As the market is forward-looking, we need to project future growth rather than focusing solely on past performance. While Nvidia’s EPS growth rate will eventually slow, the exact figure is uncertain. However, we can use the PE ratio as a reference in relation to its growth rate. For instance, even if Nvidia’s EPS growth slows to 73%, a PE ratio of 73 is still justifiable because the PEG ratio would be 1. Thus, the market has already accounted for Nvidia’s slowing growth rate, and it isn’t as crazy as one might think.
Comparing a stock’s historical PE ratio is more applicable because it reflects how much investors are willing to pay for the stock over time, cycling through periods of optimism and pessimism. While this method isn’t perfect since businesses can change (adding or removing products), it is a better yardstick than comparing dissimilar peers.
However, one must consider growth rates, not just the PE ratio in isolation. A stock with a higher growth rate will command a higher valuation, which is reasonable. For example, Nvidia’s earnings per share (EPS) grew by 803.1% over the last 12 months compared to the preceding 12 months. This would give a PEG ratio of just 0.09 (a PEG below 1 is considered undervalued). In other words, a PE of 73 can be considered cheap for Nvidia’s high growth rate.
mistake investors may make is to look at the PE ratio in absolute terms. This is particularly true for value investors who are used to single-digit PE ratios or at most, ratios in the teens. Seeing a PE of 73 might naturally trigger an alarm of overvaluation.
Finally, Nvidia’s PE chart shows it trading slightly below its average PE. There was a spike in PE in 2023 to as high as 237.24, but the PE fell back to the average as Nvidia met high expectations by increasing its EPS by multiple folds.
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