‘When it rains, it sure doesn’t rain on Ayrton Senna’. This quote from the movie The Art of Racing in the Rain, exemplifies Nasdaq listed chip maker Nvidia’s status today. While globally companies and investors brace for a slowdown as recessionary clouds gather, the sun is shining bright on Nvidia. The company is seeing a massive surge in demand for its products and is unable to meet it fully.
Thus possibly while the rest get wet from any recessionary storms, it appears it will not rain on Nvidia. And there may also be a more enduring message to take note of from its results.
AI gold rush
Nvidia’s ‘greatest beat of all time’ in its Q1 results/outlook that it reported on May 24 after US markets closed, left investors, analysts and competitors scrambling on their next moves.
The near $200 billion in market cap it added on a single day yesterday propelled it to the fifth spot in terms of world’s largest companies by market cap. Its market cap increase in a single day was nearly twice the market cap of Intel which until few years back was the most dominant and popular chipmaker globally.
The shorts scrambled to cover positions, analysts across the board had to upgrade their price targets, and competitors/other chip makers right now will be pondering how they missed the AI bandwagon and what they need to do now to join the party.
Further investors who had missed Nvidia’s rally from $3.8 in 2013 to $380 yesterday and its 165 per cent rally ytd, have some tough choices to make. Do they get in now or do they look for other stocks that can benefit from AI boom and are cheaply priced.
Trading at a trailing EV/revenue of 34 times and PE of 184 times, many may have doubts of buying into the stock now, although its growth is exploding.
Never seen a quarter like this
What stunned everyone, including the Nvidia bulls, was the company’s Q2 guidance. Its Q1 results in which revenue beat expectations by 10 per cent, was overshadowed by the 52 per cent beat in its Q2 revenue guidance. Such a beat versus expectations is unprecedented.
Tech analyst at Morgan Stanley Joseph Moore noted that he had never seen a quarter like this in the 25 years that he has covered stocks. One wall street analyst termed it the ‘guidance for ages’, while another noted that the Nvidia results are a reminder that ‘we are in an AI gold rush.’ Even the most bullish analyst and investor was taken surprise.
Earnings higher by 50 per cent versus expectations is not unheard of. Earnings is a function of revenue (demand) and costs (efficiency of operations). However revenue beat of 50 per cent is unheard of. It reflects nothing but an unsatiable demand.
This surge in demand is driven primarily by Nvidia’s data center business segment which accounted for 60 per cent of Q1 revenues. Nvidia holds the leadership position in chips for server GPUs (graphic processing units). GPUs are designed to handle complex mathematical and graphical computations. The need for the same has exploded in recent months as the AI rush between Microsoft and Alphabet and other big techs has gained epic proportions. Nvidia’s GPU chips are thus a very critical component in their quest for AI leadership, underlying the surge in its revenue. This is reflected in the company’s Q2 revenue guidance of $11 billion, nearly $4 billion more than the consensus estimate of $7.2 billion.
Implications
Mark Zuckerberg has termed 2023 as the ‘year of efficiency’ for Meta. Alphabet, Microsoft, Amazon too have been going big on cost cuts with employee retrenchments, and Alphabet even going to the extent of cutting down on employee laptops, services and of all things even ‘staplers’ for ‘multi-year’ savings. Thus while they are going big on cost cuts, simultaneously they also appear to be investing big in AI.
AI as a share of big -tech’s capex and investments is surging at the expense of others. This is sending a clear message on the importance of AI and also indicates that AI may have crossed the hype phase and is at an inflexion point.
Stakeholders across the board need to take note of this and get serious on how AI is going to change their world. It appears to be happening faster than anticipated.
The implications are wide. For example, how will the business model for Indian IT services change, which had few challenging years last decade when surge in cloud/SaaS impacted their legacy business.
What will be the impact across industries as adoption of AI changes the way business is done. What will be the impact on employees as skill set demand changes based on evolution of AI.
Another critical question – how is the Indian government warming up to this, is India still going to depend on western corporations for the latest technology in something as critical as AI, or are we going to aim for self-sufficiency, a path that the Chinese embarked on a long while back.
With many more questions, another important one is, if you are an investor how is this going to impact your portfolio? How well is your investment levered to capitalize on AI trends? Which are the companies that can benefit the most?
For example after Nvidia results yesterday, analysts were trying to pick which other semiconductor companies can benefit from the AI wave and are trading cheaper versus Nvidia. Taiwan Semiconductors (which manufactures chips for fabless companies) and semi equipment maker ASML were amongst those discussed. Can Intel too participate in the rally some time in the future? Thus there could be some upheavals and dishevels
At the same time, while the AI boom appears really, whether the AI stocks upside is a sustainable boom or is it a bubble is still up in the air. While May 25 belonged to the Nvidia bulls, the bears were quick to compare it Cisco and Intel of 2000 which are still trading today at more than a 50 per cent discount to their 2000 peak.
As all these debates play out, investors must plan to identify a cluster of AI levered stocks at good prices. If India does not offer enough opportunities in this space right now, investors must also look to expand horizons and look at international stocks with a long-term perspective.