The performance of Nvidia (NASDAQ: NVDA) over the past five years has been mind-boggling. During that period, Nvidia stock has soared 2,081%.
But the chipmaker now has a market capitalisation of $3.3trn and trades on a price-to-earnings (P/E) ratio of 54.
While that is far from unheard of – Amazon is on 47, for example – it is far higher than some investors such as myself would feel comfortable paying.
Back to the future
Step back five years, however.
Amazon had then long been a darling growth stock and looked fully priced. Since then, however, its stock has grown 135%.
That is far less dizzying than Nvidia during that period. Longer term, though, Amazon had already delivered the sort of phenomenal growth we have seen from Nvidia in the past five years – but it still managed to more than double from the start of 2020 until now.
So, might the same turn out to be true for Nvidia stock?
Could it be that, even if recent amazing gains are not repeated on the same scale, it nonetheless moves up even further in the next few years? Or has it peaked already?
The case against buying Nvidia today
To begin with, consider the bearish case about the chipmaker. I already said above that its current P/E ratio puts me off investing, as it looks expensive to me.
But earnings at the company have ballooned over the past several years. If they fell back to anywhere close to what they were just a few years back, the prospective P/E ratio would be in the hundreds, not at 54.
Might that happen?
There has been a rush by companies to buy up chips as they attempt to gain first mover advantage in their respective industries when it comes to AI. After the initial round of installations, though, demand for AI chips could fall back in years to come.
Meanwhile, competitive pressure could reduce the pricing power enjoyed by the current industry leaders such as Nvidia and Taiwan Semiconductor Manufacturing.
Here’s how things could get better from here
On the other side of the coin, though, what if AI really is a transformative trend that is here to stay?
Just as Amazon was once seen as wildly overvalued for an online retailer, Nvidia could yet exploit its competitive advantages in chip design and manufacture to get even stronger in a fast-growing part of the economy then use that strength to expand its business footprint further.
In November, the company’s chief executive proclaimed, “the age of AI is in full steam, propelling a global shift to NVIDIA computing”.
While he may want to ask ChatGPT “how can I sound more modest?”, the underlying point could turn out to be accurate. The recent surge in demand for Nvidia chips may not be a one-off blip, but rather an indication of future sales potential for the industry leader.
I’m in no rush to buy
I think either of the above scenarios could yet play out.
So, while I think the company’s technology, customer base, and ambition could yet mean that its stock has more potential ahead, the current valuation does not sit comfortably with me, given the risks.
At the right valuation, I would buy Nvidia stock in a heartbeat. For now, though, I will sit on my hands.
This post was originally published on Motley Fool
