If something has a $4trn price tag, it might not seem like an obvious bargain. But after the Nvidia (NASDAQ: NVDA) share price hit an all-time high over the past week, the chip company became the first in history to achieve such a high market capitalisation.
However, despite its meteoric rise (the Nvidia share price has surged 1,466% in just five years), could this still be a potential bargain for my portfolio?
The best may still be ahead
Perhaps surprisingly, I reckon the answer might be yes. Even at its current price, Nvidia could yet turn out to be a long-term bargain.
That is because it has a strong position in the AI race that could turn out to be both long and highly lucrative.
We have already seen the huge benefit Nvidia has reaped from selling its proprietary chips to a large existing customer base as clients seek to ramp up their AI capabilities. In the most recent quarter, Nvidia’s revenues soared 69% compared to the same period last year, reaching $44bn. Net income was up 26% year on year to $19bn.
Those figures are interesting for a few reasons.
First, they clearly demonstrate enormous growth. Secondly, they are substantial – Nvidia is not just some small startup, but a massive business that is already generating serious money.
Also, with the net income equalling 43% of revenue, Nvidia’s profit margins are mouth-watering.
If Nvidia can build on this success, for example by deepening existing client relationships while AI chip demand grows, it could turn out to be yet more profitable down the line. That could push the Nvidia share price up even from its current level.
Here’s my concern
However, while I see reasons why the share could keep moving up, I am nervous about the current valuation.
On a price-to-earnings ratio of 53, the valuation does not offer me the sort of margin of safety I would like as an investor.
Earnings growth at Nvidia has been phenomenal over the past few years. But there are risks that could hurt future growth prospects, from intense competition to tariff disputes involving some of Nvidia’s key markets.
Not only that, but it remains anyone’s guess how sustainable the demand for costly AI chips will be after the initial big spending round is over.
Lots of long-term uncertainty
Seen positively, AI demand could surge, meaning that even the sort of revenues we have seen from Nvidia in recent years are just the tip of the iceberg.
Considering an alternative scenario, however, it may be that increased capacity combined with lower selling prices sees the bottom fall out of the AI chip market at some point.
Even if demand is high – and that remains to be seen – pricing could drop to the level where profit margins are far thinner than today. That may seem far-fetched now, but it is the dynamic we have seen over time in many fast-developing markets, from home computers to mobile phones.
All things considered, then, I like Nvidia as a business and think if chip demand keeps booming, the share price could follow. But the current price does not sit comfortably with me from a risk management perspective. I will not be investing for now.
This story originally appeared on Motley Fool
