By Jack Hough
Nvidia just became the first chip maker to top $1 trillion in stock market value, and a finance professor who has invested since 2017 sold his shares. "I got lucky on that one," he says.
Perhaps. But this particular professor is nicknamed the Dean of Valuation for his decades of work on how to estimate what assets are worth. So his sale raises the question of why he thinks Nvidia (ticker: NVDA) doesn't belong in the trillion-dollar club with Apple $(AAPL)$, Microsoft $(MSFT)$, Alphabet $(GOOGL)$, and Amazon.com $(AMZN)$. After all, companies with ties to artificial intelligence are being richly rewarded at the moment, and Nvidia has a dominant market share in AI chips.
Also, which of the other tech giants look too expensive now? And is the fact that recent market gains have been powered by a handful of stocks a problem?
"This lack-of-breadth thing drives me crazy," Aswath Damodaran told Barron's on Tuesday. "You know what? Markets have never had breadth."
Damodaran teaches corporate finance and equity valuation at New York University's Stern School of Business. He has written numerous textbooks on those subjects -- "obscenely overpriced" ones, as he puts it. He recently looked at 80 years of market data and found that big bull runs were commonly carried by 10% of stocks or less. Today, he owns most of the tech giants, three of which he says he bought "at their absolute bottoms last year."
These include Facebook owner Meta Platforms $(META)$, recently $262 a share. "When Facebook hit $95 per share, I said, given its cash flows, this is like American Express [AXP} as Warren Buffett saw it after the salad oil scandal," says Damodaran. "The cash flows from its advertising business over four years covers that price. I'm buying it and hoping that they don't screw it up with the metaverse."
Historical detour: The salad oil scandal refers to a 1960s scheme whereby the Allied Crude Vegetable Oil Company borrowed from American Express using exaggerated soybean oil inventories as collateral. It used the proceeds to buy soybean oil futures, in order to push prices higher for the nonexaggerated portion of its inventory. There was a whistleblower, losses, a ripple effect, and bankruptcies, and, looking back, it created an opportunity to buy AmEx shares on the cheap. If you're wondering why no one has made a movie about this colorful episode, there's already a script and a studio, CNBC's Ron Insana is involved in the effort, and Buffett likes the idea, according to Deadline.
Back to Nvidia. "That was in my portfolio till this morning," Damodaran said on Tuesday. "And I finally got it out of my portfolio because I couldn't take the rise. You had $300 billion in a week. You're pushing the absolute limit of what sustainable value is."
He estimates that Nvidia has an 80% share of a $25 billion AI chip market today, and the most bullish assumptions put the size of the market at $350 billion in a decade. Even assuming 100% future market share, he wasn't able to get to a value closer than 20% below Nvidia's recent price. "I love Nvidia as a company," he says. "But as an investment at $400-plus per share, I just can't get there."
More broadly, Damodaran says that Nvidia is essentially a hardware company, whereas other members of the trillion-dollar club have used software to draw vast numbers of end users into their ecosystems. That creates what a statistician might call a long-tail distribution of business opportunities -- many ways to earn from new products and services.
A company that sells chips to other businesses faces natural constraints, says Damodaran. "The tails in the distribution tend to be much more prudent," he says. "The upside is not as large as it could potentially be for a consumer-based company with an ecosystem of billions of users. And that kind of crimps how much you're willing to bet on that optionality."
Damodaran compares his current thinking on Nvidia with how he felt about Tesla $(TSLA)$ when it hit $1.2 trillion in value in November 2021. "I pushed to full throttle and I couldn't get within $300 billion of that $1.2 trillion." Shares tanked. They started bouncing back around the beginning of this year. In hindsight, they were reasonably priced in January, Damodaran says, but by the time he got around to working up a fresh valuation in February, "it kind of got out of hand again."
Damodaran doesn't own Netflix $(NFLX)$. Outside of tech, he just bought Citigroup (C). JPMorgan Chase $(JPM)$ is a much better bank, he says, but the price on Citi is so low that all it has to do is "have management that can chew gum and walk at the same time."
One way to compare Citi to other banks is to look at the ratio of its share price to its book value per share. But this sort of relative valuation is for traders, Damodaran says. Investors, in his opinion, are better off estimating how much to pay for a business based on its future cash flows.
"I entirely understand the use of multiples and comparables as your way of trading," he says. "But I do have conniptions when these same people talk about, 'I care about value. This is all about valuation.' No, it's not. It's a pricing game. You play it really well. Claim credit for it when you do. But let's not talk about value in the context of pricing, because it's a very different game."
Is the market fairly priced? Don't bother trying to tell, says Damodaran. Just buy index funds and hold, or pick good stocks, or both.
How about Bitcoin's latest bounceback? Its fans are "never going to let it become a good currency because it's in their best interest to keep it as a volatile instrument that they can speculate on," he says.
Asked where the bubbles are now, Damodaran named an asset class that doesn't spring to mind as a source of systemic financial risk: professional sports teams. For example, Major League Baseball, he says, is a low-growth business with yearly pretax, pre-reinvestment cash flow of $600 million. That's worth perhaps $10 billion "on a good day." But the collective price of teams is closer to $70 billion.
Team prices today appear to be driven more by vanity than financial returns, but owners shouldn't worry about the bottom falling out overnight, says Damodaran. "As long as the number of billionaires exceeds the number of sports franchises, there is no crash coming."
Write to Jack Hough at jack.hough@barrons.com
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(END) Dow Jones Newswires
June 02, 2023 21:30 ET (01:30 GMT)
Copyright (c) 2023 Dow Jones & Company, Inc.
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