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* The Bull Case for NVDA Stock: How Nvidia Could Be Worth $1,600 by 2027

FREE REPORT 7 Top A.I. Stocks for 2024

THE BULL CASE FOR NVDA STOCK: HOW NVIDIA COULD BE WORTH $1,600 BY 2027

For better or worse, Nvidia's value now depends on how well its competition
executes

By Thomas Yeung, CFA, InvestorPlace Markets Analyst Feb 13, 2024, 3:13 pm EDT
February 13, 2024

Source: Shutterstock

From a quantitative standpoint, shares of Nvidia (NASDAQ:NVDA) are a strong
sell. The company scores an F in the MarketMasterAI stock-picking system, and my
most recent February algorithm update only gives NVDA stock 3.5% upside over the
next six months. Companies historically sell off after enormous run-ups, and
Nvidia’s 400% rise since 2021 lands it squarely in that camp. Super-normal
profits, after all, tend to attract unwanted competition.

But Nvidia is not a normal company. The company has a commanding first-mover
advantage in AI accelerator chips, a product that’s seen insatiable demand from
cloud computing providers. The Silicon Valley-based firm has been lucky;
Nvidia’s decision to remain a fabless producer (i.e. outsourcing production to
others) only worked because its primary partner Taiwan Semiconductor
Manufacturing Company (NYSE:TSM) proved to be so capable. And Nvidia’s
management had the uncommon foresight to keep its GPU software proprietary,
essentially locking in developers.

Together, that’s created a computing behemoth that even the best quantitative
algorithms cannot fully comprehend. A bull case for a $1,600 price target for
Nvidia is emerging. And here’s why it can realistically happen.

NVIDIA’S PATH TO $1,600 PER SHARE: CUDA SOFTWARE

In the mid-2000s, Nvidia began developing CUDA, a software platform designed to
run multiple processors in parallel. The goal was to create a solution for
general computing on graphic processing units (GPUs) — essentially a way for
ordinary programs to interact with these new chips.

These efforts were wildly successful.

Since then, CUDA has become the standard software for everything from computer
games to AI training. The ecosystem includes entire libraries, optimizing tools,
a compiler, and a runtime library to deploy applications. MarketMasterAI uses
these tools to run on Nvidia’s GPUs.

Meanwhile, the business side of CUDA has been even more notable. The system
remains a closed-source platform, creating a lock-in effect to Nvidia’s GPUs.
Any code optimized for Nvidia’s products must be rewritten to run on other
systems.

That’s created a formidable barrier to entry. Data centers running on Nvidia’s
GPUs have high switching costs to move systems. Even if Advanced Micro Devices
(NASDAQ:AMD) or Intel (NASDAQ:INTC) develops a strong competitor to Nvidia’s
H100, the costs of moving to AMD’s ROCm platform will dissuade many from making
the switch. In other words, Nvidia’s GPUs will remain the gold standard for AI
model training for the foreseeable future.

These facts are virtually impossible for quantitative systems to detect. All an
algorithm sees is a company whose growth is expected to slow in the coming
years; Wall Street expects Nvidia’s net profit growth to slow to 70% in 2025 and
then decline to 17.5% in 2026.

But the economics are clear: Nvidia’s fabless business model and high lock-in
effects create immense profits from a tiny capital base. Analysts estimate the
chipmaker’s returns on capital invested (ROIC) will expand from 100% today to
185% by 2026, helping Nvidia generate $66 billion of annual free cash flow. Even
if Nvidia’s ROIC falls a third by 2046, a 3-stage discounted cash flow (DCF)
model still values Nvidia at $1,600 a share, 140% upside. As analysts at
Morningstar note, “Nvidia dominates AI today and the sky is the limit for the
company’s profitability if it can maintain this lead over the next decade.”

THE RISKS TO NVIDIA

However, Nvidia’s $1,600 price target comes with significant risks.

* Competition. The greatest concern is that one (or more) competitor releases a
solid alternative to Nvidia and its CUDA software. We’re already seeing some
strong contenders. In December, AMD launched the MI300, a 3D chip that
supposedly runs 20%-40% faster than Nvidia’s flagship H100s. Intel could soon
launch rival systems of its own.
* Growth. Nvidia has faced unexpectedly stiff challengers in autonomous driving
from Qualcomm (NASDAQ:QCOM) and others. Automakers have also been wary of
locking themselves into a single computing standard. That means most of
Nvidia’s growth will come from AI training — leaving all its eggs in a single
basket.
* Cyclical Demand. Data centers and gaming are historically boom-bust
industries, with years of super-normal growth punctuated by sudden slowdowns.
Though Nvidia’s asset-light model protects the company from financial issues,
the sudden evaporation of demand will set the firm’s profits back several
years.

Together, that means Nvidia’s free cash flow could decline from 2027 onwards.
Companies like Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT) and
Amazon (NASDAQ:AMZN) plan to launch in-house GPUs in the coming years, and
merely the threat of these new entrants could force Nvidia to reduce prices and
accept lower margins. Re-running a 3-stage DCF model with more conservative
assumptions reduces its fair value to $320. (This assumes ROIC drops to 28% and
growth to 3.3% by 2047).

Nvidia’s $1,600 price target also assumes that the company will be able to
achieve 21% average growth through 2046 and maintain high returns on capital.
This will become increasingly difficult as cloud computing demand shifts from
building new AI capacity to replacing existing servers.

We’re already seeing the limits to Nvidia’s growth. In 2023, the firm returned
$9.6 billion of its cash to investors after finding nowhere else to invest it.
And only time will tell whether this is the start of a more worrying trend.

SHOULD YOU BUY NVIDIA STOCK?

The problem with valuing a company like Nvidia is that most of its cash flows
are far into the future. Only 8% of Nvidia’s current market capitalization is
explained by cash flow over the next three years, while the next 20 years
explain 33% of Nvidia’s value. The remaining 63% of Nvdia’s value sits beyond
2046. By comparison, cash-generating Qualcomm will justify almost 20% of its
value in the next 3 years.

That means tiny changes in today’s assumptions will have outsized impacts on
Nvidia’s justified value. Increasing growth rates by just 1% annually from 2027
onwards raises Nvidia’s fair value by 14.5%, all else equal. Shrinking growth by
1% cuts 12.2% from its market capitalization… more than the entire market
capitalization of Intel. That makes an investment in Nvidia riskier than people
might expect… which is why MarketMasterAI could be right about the company’s
chances over the next six months.

Nevertheless, Nvidia has surprised investors before. The company remains the
only notable player in AI training. And if its competitors fail to launch
compelling alternatives, investors can expect Nvidia to keep rising from here.
After all, the sky’s the limit when it comes to AI.

On the date of publication, Thomas Yeung held a LONG position in GOOG and GOOGL.
The opinions expressed in this article are those of the writer, subject to the
InvestorPlace.com Publishing Guidelines.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the
highest-tier subscription at InvestorPlace. He is the former editor of Tom
Yeung’s Profit & Protection, a free e-letter about investing to profit in good
times and protecting gains during the bad.

Technology, Artificial Intelligence, Semiconductor

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Article printed from InvestorPlace Media,
https://investorplace.com/2024/02/the-bull-case-for-nvda-stock-how-nvidia-could-be-worth-1600-by-2027/.

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investorplace.com Open in urlscan Pro
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