Overconfidence and Bubbles
Craig White, LL.B. BA. CIM.
Portfolio Manager at Lionridge Capital Management
One of the big stories of the past week is the dramatic rise in Nvidia's stock as it released 2nd quarter guidance which was one of the largest guidance beats in recent memory.
Nvidia projected $11 billion of 2nd quarter revenue, whereas analysts had only been expecting them to earn about $7 billion of revenue in the second quarter a 57% beat.
As a result the stock price has shot up about 28% since last week and briefly traded over $1 Trillion yesterday.
As a result of this and all the hype surrounding AI, there have been ALOT of opinions on the valuation of Nvidia.
Many people are assuming that Nvidia is another bubble similar to other bubbles we've seen recently like crypto. On the surface this seems to be the case. If we assume the second quarter guidance is correct and similar results are recorded over the next twelve months, then Nvidia is currently trading at about a 58 P/E and about 22 times projected revenue. Those seem like pretty expensive multiples, even for a company as great as Nvidia.
One of the characteristics that human beings really struggle with when forecasting the future (including myself) is that we tend to view the future as a linear extrapolation of what's happened before. If a company has grown at 10% over the past three years then we will extrapolate that growth out into the future.
The trouble with Nvidia and companies like it, is that there is nothing linear about how Nvidia has grown over the past three years, or in how it is currently growing in the 2nd quarter. Nvidia's revenues since 2020 have been:
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There is nothing linear about this, and so applying a linear growth rate and extrapolating an appropriate earnings or sales multiple based on that is likely to make a lot of people look silly.
I think that we've seen this with other companies in the past where critics applied normal growth rates to companies that were simply not normal. Tesla is certainly one example of a company which has defied the critics (including myself) by being able to impressively ramp up growth.
It's just really hard to predict what the AI landscape is going to look like even 12 months from now, let alone 5 years out. We also don't know what the competitive position of Nvidia will be in the future. With these known unknowns, it is really hard to say that Nvidia is definitely not worth the current market cap it is trading for.
My point in this is not to suggest that you should go out and buy Nvidia or Tesla stock. I don't think you should do that. But I do think that we should all be humble and recognize that there are limits to how well we can predict the future when it comes to exponentially growing companies like Nvidia or Tesla. So we shouldn't be too overconfident in our bearish OR bullish opinions when it comes to these companies.
The good news is that we don't have to be. Investing is a game with no called strikes. I don't have to have an opinion on the valuation of Tesla or Nvidia. And that's good because knowing Nvidia's future is very very hard, at least for me. I'm happy to watch from the sidelines.
Chief Analyst at RiskHedge │ Rational optimist
9moNvidia will keep marching higher. But I took some profits recently, nonetheless. I see better opportunities in other AI infrastructure plays.