Nvidia owes you $950 billion
A brief discussion on NVDA’s valuation
Nvidia earnings were pretty good today. But for a company now valued at nearly a trillion dollars, pretty good is no longer enough.
Stock in a company is a claim on free cash generated by that company over its life. As of this writing, Nvidia needs to generate $950 billion of discounted cash flows over its lifetime of earnings in order to equal its present value.
Cash flows are “discounted” because earnings in the future are not as valuable as earnings received today. The sum of all discounted cash flows is the net present value, or NPV. That is, when company is selling at a price equal to its NPV, you receive exactly $1 in return for your $1 investment. Investors should aim to pay less than NPV, whereby you receive more than $1 for each dollar invested.
With investing 101 out of the way, let’s talk about NVDA: At the quoted market price of ~$380, multiplying by the number of shares outstanding, you are paying around $950B for a claim on Nvidia’s future cash flows. So, how is Nvidia going to generate $950 billion of discounted cash flows?
GAAP earnings per diluted share for the quarter were $0.82, up 28% from a year ago [link], on revenues of $7.2B.
These revenues and earnings are in the middle of a frenzied mania around Generative AI (or as some say, “It’s just computers doing computer stuff”), and the market has quoted NVDA higher and higher in recent months to reflect this excitement that ChatGPT and LLMs and suchlike will result in permanently higher and accelerating demand for Nvidia’s products.
Let’s say Nvidia’s earnings double every 5 years for the next decade and a half. Quite an impressive growth rate, and starting from very strong earnings. The discounted cash flows of a stock earning (0.82 * 4) = $3.28 per year and growing at 15% per year for 15 years. It would produce $183 per share in cash flows over that period, and discounted at 7% (I use the current long-term mortgage rate; I avoid the irrational circularity of WACC) gives us $119.58 per-share net present value of NVDA. Not quite the $380+ stock price ($950 billion). So, under these assumptions, Nvidia is overvalued by ~3.5 times — in other words, we would be paying $3.50 to buy $1.00 in discounted cash flows. Not a good investment.
But you might say, NVDA earnings grew 28% compared to last year. This is a new era of ChatGPT and large language models. Elon Musk! And those TPUs from Google and Amazon don’t matter. So let’s see what happens when we assume Nvidia will instead enjoy astonishing 30% earnings growth every single year for the next 15 years.
Under these conditions, assuming its current (historically high) 25–30% net profit margin is not competed away, Nvidia would rake in an absolutely stunning $6.29 trillion in revenues over this period of 15 years and generate $1.8 trillion in earnings, or $716.59 per share. (by comparison, the cumulative earnings of Intel over the past 40 years is $495 billion). In this scenario, the net present value of one NVDA share would be $307.18, or about $760 billion. We’re getting closer, but under these assumptions NVDA remains overvalued by 25%. but to reach $380/share NPV, we would need even more optimistic assumptions.
Obviously others may use different discount rates or growth assumptions or terminal values. Even though it’s never possible to discern exactly what a company is worth, it’s quite useful in investing to know what a company definitely is not worth. This allows you to avoid things that don’t make sense — in other words, avoid paying more than a dollar for $1 in discounted cash flows.
As this article showed, the incredible arithmetic needed to justify a present value of $380 per share would require yet higher growth and profitability projections beyond the generous assumptions already made earlier — going much further may require running the computation on one of the new Nvidia H100 GPUs, and is therefore left as an exercise to the reader.
