9 months ago • 2 mins
Back in January I showcased Nvidia’s credentials as potentially the single best investment play on the emerging artificial intelligence (AI) theme. The stock’s up more than 40% since then, as the noise around AI’s reached deafening levels.
One of the biggest risks to Nvidia was (and still is) its stock valuation. And after its recent, sizable upward move, kicking the valuation tires is more important than ever.
My preferred valuation technique for any growth stock is discounted cash flow (DCF) and I created a downloadable template you can use for your calculations here. There are two ways to use it. First, you can play around with some numbers and see what growth rates the market seems to be pricing in. This is what I did in January, and concluded that the market’s assumptions seemed, well, not unreasonable.
Or, second, you can plug in some actual forecasts to spit out a valuation. That’s what I’ve done this time around.
Plenty have gazed back at Amazon’s stock price and wondered…“if only I’d put $10,000 into Amazon way back when”. And no wonder: its stock rose an unimaginable 15,000% between 2002 – the year it first achieved positive cash flow – and 2020 – its peak cash flow year. That would have turned your ten grand into one and a half million bucks. And the main reason for that is the impressive 34% compounded annual growth in cash flow over that time.
Now, if you believe AI’s going to be the catalyst for another technology revolution, and you think Nvidia could be at the center of it, then maybe 35% annual cash flow growth for Nvidia over the next 18 years isn’t inconceivable.
But let’s just calm down for a second. Plug that kind of growth into the calculator, and you’ve got a market value for Nvidia of $4.6 trillion, nearly twice Microsoft’s current value and, for perspective, more than 10% of the entire US economy (at roughly $30 trillion).
Even for the giddy optimists, that’s probably a stretch. But, maybe 25% a year isn’t (yes, I’m putting my finger in the air here). After all, Apple’s managed more than 40%, and Google 38% annual cash flow growth since 2002.
So if Nvidia grew cash flow 25% a year for the next 18 years, and then slowed to a pace that’s more in line with global economic growth – 2.5% – thereafter, that’d equate to a market value of $1.4 trillion, a little more than twice today’s level. And maybe that’s not totally out of the question: that’s roughly Alphabet’s current market value.
Of course, plenty can (and, let’s face it, probably will) go wrong. Nvidia could be outcompeted. AI mightn’t be all it’s cracked up to be, and Nvidia could mis-execute in a whole host of ways.
But the point of the exercise is to see whether what’s priced in is outrageously unrealistic, or maybe achievable. That part’s down to you.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.
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