On Feb. 22, 2024, Nvidia’s stock performed one-day heroics probably never matched in the annals of capitalism. By 10 a.m., its shares had soared almost 15%, lifting its market capitalization to $1.91 trillion from $1.66 trillion at the previous close. The gain of $250 billion equals 40% the valuation for Tesla and 80% that of Oracle, and exceeds the worth of Intel by 20%. Nvidia is now the straw stirring the cocktail in the investment world. Its earnings beat, reported after the market close on Feb. 21, ignited a frenzy that sent the Nasdaq 100 soaring 3% by midafternoon on the 22nd.
Wall Street analysts cheered the results, with no fewer than 18 brokerages lifting their forecasts for gains beyond its current price of almost $800 by year-end. Goldman Sachs hiked to $875, while Bernstein raised to $1,000 and KeyBanc to $1,100.
The optimism is certainly understandable, given Nvidia’s sorcerous results, and the widespread view that the AI domain it dominates will prove the transformative technology of the millennium. For FY 2024 (ended Jan. 31), Nvidia grew GAAP revenues by 126% to $61 billion, and raised net income almost sixfold, to $29.8 billion. Nvidia is exhibiting operating leverage on a scale probably never before witnessed, meaning that it is booking big earnings increases as a share of every dollar of new revenue. For example, the gross margin rise of 57% to 73% shows that Nvidia this year pocketed 30% more on each comparable unit shipped to customers over last year, based on the selling price versus what it paid to make or purchase the products and materials. It gets better. Its R&D, overhead and other operating costs, less special items, rose a piddling 11%, one-tenth the rate of increase in its sales.
Despite those spectacular results, the bar just jumped enormously for future earnings
Analysts point out that Nvidia’s P/E multiple doesn’t look outrageous. Prior to the jump on Thursday, it stood at 56 based on full FY 2024 earnings of $29.8 billion, and the Wall Street crowd used much lower numbers by citing forward estimates incorporating giant gains in the quarters to come. Overnight, the 15% jump in its share price raised Nvidia’s multiple to 64. In the investment community, that substantial figure appears to scare almost no one.
What should give pause is projections on what Nvidia will need to earn, say, a decade hence to be worth anything like its current cap of $1.91 trillion. In fact, it’s interesting to examine just how much the historic one day leap has raised the bar. Let’s say investors will want a 10% annual total return from Nvidia. After all, it’s a risky stock. The options action prior to the earnings release underscored that investors were extremely nervous that even mildly disappointing results would hammer the stock, simply because of the great expectations built into the price.
It’s especially interesting to compare the earnings Nvidia would have needed to generate when its market cap was $1.66 trillion in Wednesday compared to the requirements today, after adding $240 billion.
So let’s start with what was required before the mega-bump, to reach returns of 10% a year. When Nvidia’s cap was $1.66 trillion, it had to notch a valuation of $4.33 trillion by 2034 to reach our goal. Assuming that by then it’s still growing pretty fast, but heading for maturity, we’ll assume it boasts a better-than-average PE of 25. In that scenario, the profit needed to grab the prize is $173 billion 10 years hence. Getting there equates to 18.9% yearly growth in profits, on average, over that span.
That’s one heck of a stretch. But on Thursday, the stretch got a lot more elastic. At the current $1.91 billion cap and our 25 assumption for a P/E, Nvidia must make not $173 billion, but $200 billion by 2034. That’s well over twice the sub-$100 billion numbers Apple and Microsoft are showing today. Adjusted for 2.5% yearly inflation over the next decade, it’s 50% more than Apple earned in the last four quarters. Hitting the $200 billion mark in 2034 requires annual increases of 21%, 2.1 points more than the 18.9% needed before the Thursday run-up.
That may not sound like a huge difference. But consider this: Nvidia after the February 22 surge now has to add an average of $17 billion a year earnings to what it made in the previous four quarters through 2034, compared with a required $14.3 billion in extra profits prior to the one day explosion. As our projection that the multiple will fall to 25 suggests, Nvidia would be growing profits at way over the 21% average in the first few years, and the percentage gains would gradually decline. Say by the start of 2034, the rate of increase has fallen to 12%. Nvidia would still need to produce an additional $21 billion in profits that year, over and above the 2033 figure, to hit the $200 billion target. Adjusted for future annual inflation of 2.5%, that equates to over $14 billion in today’s dollars. What Nvidia must generate in added earnings exceeds what all but around 18 Fortune 500 companies individually booked as total profits in 2022, and more or less matches what Procter & Gamble made that year.
Put simply, the problem isn’t that 21% earnings growth, for the tech superstar of superstars, looks so daunting. It’s that Nvidia already earns tons of money, and sells at a big multiple to those fat earnings. The cause for caution: The staggering size of the year over year earnings increases that are baked into its Brobdingnagian valuation, on the order of $10 to $20 billion annually, and the haymaker penalty if it falters. Competitors will jump rush to capture a share of its sumptuous margins. Stiffer competition will cause prices and profitability to drop. The latest surge just made the adjustable mountain Nvidia must climb far steeper. No company has ever delivered such astounding results so quickly as Nvidia. And no company has ever had to scale such formidable heights to surmount the law of large numbers.