and climbing. After falling in recessions and corrections, it usually takes five years for the market price-to-revenue multiple to recover and 10 for the price-to-sales multiple to regain peak levels.
In this sense, a super-financialized US economy is statistically betting that the NVIDIA bubble never pops, so to speak. Anyway: let’s return to those two statistics. 75% of the global knowledge workforce using AI, versus $50 billion spent on Nvidia chips, versus $3 billion in revenue. You may not bat an eye at this, but I think the ‘misleading statistics’ here is most certainly the revenue versus the money spent on NVIDIA chips.
We are at the beginning of a wholly new era of computing. It's already revolutionising how we interact with computers, transforming jobs, and redefining the nature of work itself. We are merely scratching the surface of the profound impact this technology will have.
We should evaluate the value of the 'AI sector' by asking ourselves,
"How much have generative AI startups figured out how to monetize in about 18 months?"
However, how do you value a company that forms the foundational layer for a whole new era of computing and work? It's challenging to say the least.
NVIDIA is arguably the most pivotal company in this transformation. As such, is a valuation of 77 times forward earnings – about half of what leading stocks in the “dot-com” era reached – excessive? I'm not sure.
However, I firmly believe that the AI market won't just grow; it will expand massively, absorbing substantial portions of other markets over the next decade. Whether that means NVIDIA is headed for a price correction is anyone's guess.
One telling point is that despite how well they’re doing, NVIDIA’s CEO Jensen Huang isn’t resting on his laurels.The Information published on June 18th published an in-depth analysis on Nvidia new strategies, highlighting NVIDIA’s CEO, acute awareness that one-time hardware titans like Cisco downfall that now peddle software and cloud services, is aggressively pushing his company to do the same – putting it in direct competition with its largest customers.
The article is well worth a read, but a particularly striking concern from Huang was his worry about data centre capacity. "I was wondering if NVIDIA’s largest customers were going to run out of space in their data centres to put [its AI chips]," Huang said. In other words, if we think the current structure of the industry will remain static, we are mistaken. This is a pivotal moment in time. And to be clear, none of this should be taken as investment advice.
What's incredibly exciting is that these questions, typically confined to the realm of venture capitalists, who are inherently forward-looking, are now being debated in public markets. With NVIDIA, the world's most valuable public company, at the heart of this technological transformation, we're witnessing a fascinating shift in how valuations are considered. This narrative is one we'll undoubtedly revisit in the future.
