Defenders of NVDA will point out that NVDA not only has enormous technological advantages, but customers are now standardizing around its products. The reason we have so many mega-cap technology stocks is that the sector has a tendency towards winner-take-all economics, thanks to some variation of network effects. So NVDA is—and has the potential to stay—the 800 pound gorilla in data center technology.
(2) Manufacturing risk
NVDA’s capital light model is a strength but also a potential vulnerability. NVDA relies on third parties to manufacture its products, especially TSM. A military confrontation over Taiwan, or even the threat of it, could severely damage perceptions of NVDA’s ability to deliver product to its customers. NVDA is looking to diversify into American production facilities over time, and potentially work with INTC, but this is likely years away.
(3) Valuation risk
High multiple growth stocks are very sensitive to any perceived change in the growth outlook as well as overall market conditions. NVDA is a “high beta” stock, which means it is statistically much more sensitive to changes in the direction of the broader market than the average stock.
We witnessed in 2022 how NVDA dramatically underperformed not just the S&P 500 but the Nasdaq 100 as growth stocks fell out of favor.
(4) Sentiment risk
NVDA is a market darling. It is perceived as unstoppable. Everyone wants in. But sentiment can shift rapidly. Fear of missing out can quickly become fear of missing out on cashing out.
(5) Regulatory risk.
Like other mega-cap technology companies, NVDA’s current market dominance has caught the eye of regulators. This could become problematic over time.
(6) The unknown
Accelerated computing is an exciting new avenue for the technology sector, but it is also uncharted waters. Things change. Just as investors a couple of years ago misunderstood the magnitude of the data center growth opportunity, they don’t have perfect visibility into how the next two years will play out. Investors today are extrapolating trends, but trends do not always persist.
Does the stock split mean anything?
Probably not much. After the close of trading on Friday, June 7, NVDA shareholders will receive nine additional shares for every one share they own. The stock split is a nice signal of confidence, has attracted investor interest and perhaps contributed to recent momentum.
Ultimately, however, ten dimes are worth as much as a dollar. Companies execute stock splits to improve liquidity. While a lower share price could improve access to smaller investors, NVDA has a $3 trillion market cap. Small investors should have less ability to influence how NVDA trades relative to meme stocks, for example, that have market caps in the single digit billions or lower.
Liquidity also works both ways. Retail NVDA shareholders will have greater flexibility to sell down their position after the stock split.
Should you buy or sell NVDA?
Perhaps the most important question of all is whether an investor should jump on the bandwagon or avoid it.
NVDA is clearly a phenomenal company that has a leading position in a growing market that has open-ended long-term growth potential. It has delivered extraordinary results for investors. It is not irrational to want the be part of this.
As we observed above, NVDA is already a major component of most equity indices, and NVDA is likely to be highly correlated with the overall direction of the market. Any decision to buy NVDA should be made in that context. How much NVDA do you actually already own?
NVDA may continue to deliver exceptional growth for years and as a result could have more upside. It is quite plausible it could outperform the market and tech peers. But it is a lot harder for data center revenue to grow from $100 billion to a $1 trillion than it will be to grow from $10 billion to $100 billion.
NVDA could continue to be a great investment, but it is almost physically impossible for the stock to deliver the sort of explosive returns it has in the past. The numbers at this point are simply too large.
The sell decision is interesting, because almost any investor who has an NVDA position is sitting on a large unrealized capital gain, perhaps a very large one relative to the size of the investment.
Let’s take the case of an investor who purchased the shares in October 2022 and is now sitting on an unrealized capital gain that is approximately 90% of the total market value of the position. If this investor were to sell his or her position, depending on his or her tax bracket, state residency and other factors, it could generate a substantial cap gain tax payment.
When sitting on an investment with an unrealized capital gain, one is in effect receiving an interest free loan from the government to continue to own the shares. When unrealized gains are particularly substantial, there is a cost to selling that can become material and should rationally be taken into account.
Conclusions
While everyone wants a firm answer, there are some investment decisions that legitimately fall into a gray area.
For investors who currently do not have any allocation to NVDA and want some exposure to its open-ended long-term growth potential, we see the logic of buying some, with eyes wide open to the risks, even after these extraordinary returns.
For investors who already have significant indirect exposure to NVDA through passive funds or other vehicles, we think this is a very strong argument to look elsewhere for opportunities to play the AI theme. Only a few companies in the world have the kind of material representation in stock indices that NVDA now has, and these stocks (MSFT, AAPL, etc.) are generally much less volatile.
For investors who are sitting on large unrealized capital gains in NVDA and have a long time horizon, we see the logic of letting the investment continue to play out and seeing just how far Jensen Huang can take this business.
