Is Nvidia's lofty valuation justified?

$NVIDIA Corp(NVDA)$ 

Currently, Nvidia's P/S and P/E ratios (41 and 225 respectively) are way beyond the industry and its own historical averages and norm. With a YTD performance gain of 196%, its prices are in uncharted territory, reminiscent of the meme stonks hype. Despite concerns about over valuation, analysts continue to pump out higher price targets. Do these price targets speak for themselves? Is there something unique about Nvidia that is not immediately noticeable?

Identifying the advantages that Nvidia hold

1) a performance lead

Nvidia holds an undisputed performance lead over it peers. Case in point, its rival, AMD had to dedicate larger amount of compute power and have to pack beefier hardware specifications (as seen in its instinct line of Graphical Processing Units/GPUs) into its product in order to compete with Nvidia at the same level.

This illustrates a primary advantage that NVDA possess, superior hardware performance which can only be quantified in terms of benchmark numbers but not in terms of stock prices. We can however, use AMD’s YTD performance as a gauge for changes to NVDA's stock prices. We should naturally expect NVDA to be better rewarded by the market and indeed it is (vs 60+% YTD performance gain).

NVDA vs AMD

2) technological superiority 

The superiority we see in Nvidia's product performance as we know can be attributed to its engineers, and most importantly, its software (CUDA). At the same time, it is reported that NVDA still utilizes an older monolith styled chip architecture as compared to AMD and Intel, which are both focusing on a chiplet design for their newest generation of product. In 2024, NVDA is expected to announce its new architecture. This could very well indicate that NVDA is at least a generation ahead of its peers.

These advantages thus allow NVDA to dictate industry direction, pace and prices, as already evident in most of its past releases. As the trail blazer, this forces NVDA's competitors (and even startups) to differentiate. For instance, AMD had to pack a significantly larger memory capacity in its latest gen of product, i.e., 192 GB vs 80GB by NVDA. Such an aggressive posturing by AMD is welcomed since it offers enterprises a more value-oriented proposition, but ultimately, there is a limitation to how much power that can be packed into a circuit board, and how far AMD can proceed with such a strategy less they over exert themselves.

NVDA could thus strive for monopolistic control by utilizing the same strategy as its rivals but has no need for given its already superior product profit margin. Case in point, it is estimated that 550,000 NVDA H100 GPUs will be sold in 2023, with each delivering a profit margin of 1000% (sources not confirmed). This is logical since a beefier hardware specification would command a lower profit margin. This means that NVDA has a margin of safety when it comes to its product releases, with the ability to easily counter its rival's offering and catch them off guard.

As a result, what we are seeing currently is a natural delineation across the market segments of enterprise and consumer GPUs, with AMD setting its product at a lower price point.

H100 profit margin

3) it's reputation

Nvidia's GPU is also widely adopted by the community and there are significantly more documentations and support available online. This solidifies its reputation as a trusted and reliable brand. The dissemination of such knowledge accumulated over the years is also assisted by Googles' indexing engine.

Furthermore, Nvidia is a stock market darling. Being one of the hottest stocks in 2023, recent trends and hype have only further bolstered its reputation. Alongside OpenAI and Microsoft, with NVDA role as an enabler of it all, it's branding and image will be etched in the minds of its consumers as the premier of an AI driven future.

Since unnoticed stocks tend to underperform the market, when the NVDA stocks gains the spotlight, this attention inherently becomes one of its advantages that contributes to its volatility, hype and market momentum, ultimately helping move its stock prices.

4) A new line of revenue

Apart from its traditional lines of revenue, enterprise software and professional services are at the moment, a promising area in which NVDA is venturing into.

While it's software may not necessarily be the best, its expertise in hardware design and in its own proprietary tech, CUDA, will be the differentiating factor since its competitors cannot easily replicate this.

Such a revenue source complements its hardware sales, which are constrained by production lines and refresh cycles.

Nvidia showcasing its enterprise software

Recommendation:

Vast majority of the market share currently belongs to NVDA, followed by AMD and Intel. NVDA dominates the premium and high-end range of products, in which it will likely reign supreme for the next few generations of cards, supply constraints, pricing, geopolitical factors as well as the need for diversification are currently driving AMD to soak up 'lost' business opportunities.

For instance, reports show that companies are experimenting with AMD's product. While AMD's product pales in hardware and software performance, recent updates to its software drivers have driven gains in standard benchmarks.

This could very well illustrate that behind the scenes, AMD can value add to its clients by providing customization services to push performance on specific workloads.

Thus, investing in both companies could allow an investor to capture a large chunk of the industry's growth.

AMD's CEO predicting market size