Nvidia (NASDAQ:NVDA) is currently undergoing tremendous growth which does not seem to be ending any time soon. This has caused the share price of Nvidia to witness a huge increase in value. As a result, Nvidia’s stock is trading at high valuation levels, making investors increasingly afraid that the surge that is seen might be a bit too much for this stock. In their eyes, a downfall of Nvidia’s share price is more than likely because of its outperformance. But while it did see an abnormal surge, I believe that this is wholly justified and expect this surge to continue even further.
A sudden surge in top line growth from Nvidia can be clearly seen in the graph that depicts the annual revenue below:
Revenue growth has been on the increase and is expected to keep increasing going forward. For the last three quarters, Nvidia’s yoy revenue growth has averaged above 50%. This is thanks to two trends in particular that are expected to go on in the same manner going forward with one of the two laying the foundation for an even more exceptional time of growth in the future.
Profiting off the gaming industry
A major growth driver for Nvidia has been its gaming segment. Just during its most recent quarter, the company saw revenues in this segment increase by 49% yoy to $1.03 bln, over half of the total revenue generated in the quarter. Despite the strong increase in revenue lately, the outlook for the industry looks very bright and will cause Nvidia’s revenue for this segment to keep seeing strong growth rates.
The whole industry is currently undergoing a big development as eSports become increasingly popular. Gaming developers are shifting focus to AAA games that are meant for eSports. Overwatch is a good example of this. The game was specifically designed for eSports and added 30 mln players during the first year after its release. Nvidia’s GeForce is the graphics platform of choice for all the top eSports tournaments.
Thanks to the AAA games needing better GPU performance, Nvidia’s GPU sales have increased. And now that eSports is gaining a lot of popularity, this trend will continue as more players feel the need to buy GeForce. Management said this about eSports during the most recent earnings call:
“With apologies to the start of the baseball season, e-sports is now as popular among U.S. male millennials as America’s favorite pastime. More people watch gaming than HBO, Netflix, ESPN, and Hulu combined.”
So it is safe to say that eSports is seeing huge increases in popularity. This in turn will make Nvidia’s products increasingly popular among gamers.
AI is the future
Although the growth rate that is seen in the gaming segment is quite extraordinary, this is not the main reason to buy this stock. Nvidia’s focus on AI is what makes this stock’s future so amazing. AI has emerged as the most important and powerful force in technology. And Nvidia is the obvious leader of this revolution at the moment with its GPUs.
During the most recent quarter, the company saw its data center revenue almost triple, reflecting the huge increase in interest in AI. All major internet and cloud service providers throughout the world are now working with Nvidia Tesla-based GPU accelerators. Think of names like Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), IBM (NYSE:IBM), and Microsoft (NASDAQ:MSFT).
The opportunities that AI offers companies seem to be endless. For example, the autonomous car industry is in its early days with manufacturers developing and testing their own versions. But autonomous cars need AI and therefore this new industry will become a source of growth for Nvidia as well. It is expected that autonomous cars will eventually completely take over regular cars, which indicates a tremendous increase in the demand for Nvidia’s products. Because as Nvidia’s management states:
“We continue to view AI as the only solution for autonomous driving. The nearly infinite range of road conditions, traffic patterns, and unexpected events are impossible to anticipate with hand-coded software or computer vision alone.”
It is expected that most software in the future will feature some part of AI in it. The company is not just sitting by and hoping that others will gain enough interest to make its products popular. The Nvidia Deep Learning Institute has plans to train 100,000 developers this year, a 1000% yoy increase, with a dozen new self-paced and instructor-led labs.
Returning value to shareholders
The recent increase in Nvidia’s top line has caused its bottom line to significantly increase as well. Since FY 2017, Nvidia has managed to more than triple its net income in the TTM. The company is starting to see increasing value. And when that happens, it is time to give something back to your shareholders. Nvidia does this in the way of dividends and share buybacks. Nvidia did not start paying out dividends until 2013. It started at $0.07 annually and has now grown to $0.56, or 0.4%.
Although this percentage is quite low, we must not forget that the company only recently started its path of amazing growth. It will take a while before dividends will catch up with the share price as this is still very much an extraordinary growth stock. Management intends to return $1.25 bln in total to shareholders over the course of FY 2018, or 1.4% of the current market cap.
Increasing competition a possible risk
One risk for the amazing growth story is of course competition. Nvidia is currently ahead of everyone in the area of AI. But since the technology sector is a very competitive one, we have to keep checking whether Nvidia’s products stay superior to that of its competitors now that AI is becoming increasingly popular.
High valuation, but an amazing growth stock
While the main risk is of course seen as the high valuation this stock currently has, it is not as absurd as it might seem. The current P/E of 49.9 is not even double that of the industry average of 26.1 while the company is seeing growth rates around 50% and an even better outlook. The gaming segment is expected to go ahead at a similar pace, while its AI business is expected to boom over the coming years.
This is more than enough reason to justify a valuation of a P/E that is less than 50. Therefore, I believe that Nvidia still has upside potential and is far from overvalued. That being said, investors should realize that investing in Nvidia means investing in a growth story. The high valuations that come with this can cause risky investments. And although I believe this stock could go higher, be sure you feel comfortable with the risks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.