Nvious?
Good morning! I hope everyone enjoyed the summer. I certainly enjoyed some time with family and getting ready for what the final third of the year will bring. It’s unlikely that we will have a smooth finish to the year with all eyes on the Federal Reserve and the U.S. Presidential Elections.
So far, the major market story for the year has been the continued build out of artificial intelligence capacity and the performance of the semiconductor sector. Nvidia is the story of the year (again) after the stock has more than doubled in 2024, carrying the U.S stock market along the way. Should we stand in awe, or should we be concerned with the dominance? We wrote in January about a similar story in Canada with Nortel Networks in the late 1990’s (“The Magnificent One”). What are the similarities and differences between Nvidia today and Nortel in the late 1990s?
CAPEX Winner
The key commonality between Nortel and Nvidia is that both were winners in the build out of key infrastructure for a new technology. Both have sold hardware rather than software. Nortel was a large supplier of optical equipment which helped speed up and expand the required infrastructure for the internet. Nvidia is selling the infrastructure needed for data centers and the computing boom.
Another commonality was that both rely on very large clients. In the case of Nortel Networks, sales were led by groups such as Broadcom, who used their large capital expenditure budgets to buy more solutions from Nortel. Much like Nvidia, their client base was concentrated. The revenues for Nortel were cyclical in nature and tied to the capital expenditure budgets of their customers. Any slowdown in their customer’s expenditures or funding, would lead to a slowdown in revenues. Nvidia’s sales are dominated by other members of the so called Magnificent 7. Today, we see huge capital expenditures from the Magnificent 7, which eclipses the entire energy sector.
The problem with both the factors above is that both businesses are built on the supply of hardware, with a client base that has cyclical expenditures. Unlike software companies, neither Nortel or Nvidia built subscription or repeatable revenue businesses.
Profitability
The key difference between Nortel’s story and that of Nvidia is the profitability. Unlike Nortel, Nvidia is a very profitable business. Nvidia’s core business is selling data center computing platforms (read “cloud computing” and “AI”) with high margins. Nvidia is generating record profits and recently announced a $50 billion stock buyback program. The company is growing so quickly that it no longer needs the same level of shareholder capital.
A problem with being the leader in a dominant sector, is that other firms and even customers will look for alternatives to compete against you. Nvidia’s business currently has operating margins of over 60%! This creates envy, competition, and substitution. AMD, Intel and Arm aren’t going to sit back and watch Nvidia dominate. All are coming to market with advanced chip IP and are securing production capacity. Amazon, Google, and Microsoft are developing their own chips in a bid to increase their own capacity, but also lessen their reliance on Nvidia.
As a society it is hard to say we have reaped benefits from AI yet. The same can be said for Nvidia’s customers. David Chan from Sequoia Capital estimates that major tech companies will need to recoup over $500 billion in revenue to break even on their AI expenditures. Will they face backlash from their shareholders on their capital expenditures? Will they need to cut back spending? Will their demand for Nvidia’s solutions wane?
Nvidia’s excellent financial performance, growth, and shareholder returns could continue for some time. However, when looking at the stock price today, I find it hard to get comfortable that paying 38 times today’s earnings considers the risks faced by Nvidia. It’s a cyclical business, reliant on others’ capital expenditures in a sector that has yet to prove it’s worth for their customers. Much like Nortel in 2000, Nvidia’s business today appears to be priced for perfection.
About Grayhawk
As a Chief Investment Office, Grayhawk Investment Strategies Inc. (“Grayhawk Wealth”) (“Grayhawk”) works with successful Canadian families to provide personalized investment management services, curated to help position them to achieve their wealth goals and accelerate their impact.
Grayhawk Wealth has offices in Toronto, Calgary and Montreal and is registered as a Portfolio Manager and Exempt Market Dealer in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Québec and Saskatchewan and as an Investment Fund Manager in Alberta, Ontario and Québec.
Cautionary note regarding forward-looking information
This release contains forward-looking information. Such forward-looking statements or information are provided for the purpose of providing information about Grayhawk’s current expectations and plans relating to the future. Readers are cautioned that reliance on such information may not be appropriate for other purposes. Any such forward-looking information may be identified by words such as “proposed”, “expects”, “intends”, “may”, “will”, and similar expressions.
Forward-looking statements or information are based on a number of factors and assumptions which have been used to develop such statements and information, but which may prove to be incorrect. Although Grayhawk believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward-looking statements because Grayhawk can give no assurance that such expectations will prove to be correct. The forward-looking information in this release reflects the current expectations, assumptions and/or beliefs of Grayhawk based on information currently available to Grayhawk. Any forward-looking information speaks only as of the date on which it is made and, except as may be required by applicable securities laws, Grayhawk disclaims any intent or obligation to update any forward-looking information, whether as a result of new information, future events or results or otherwise. The forward-looking statements or information contained in this press release are expressly qualified by this cautionary statement.
Media inquiries
For all inquiries please contact our communications team.
Email: connect@grayhawkwealth.com
Tel.: 1 877 665 9951