Image source: Getty Images
It has been a simply stunning few years for Nvidia (NASDAQ: NVDA). Nvidia stock has comfortably more than doubled over the past 12 months, moving up 136%.
Over five years, though, the performance looks even more spectacular. In that period, the increase has been 2,150%.
So £20k invested in Nvidia early in 2020 would now be worth £450k. Yes, £450k. Wow!
But I did not buy Nvidia shares five years ago and never like to overpay for shares. So, before even considering whether I think Nvidia stock can move higher from here, can it justify its current valuation?
Massive, proven company in the vanguard of huge change
I think the answer, quite possibly, is yes.
When a small company more than doubles in valuation in one year, that is one thing. But Nvidia has a market capitalisation of $3.5trn.
That means a vast amount of smart money is invested in the share, on a grand scale. Now, that does not mean there might not be a lot of dumb money there too (or merely speculative money). However, it does grab my attention that despite its already huge scale, the company has managed to grow so sharply in valuation recently.
Nvidia has a proven business model and is hugely profitable, with strong profit margins to boot. Its proprietary chip technology gives it a real competitive edge. Best of all, it is riding a wave of AI spending that could actually grow in years to come.
Does that make its price-to-earnings ratio of 55 cheap?
I do not think so. But it does explain why Nvidia stock may merit that valuation (or even a higher one), if prospective earnings grow at anything like their recent clip. That could happen if AI gathers pace and more businesses invest in it.
Frontier industries can be exciting, but risky
So Nvidia is like a pioneer in a frontier town that is potentially set to explode in size and wealth.
However, as any fan of classic westerns knows, frontier territories can also turn fairly nasty pretty fast.
That can be because others come to stake their claim, a new sheriff (or regulator) rides into town, or the initial burst of heavy spending dries up and is not replaced on anything like the same scale. I see all as risks for Nvidia — if not necessarily today, then at least in the medium term.
When I invest, I like to have what Warren Buffett calls a margin of safety.
I do think that if the AI market keeps heating up and Nvidia continues to fire on all cylinders as it has been lately, we could see the stock price not only maintain its current level but potentially move up strongly even from here.
But as an investor, I do not feel comfortable that the current price offers me sufficient margin of safety in case some of the risks I mentioned above come to pass.
So, for now, I have no plans to invest.
