The Question Is, By How Much?
"A blind deference to multiples without understanding their limitations can severely hamper the effectiveness of an investment process." Michael J. Mauboussin
Nvidia has become the largest company in the world once before, but it is possible that after beating earnings handily today it could take up that mantle in a more permanent sense. The firm's parallel computing technology has become central to the artificial intelligence arms race. Indeed it has become central to the very act of modern computing.
The commercial position of Nvidia could be currently described as akin to someone having a monopoly on gunpowder in August 1914. Because of this the firm has been able to be Wall Street expectations consistently, and will do so again today. It is easy to see when looking at the firm's revenue growth that the price gains have not been caused by irrational exuberance.
It can get confusing after such a wild-eyed price run higher. It is perhaps somewhat intuitive to assume such parabolic gains will be met with sure ruin, but when you look into this company, it is very clear that the firm is fundamentally justifying these price gains.
Of course, since it is a high-growth technology stock, it appears relatively and intrinsically overvalued, but this is just curse of being the market's primary darling. It's tough to be the prom queen in some ways. You can see that when we analyze Nvidia's intrinsic valuation profile, it looks very overvalued.
Yet, when we look at fundamental analysis from an incremental perspective we can see that despite Nvidia's legendary price gains over the last years, it is becoming less undervalued, not more. When you look at the valuation scorecard from February 2023 as compared to the one from today, you can see that the firm has become significantly less undervalued. It is not running away from its fundamentals.
It is likely that the current age of artificial intelligence is just a primitive iteration of the exciting technology. For instance, it takes megawatts of energy to produce the generative AI we've grown so accustomed to using and it only takes 20 watts to run the vastly more capable human brain. So, Nvidia's edge may very well be rendered moot by an eventual artificial general intelligence, but that time has not yet come and is likely decades away. Consider the dominance displayed in the company's last earnings report:
For now, it's Nvidia's world. If you look at what they achieved in their last earnings report and you realize that the data center revenue has really just started taking off, it's easy to imagine why they can easily beat numbers this quarter, despite Wall Street consistently raising expectations. Wall Street will eventually catch up and Nvidia will eventually give a tepid guidance, but I think we are at least a few quarters away from such an eventuality.
Our Recent Trade on Nvidia
Nvidia has had a rough past few weeks. Around the large volatility event on August 5th, the stock was heavily punished. The firm lost hundreds of billions in market cap and many proclaimed the end of its amazing run. However, the stock snapped back rapidly in one of its quickest and most substantial price gains ever. On August 8th, I gave you a trade that exploited this amazing runup in a risk-defined fashion.
In a normal long strangle trade, you have one put for every call. However, I had an extremely bullish disposition I found calls further down the curve that had some convexity. These calls have appreciated so much, that you can sell one of them and still exit the trade at a gain with a call option remaining going into earnings. Our trade, as of yesterday's close is up 125%.
We entered this trade based on sound rationale. The collapse of the VIX curve was one harbinger of Nvidia's rise, for instance. But beyond that, the firm has simply been able to keep ahead of Wall Street analysts and we didn't see that changing this quarter. While many who entered the trade may want to sell half of the calls to get a free look at earnings, I am personally keeping my calls going into the report. I think the risk/reward is favorable for a big beat that results in significant price gains. Nvidia will likely become the biggest company in the world for a more sustainable period. The beginning of the Federal Reserve cutting cycle should be supportive of valuation, which as you see above, as already been improving.
