Only a few companies are worth more than a trillion dollars on the stock market, including Apple, Microsoft, Amazon and Alphabet. Driven by the rise of artificial intelligence, chipmaker Nvidia joined the group this spring. Despite their size, investors grant generous valuation multiples to these companies. How do you justify buying stocks at these valuations?
“The question of the valuation of a security is quite subjective,” says the chief investment officer of the firm Cote 100, Philippe Le Blanc.
Ultra-large-cap tech stocks are getting “some hype” from investors and valuations reflect that, he adds.
This expert believes that we should expect a lower relative stock market performance from mega-companies like Apple, Microsoft or Alphabet.
Can you buy, for example, shares of Apple and expect a compound annual return of 15% for 10 years knowing that the market capitalization of the company is already at 2.800 billion? he wonders. That would translate to a stock market value of $11.4 trillion, not taking into account likely future share buybacks.
“Is Apple expensive at nearly 30 times expected profits? In my opinion, yes, but it is largely justified by the financial performance and the dominance of its business model,” he explains.
But given the size of Apple, Philippe Le Blanc adds that it’s hard to believe the stock will offer very attractive returns in the years to come. “Time will tell,” he said wisely.
Portfolio manager Bill Mitchell of Montreal-based Palos Management said investors have always been willing to pay high multiples for growth.
“Particularly in the tech sector,” he says.
“If you compare Nvidia’s valuation ratios to those of companies like AMD and ServiceNow, it’s arguable that Nvidia is still cheap. »
High valuation ratios indicate high or higher growth expectations. “BCE or Couche-Tard, for example, won’t have high price-earnings ratios because things are pretty stable in their lines of business,” says Bill Mitchell.
Bill Mitchell adds that if Nvidia’s sales and profits explode – and that’s what the market seems to be anticipating – the ratios will adjust.
At the current stock price, Nvidia is trading at more than 200 times its earnings for the past 12 months and nearly 50 times for the next 12. What can happen?
Last year profit: 4.4 billion Number of shares outstanding: 2.5 billion Profit per share (4.4/2.5): $1.76 Price per share: $380 Multiple of profit ($380 /$1.76): 215x
Nvidia’s market capitalization reflects the value of profits over the next 215 years if they were to remain at their current level. In practice, however, investors are betting that these profits will experience strong growth, which will reduce this multiple. The Historical S-Index “Standard”
“One of two things,” said Bill Mitchell. Either earnings rise significantly to drive down the ratio, or the stock price falls to drive down the ratio. »
Going forward, he said, investors can expect an “explosion” in the supply of exchange-traded funds specializing in artificial intelligence because this sector is in vogue.
“And I can almost guarantee that the largest holding in each of these exchange-traded funds will be Nvidia. When people buy shares of these exchange-traded funds, the fund managers will have to buy shares of Nvidia, which will naturally support the stock. »
He also expects Nvidia to have the power to set prices for its chips due to demand. “If you have a product that people want, people will pay. »
Montreal-based asset manager Claret was a long-time shareholder of Intel in the 1980s and 1990s. “It’s crazy how one company doesn’t dominate the semiconductor industry for long. We thought there would be no one who could beat Intel,” said Claret Chief Investment Officer Alain Chung.
He points out that at its peak around the turn of the 2000s, Intel’s stock traded at a price-earnings ratio of 65 times. Intel still commands a respectable stock market value today at around $150 billion. However, Intel’s stock has lost approximately 50% of its value in the past two years. Above all, the value of Intel today is much lower than that of Nvidia.
Alain Chung struggles to understand the value given to Nvidia. “At 200 times this year’s profits, you can’t really explain a valuation when it’s unreasonable. Nor form a rational reasoning about what is going to happen,” he said.
“You can’t justify buying a stock at 100 times its profits other than thinking the profits will double, triple, and quadruple. It would be an exceptional company. There is 1 in 10,000. Identifying it is a stroke of luck. »
He adds that theoretically, a ratio of 60 times profits implies that profits must quadruple for the ratio to fall back to 15 (which would be more within the norm).
“Do you know of any companies that quadruple their profits over a one-year or two-year horizon? A company that generates a profit of 1 cent per share can quadruple it to 4 cents. This is less obvious for a company that is already making big profits. It’s almost impossible to think that Microsoft, for example, could triple its profits in a year. If Microsoft’s rating is generous, Nvidia’s is doubly generous! »
According to Alain Chung, it has more to do with speculation than investment. “All I can say to anyone buying these titles is good luck!” When people expect the profits to increase a lot, the company is better to generate big profits because otherwise the stock will crash. »
In all, 40 of 49 analysts looking at Nvidia recommend buying the stock, which is worth around US$425. Their average target within 12 months is US$466. Some see the title at US$700 and even more.
Analyst Srini Pajjuri of Raymond James predicts Nvidia’s revenue will double to US$53 billion in fiscal year 2025.
