4 Risks Nvidia Investors Should Consider as They Celebrate the ...

Nvidia (NVDA) has started trading today on a split-adjusted basis. Investors have a lot to celebrate, as Nvidia has been a stellar wealth creator and is up a whopping 3,243% over the last five years.

NVDA's market cap surpassed $1 trillion just last year, and it became the third member of the $3 trillion market cap club last week. Its market cap briefly surpassed that of Apple (AAPL), which became the world’s largest company in 2011, and has held on to that title for the most part since. However, Microsoft (MSFT) overtook Apple in January, and since then the iPhone maker hasn’t been able to reclaim the top spot.

Returning to Nvidia, there are four risks that investors need to watch out for right now, even as they celebrate the stock split.

www.barchart.comQuestion #1: How Long Will the AI Capex Boom Last?

One common theme in Q1 earnings calls of Big Tech companies like Meta Platforms (META), Alphabet (GOOG), and Amazon (AMZN) was that they are scaling up their capex towards building artificial intelligence (AI) infrastructure. This growing capex has kept Nvidia’s cash registers ringing, quite literally.

However, the question Nvidia investors need to ask is how long the hyperscalers will keep the taps open for the AI capex. 

To be sure, tech companies are telling shareholders to be patient with their AI investments. Meta Platforms, for instance, compared its AI investments to past initiatives like Reels, Stories, and the transition to mobile to drive home the point that Meta shares can be volatile during periods when the company is investing in new products that have yet to be monetized. 

While investors are currently cheering every mention of the term “AI” during earnings calls, soon enough they might start weighing the monetization of the AI capex - and if monetization is not happening to an extent that can justify the massive spending, companies will be under pressure to curtail their capex.

Question #2: Can Other Chipmakers Play Catch-Up with Nvidia?

Nvidia has had a home run with its AI chips, which have become the industry standard. However, rival chipmakers like Advanced Micro Devices (AMD) and Intel (INTC) are also trying to play catch-up - and while the kind of revenues they expect to generate from sales of AI chips in 2024 is a fraction of Nvidia’s, there is a risk that they might come up with compelling products at competitive prices.

Also, Big Tech companies are working on their own chips as they try to cut down their spending on buying them from Nvidia. Notably, Nvidia’s revenues are also quite concentrated, and one single unnamed customer – which UBS believes is Microsoft – accounts for almost a fifth of its revenues in the fiscal year 2024. Such revenue concentration is always a risk, and if large customers cut down on buying Nvidia’s chips, it could have a significant impact on its growth.

On a related note, the premium pricing and eye-popping margins that Nvidia is currently making might come under pressure as other companies launch comparable products. The AI price war in China, where even Nvidia has reportedly cut prices on some of its chips amid competition from Huawei, is something that investors might want to keep an eye on.

Question #3: Will the U.S. Expand China Export Restrictions?

The U.S. has imposed restrictions on sales of high-power chips to China, fearing their military use by the Communist country. Nvidia has cautioned that U.S. chip export restrictions will jeopardize its long-term competitiveness in the Chinese market. 

During the fiscal Q3 2024 earnings report last year, Nvidia’s CFO Colette Kress said, “The export controls will have a negative effect on our China business, and we do not have good visibility into the magnitude of that impact even over the long term.”

There is always a risk that the U.S. might expand export controls. Notably, the U.S.-China rivalry – which seems like the “new Cold War” – is a potent risk for companies like Nvidia that have significant exposure to the mainland.

Question #4: Is Nvidia’s Valuation Getting Stretched?

Nvidia’s rally has been backed by strong growth in the company’s top line and the bottom line, with revenues in the current fiscal year expected to be 11 times what they were in the fiscal year 2020.

However, there are fears that the valuations might now be getting a bit overstretched. Nvidia's next 12-month (NTM) price-to-earnings (PE) multiple stands at nearly 42x, which is the second-highest among “Magnificent 7” stocks. 

Also, while the valuations are at a discount to Nvidia’s three-year average multiples, they are a premium to the average multiples over the last year.

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Nvidia’s price/earnings-to-growth (PEG) multiple looks reasonable at 1.3x, but it has the highest price-to-free cash flow multiple among the Magnificent 7 stocks.

All of that said, the momentum is currently with Nvidia, especially as the stock trades post-split today. However, it would be prudent for investors to remain cognizant of the risks the Jensen Huang-led company faces, as its price action draws parallels with Cisco’s rally in the dot-com bubble days.

On the date of publication, Mohit Oberoi had a position in: NVDA , AAPL , META , GOOG , MSFT , AMZN , INTC . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.