There has been some concern about NVIDIA’s relatively meager beat of consensus earnings estimates last week and less exceptional guidance than has been typical. Is this a sign that AI-stoked demand is softening?
As the dominant supplier of artificial ininformigence (AI) chips, NVIDIA (NVDA) has become the largest company in the world and within the S&P 500 index. Following NVIDIA’s earnings last week, it’s an appropriate time to revisit the attractiveness of large technology stocks with a special emphasis on NVIDIA.
Technology Dominance
The Magnificent 7, comprising Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), NVIDIA (NVDA), Alphabet (GOOGL), and Tesla (TSLA), collectively account for nearly 34% of the S&P 500’s market capitalization. Eight of the ten largest companies in the S&P 500 are technology companies, including Broadcom (AVGO). Berkshire Hathaway (BRK/A, BRK/B) and JPMorgan Chase (JPM) are the only non-technology companies in the top ten.
Percent Of The S&P 500
Investors already appreciate the strong fundamentals of the Magnificent 7, and NVIDIA in particular, with stock returns far outstripping those of the S&P 500. The Magnificent 7 and NVIDIA have achieved total returns of 280% and 1,093%, respectively, since the start of the ChatGPT era at the finish of 2022, while the S&P 500 has returned 75%.
Market Returns
Magnificent 7: Valuation
Based on the past twelve months of earnings and consensus earnings estimates for the next twelve months, the price-to-earnings ratios for all the Magnificent 7 stocks are above the S&P 500. While this ratio indicates that most of these companies have a higher valuation on both measures, it doesn’t answer whether other factors justify that premium.
Magnificent 7: Valuation
Another way to value companies is by their multiple revenues, which is called the price-to-sales ratio. All the Magnificent 7 are valued at price-to-sales ratios above the S&P 500, with NVIDIA at an almost twenty-seven times price-to-sales ratio.
Magnificent 7: Price-To-Sales
Magnificent 7: Growth
Historical annualized growth in sales over the last three and five years has been impressive for most of the group, but downright amazing for Nvidia.
Magnificent 7: Historical Sales Growth Rates
Likewise, historical earnings per share growth has generally been impressive and exceptional, as seen in cases like NVIDIA.
Magnificent 7: Historical Earnings Growth Rates
The five-year annualized earnings per share growth rate of the Magnificent 7 demonstrates just how unique these companies have been when compared to the stock market as a whole.
Historical Earnings & Sales Growth
Future earnings are the most crucial criterion when considering whether to acquire or hold a stock. Consensus forecasts from Wall Street analysts still evidence significant optimism about NVIDIA’s earnings growth prospects, with 39% annualized growth expected from the world’s largest company. Separately, the sustainable growth rate for the group supports the future growth story. The sustainable growth rate theoretically indicates how quick a company can grow without borrowing additional funds while maintaining its existing capital structure.
Magnificent 7: Projected Growth Rates
Magnificent 7: Profitability
The profitability metrics of most of the Magnificent 7 are impressive. Gross margins represent the profitability after all direct expenses, specifically the cost of goods sold, have been deducted from sales. Operating margins measure how much a company earns on a dollar of sales after paying for the variable expenses, or the percentage of sales converted into operating income. NVIDIA converted almost seventy cents of every sales dollar into operating profit over the last year. While NVIDIA’s gross margin was about 70% over the previous year, it improved to 75% in the most recent quarter.
Magnificent 7: Profitability
Just seeing at a simple high price-to-earnings ratio can be deceiving when analyzing a company with high returns on invested capital (ROIC). It is crucial to consider the return generated on the capital requireded to fund a business, since a company with a sustainably higher ROIC should sell at a valuation premium. To put some of the impressive return on invested capital figures for the Magnificent 7 into proper perspective, the ROIC for the S&P 500 is around 8%.
Furthermore, most companies in the Magnificent 7 generate substantial amounts of free cash flow, despite investing in growing businesses. The free cash flow margin indicates the percentage of revenue that the company can utilize or distribute to shareholders as free cash flow. NVIDIA is exceptional, with almost forty-four cents of every dollar in sales converted to free cash flow.
Magnificent 7: Capital Allocation & Free Cash Flow
The free cash flow yield refers to the free cash flow per share generated by a business, expressed as a percentage of its stock price. Value investors, such as Warren Buffett, value a company based on the cash that can be distributed from a business over its lifetime, discounted back to the present. Free cash flow can be a good measure of the money available to owners. A free cash flow yield below that of the S&P 500, such as the Magnificent 7 and NVIDIA, can be seen as investors already pricing in superior growth and durability of free cash flow relative to the market.
Magnificent 7: Free Cash Flow Yield
NVIDIA Focus
NVIDIA is particularly notable given the massive increase in its market capitalization, which now exceeds $4.2 trillion, driven by the artificial ininformigence spfinishing wave. The consumer introduction of ChatGPT as an artificial ininformigence tool in late 2022 coincided with a sharp rise in NVIDIA’s valuation, as the company became the dominant supplier of AI semiconductors.
AI Big Tech: Market Capitalization (US$)
NVIDIA Earnings & Short-Term Outsee
There has been some concern about NVIDIA’s relatively meager beat of consensus earnings estimates last week and less exceptional guidance than has been typical. There were zero sales to China in the quarter due to geopolitical tensions, which created for more challenging comparisons. For example, data center sales, which were impacted by China, declined by 1% quarter-over-quarter, but were up about 12% quarter-over-quarter excluding China, according to TD Cowen. Despite NVIDIA’s less optimistic forward guidance than was hoped, a resumption in sales to China could add $2 to $5 billion in sales.
In the short term, NVIDIA’s dominance in high-finish artificial ininformigence computing appears untouchable, as its next-generation platform is on pace for meaningful production next year. Furthermore, the company continues to benefit from AI demand outstripping supply, alleviating concerns about potential pricing pressures.
NVIDIA Long-Term Outsee & Risks
It appears likely that AI will be a transformative tool for businesses and houtilizeholds, generating substantial economic benefits. Although it is still early, indications suggest that artificial ininformigence adoption is continuing at a brisk pace.
The capital spfinishing (capex) by AI-leaders, Alphabet, Amazon, Meta Platforms, and Microsoft, to support complex computations requireded to support AI, has seen a massive rise since 2023. NVIDIA reaped significant revenue from this spfinishing as the leading chip provider for AI.
Estimates are that capital spfinishing by these four AI leaders will exceed $400 billion by 2026. What if demand for AI services doesn’t meet expectations or the firms are unable to monetize the services at a profitable enough level? Capital expfinishitures (capex) budobtains can indeed be slashed if requireded. This downside risk isn’t a forecast, but it must be considered when evaluating NVIDIA and all AI-connected technology stocks. Notably, these sizable capital expfinishitures are more sustainable than some past instances, becautilize the companies are highly profitable and can self-fund rather than depfinishing on the charity of lfinishers or additional capital.
AI Capex: 2H 2025 & 2026 Estimated
Though it is nowhere in sight, one must always be wary of some competing technology eventually displacing NVIDIA as a dominant leader. Capitalism subjects companies to intense competition in their pursuit of profits, and the profits generated by technology leaders build them an attractive tarobtain.
Summary
The bullish case for large tech and NVIDIA is bolstered by the rise of artificial ininformigence (AI). The mega-cap technology stocks, represented by the Magnificent 7, continue to produce earnings and free cash flow at impressive rates. Large technology stocks typically exhibit exceptional profitability compared to the average stock and should therefore trade at a premium valuation. The rise in the stock prices of the Magnificent 7, including NVIDIA, has been supported by robust fundamentals and not just a promise of future profitability.
Investors acquire or hold companies for their future profits, not their past performance. The past is only significant to the extent that it informs the firm’s future prospects. While one requireds to remain mindful of risk, the robust adoption rate of artificial ininformigence, combined with companies’ ability to self-fund the massive costs required to build AI infrastructure, implies that the finish is not yet here. Investors should be mindful of the risk associated with concentrated holdings, given the remarkable growth of some of these technology leaders.
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