Chris’ note: The artificial intelligence (“AI”) boom has been this year’s biggest stock market story. And the biggest story in AI is chipmaker Nvidia. Its shares have rocketed 185% this year.
So, today, I’m passing along a Q&A with our new tech investing expert, Colin Tedards. He’s taking over the helm at our Bleeding Edge e-letter. And he’s been laying out a road map there for how to profit from the AI boom.
As you’ll see, although a lot of folks claim it’s in a bubble… Nvidia’s run-up isn’t as crazy as it seems.
Q&A With Colin Tedards, Editor, Brownstone Research
Chris Lowe: We’re going to get into the question of AI and how to profit in just a minute, Colin. First, let’s start with some background about you. How did you get interested in investing?
Colin: My interest in the stock market started at the kitchen table with my dad. This was before the internet, smartphones, and tablets. We would get the morning paper. And we’d open it up and look at the stock tickers and their prices.
There was a young investors mutual fund. This was also before ETFs. And if you had only a little money, you invested in mutual funds. I was refereeing basketball making about $5 an hour. But I saved up $1,000. And I sent it in.
It paid off. This was during the dot-com bubble in the late 1990s. A year later, I’d doubled my money. I’m thinking, “I’m Warren Buffet. This is going to be easy. I’m going to be this star investor.”
What I didn’t know at the time is that markets go up… and they come down. After a year, I was back to my thousand-dollar principle. But I was hooked. I knew the stock market was going to be a part of my life.
Over time, I started doing more in-depth research on stocks. I developed a passion for it. And that morphed into a YouTube channel with more than 120,000 subscribers. It’s focused on the earnings reports of the world’s top tech and growth stocks.
Chris: What do you get out of reading these earnings reports?
Colin: If you don’t read these reports yourself, you get a filtered version of what’s going on. It could be filtered through an analyst working on Wall Street who may have a client they’re trying to take care of. Or maybe the bank has a large investment in that stock the analyst is writing about.
Alternatively, you could be getting it filtered through the mainstream news outlet. And it has its own incentives to spin what’s going on.
If you go straight to the source, you might learn that some companies have low gross margins. That means even high revenue growth leaves it with low profits.
Or you might see a company’s inventory ticking up – a sign of slumping sales. Or maybe its debt levels are starting to be a problem. There’s a lot of these kinds of insights. They tell you a lot about a stock’s value.
Chris: What’s your take on the run-up in Nvidia this year? Is that about fundamental growth? Or is it more a mania kicked off by recent advances in AI systems such as ChatGPT that have captured investors’ imaginations?
Colin: With Nvidia, it is about massive sales growth. Sales growth that the folks on Wall Street did not expect. That’s why its shares popped.
Nvidia forecasts sales of $11 billion in the second quarter. That’s 54% higher than Wall Street analysts were expecting.
And on top of exploding sales growth, the company has sky-high gross margins. It can charge whatever it wants for its chips. It’s the only name in town for AI right now.
And it doesn’t just make the specialized chips needed for AI systems. It’s also moving in AI servers. These are needed to process in the “cloud” all the questions we ask ChatGPT and other AI systems.
Chris: I didn’t know Nvidia was so deep in AI.
Colin: Most people don’t. But some investors are correctly realizing that Nvidia is a picks-and-shovel play for the AI boom.
AI servers are going to drive the next layer of AI products from Microsoft, Google, Meta, and other Big Tech AI firms.
Microsoft has already layered AI into its Bing search tool. It’s now going to layer AI into its Office suite of apps. Google is layering AI into its search tool. It will do the same with its other apps.
Chris: Nvidia trades on a price-to-earnings (“P/E”) ratio of 211 versus an average P/E ratio of 159 for rival chipmakers. Is it overvalued?
Colin: If all we had to do is look at a P/E ratio and buy and sell based off that, being an investor would be the easiest job in the world. P/E gets here, you buy. P/E gets there, you sell. It’s a little more complicated than that.
To figure out if Nvidia is overvalued, we have to think about the size of its addressable market.
Lisa Su is the CEO of rival chipmaker AMD. In a recent presentation, she valued the AI server market at $30 billion. And she projected that, in five years, it’s going to go to $150 billion. That’s a 50% compound annual growth rate over five years.
$150 billion is more than the combined revenues last year of Intel, AMD, and Nvidia.
And we’re not talking about the regular cloud-computing servers these companies are engaged in. We’re not talking about their chip sales. We’re talking about just AI server demand.
Intel is years behind on AI. So, AMD and Nvidia will capture almost all that $150 billion market. But Nvidia is far in the lead.
It’s at least a year ahead of AMD. But you’re going to see both these companies continue to move. They’re going to capture the vast majority of that $150 billion. And at 60% or 70% margins. Because when you only have one or two players in town, you can charge whatever you want.
There’s not going to be a lot of downward price pressure when Microsoft, Amazon, Google, Oracle, and IBM are your customers. Last time I looked at Microsoft’s balance sheet, there’s a lot of cash there. Same thing with Amazon and Google.
Is Nvidia overvalued?
It’s certainly pricing in perfection. But perfection, when you are the market leader, is not out of the question. Nvidia is the Michael Jordan of the AI server business right now. And Michael Jordan delivered a lot of times over his career.
So, Nvidia’s price rise is not as crazy as it may seem from just a pure metric standpoint.