Wall Street Is Betting On AI As Nvidia's Stock Rises. Investors Say It's Worth The Premium

A growing trend in artificial intelligence (AI) has been taking over the technology sector over the past few weeks, and Wall Street has been raving about Nvidia for weeks as investors attempt to capitalize on the growing trend.

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The praise has translated into an outstanding performance for the shares, which have soared nearly 86% this year and are on track for their best quarter since 2001 - after a 50% tumble in 2022, which saw the shares lose more than a third of their value.

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ChatGPT has indeed been gaining big money thanks to the market's recent rotation back into technology stocks after one of the worst years the sector has experienced in more than a decade, but the primary catalyst behind the stock's gains is the growing demand for AI capabilities in the wake of ChatGPT's phenomenal debut. The market is hungry for companies that can capitalize on this trend, and investors are eager to find those companies.

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Metaverse and AI aren't just buzzwords. As the technology develops, it will open up a range of new economic opportunities similar to those created by the internet and cloud computing. Because the market is expanding, Nvidia will have more opportunities to grow, which is why some people think its stock has further upside potential.

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Global economic growth could reach $7 trillion over the next 10 years based on Goldman Sachs's broadest definition of artificial intelligence. In a recent report, Bernstein calculated that ChatGPT could generate "tens of billions" of dollars annually.

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Despite losing a little share, Nvidia will still grow very rapidly, according to Raymond James analyst Srini Pajjuri. "It's not necessarily a negative," he said.

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Stocks of Nvidia trade at about 58 times forward earnings. The valuation of the company was roughly 26 times just a year ago. Considering the S&P 500's average multiple of about three times, the contrast is even starker. As a result, investors are questioning whether Nvidia is worth it's premium.

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Those who support Nvidia say the company's focus on graphics processors allowed it to build an efficient chip that was well worth the price and gave it a headstart on its competitors.

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Achieving unrivaled AI dominance

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A graphics processing unit, or GPU, is a chip that creates images and graphics, and it represents the backbone for many new AI needs. In recent years, the company has made significant investments in AI for gaming, a field that's paying off as the technology evolves.

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Several hundred GPUs are typically needed to train many emerging AI models, according to research from New Street Research. The company controls 95 percent of the GPU market for machine learning.

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“There were years ago when most of the rest of us were kind of unaware of what generative AI could do for the world, and they saw that generative AI had the potential to be a really big deal,” said Karl Freund, principal analyst at Cambrian-AI Research, in an interview.

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An example of the term generative AI is a system that generates text or images based on large language models or ChatGPTs. As Nvidia unveiled new AI technologies at its GTC conference, attention has only grown to its capabilities in this area. Software and computing platforms that are compatible with GPUs were included, such as CUDA Quantum.

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The chipmaker's AI dominance has been hailed as a "key AI enabler" by Goldman Sachs and Bank of America. 

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“There is no doubt that NVIDIA remains one or two steps ahead of its competitors when it comes to accelerated computing silicon/systems, software, and ecosystems”, wrote Harlan Sur of JPMorgan. 

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It pays to be first

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The juggernaut is hard to compete with despite competitors such as Advanced Micro Devices and Intel trying. In the long run, Freund predicts Nvidia will control 90% of the market, with its competitors taking the remainder.

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Friends explained that Nvidia's engineering and relationships with academics and research organizations, along with the hardware and software, could stymie competitor plans.

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“The idea that anyone can catch up is beyond my comprehension," he said.

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Raymond James' Pajjuri explained that CUDA software supports a huge ecosystem of developers, and is capable of programming GPUs. As AI developed, that ecosystem expanded and created a "barrier to entry" for newcomers.

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The importance of this first-mover advantage cannot be overstated. Pieran Maru, an investment analyst at global asset management firm GAM Investments, explained some companies may encounter resistance if they attempt to switch to a new language due to the number of engineers who are already using Nvidia's software.

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Since the sharp rise in Nvidia shares, he has reduced some of his overweight position. Although the stock has a high valuation, he said it remains a good investment due to its focus on disruptive growth.

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According to Paul Meeks, a portfolio manager with Independent Solutions Wealth Management, despite the steep PE, he does not overweight it in terms of portfolio weightings; however, he sees its AI activation as a “slam dunk” and a “top of the class” enabler.

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“There's a lot of selling going on, but remember as well that the stock was beaten so badly last year, that even if it comes up 80% off the bottom we're still far below where it once peaked in the golden days," he explained as he went on to comment.

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The forward PE ratio of Nvidia peaked at about 65.5 times in November 2021, just at the start of the Nasdaq Composite's all-time high, around the same time that Nvidia's forward PE ratio peaked. The stock was at its lowest price in October of last year, closing at $112.27 per share.

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There are a lot of people who won't be able to afford it, however. In addition to owning Taiwan Semiconductor, Michael Brenner of FBB Capital Partners owns ASML Corporation, a company that is involved in Nvidia's supply chain and could benefit secondarily from the growth in the market.

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It has not changed the position of Wall Street, which has lifted its price target on shares of Broadcom to $300 in a recent note to clients. This represents an 11% addition to the price from Wednesday's close, according to Rasgon.

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Despite Rasgon's acknowledgment that shares trade at an expensive price, he further pointed out that there is a lot of opportunity for growth.

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“The market continues to look for, and we are struggling to find, a way to play these AI themes beyond those we are currently doing at the moment, so many investors continue to look for the 'best' way to play these themes,” he wrote.

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