Most readers will know that microchips are the building blocks of the modern digital world, and while many will not know Nvidia you may already be a regular user of its technology.

The company’s silicon chips enable video recommendations on TikTok, grammar checks in Word online, and augmented-reality shopping experiences on Facebook, and we believe it could become one of the world’s most important technology designers.

This is a fabulous company right at the bleeding edge of chip technology, helping accelerate the evolution of artificial intelligence with microprocessors that power the next generation of computing. And it is really catching on with investors, catapulting its valuation to within touching distance of the big tech five that dominate the US (and world) stock markets – Microsoft, Apple, Amazon, Alphabet and Facebook.

So far, only Tesla has really managed to break into this exclusive club, yet this year’s 136% share price rally saw Nvidia become the S&P 500’s seventh largest company courtesy of its $792 billion market cap, powering past Warren Buffett’s Berkshire Hathaway on the way.

CLOUD GOLD STANDARD

Nvidia’s premium processors were initially used for graphics-heavy computer games, striking key licensing deals to place its chips in Xboxes and PlayStations. But the ability of Nvidia’s GPUs, or graphics processing units, to accelerate the speed of data processing was quickly discovered by the major cloud service providers, Amazon Web Services, Google Cloud, Microsoft Azure et al, and has now become the gold standard for running apps and processes in the Cloud.

Savvy fund managers have leapt at the chance to back the business. ‘We believe Nvidia’s opportunity lies at the confluence of three major secular trends over the next decade – artificial intelligence, augmented reality and 5G,’ said Stephen Yiu of the Blue Whale Growth Fund (BD6PG78) when he first invested in the company in June this year. ‘All three themes drive increasingly higher demands on processing power, something Nvidia is well-positioned to supply,’ he said.

The company’s technology is also likely to play a vital role in the development of self-driving cars and the future of the internet, or metaverse, as it is increasingly being called – the development of which led Facebook to change its name to Meta this year.

Investors got a glimpse of the substantial scale of the opportunity before Nvidia after the chip designer posted record third quarter sales on increased demand for video gaming. The company also predicted a strong end-of-year (to 31 January 2022) as more companies push into the metaverse.

Nvidia reported $7.1 billion in third-quarter sales in an after-hours release on 17 November, a 50% jump from a year ago, thanks to ‘record revenue from the company’s gaming, datacentre and professional visualisation market platforms,’ the company said, with the ongoing chip shortage doing no harm to pricing.

FORECAST BEATING HABIT

That beat Wall Street forecasts for $6.8 billion in sales, while adjusted earnings per share of $1.17 topped analyst estimates of $1.11 as well. That makes it the 11 quarters of back-to-back beats. That track record goes back to 2014 if we ignore a pair of revenue misses in 2018/2019. This leaves Nvidia on track to hit earnings of at least $4.32 per share this full year on $26.7 billion of sales, implying nearly 70% and 60% growth respectively, and it might yet beat those estimates.

Analysts anticipate this rapid growth to carry through to 2022 also, forecasting $31.3 billion and $5.09 in the year to January 2023.

Of the 42 analysts that cover the stock, according to Koyfin, 35 are buyers with five more on hold. Just 1.05% of the stock is in the hands of shorters. Readers might wonder why more analysts are not cautious of the rating given the 2022 price to earnings multiple of 73, falling to 62 the following year.

Nvidia’s financial delivery over several years is a good reason. The company has put up compound average growth rates of 32% and 42% in sales and earnings before interest, tax, depreciation and amortisation over the last five years, while net margins are expected to go from 26% this year to 33% next.

Return on investment has averaged 25.6% over five years while return on equity has averaged 34.1%. This year the company is expected to throw off around $4.7 billion of free cash flow.

Grasping its opportunities in the metaverse, self-driving vehicles and maintaining its clear lead in gaming and cloud applications are likely to bolster that growth, profitability and returns record.

It’s a stock that is not suited to unadventurous investors, there is a long way to fall if management takes its eye off the ball, but we see Nvidia as one of those stocks that will never look inexpensive on traditional metrics, yet may well do when investors look back at the current all-time high of $316.70 three to five years from now.

Disclaimer: The author Steven Frazer owns shares in Blue Whale Growth Fund

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