Artificial Intelligence (“AI”) Will Change the World. Who Benefits?
It’s hard to ignore the rally in Nvidia (NVDA) after reporting revenue and earnings that were well above expectations and, more importantly, raised fiscal 2Q guidance to $11.0 billion (+/- 2%) vs. analysts’ estimates of $7.2 billion. The stock promptly added $184 billion to its market capitalization, finishing shy of the trillion-dollar club ($939 billion).
Did you know There are only 57 stocks with a market cap of $184 billion or more in the entire global stock market?
According to Barron’s, NVDA’s spike is the third largest one-day gain in market cap ever–second only to Amazon and Apple in 2022, both with $191 billion gains in one day. Analysts, on average, promptly raised NVDA’s 12-month price target to $434/share from $339/share the day prior – a 28% increase.
We have NVDA as an underlier in several structured notes, where terms and structure have the potential to limit risk. As you can imagine, this has worked out well for investors so far.
We identified a growth inflection from NVDA’s recurring revenue engine in software and services derived from its large installed hardware base and ecosystem. The stock was simply too expensive relative to its expected growth and execution risk, as headwinds remained in certain, previously highly touted, applications like crypto mining and gaming. Our validation process identified this, and its relative score required the additional risk mitigation found in a structured product.
By nature, we are skeptical of consensus. While in the short run it can be painful to bet against the crowd, in the long run it often provides the basis for meaningful non-correlated returns. That said, it seems appropriate that the application of artificial intelligence and machine learning will meaningfully change the way we live, work and play. Of course, with such things, it’s always a question of definition, magnitude, and timing.
We are at the beginning of a transition period, a time of discovery and trial and error.
The world is racing rapidly to understand which people, processes, and products can be made more efficient or even replaced with the help of AI.
There is no doubt that Nvidia is a juggernaut and that it currently has no real competitors in providing chips, software, and architecture – indeed, a complete ecosystem for computing – to an AI-driven world. NVDA is the arms dealer in the global chase to implement artificial intelligence solutions to every aspect of daily commercial life. But this does seem like too much, too fast in terms of the reaction of the stock price relative to what we can understand of the opportunity.
NVDA is up 160% YTD and 124% over the last year. And we have seen this before with Nvidia – a great company that routinely identifies game-changing opportunities early and exploits them, such as in gaming and crypto. Only to find that, eventually, the race to secure the fastest chips for these specialty applications runs its frenetic course, and demand settles down to a more normalized cadence. For NVDA, this means growth slows and comparable “spike” periods become massive headwinds in a “beat and raise” world. Again, the question becomes one of magnitude, timing, and critical mass.
Understand risk and keep a long-term perspective.
Do we think that Nvidia’s long term growth story has been enhanced by its massive lead in providing the most attractive chips, architecture, and software ecosystem to those pursuing AI superiority in their respective businesses? YES.
Do we think that the accelerated growth in demand for its superior products and services will continue at this pace, indefinitely? NO.
While it will always take massive computer power to train AI models, the urgency and pace of adoption will undoubtedly slow as use cases are identified, addressed, and exploited.
Purely from a visceral perspective, the “picks and shovels” aspect of the Nvidia story makes it the easiest to understand and play in the AI space with the highest probability of success. However, investors should beware of the boom-and-bust aspect of such periods of inflection which will undoubtedly create a bumpy ride along the way and may lead to disappointment for those that caught the wave too late.
A long-term perspective should be the best remedy.
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Source of statistics is Bloomberg, unless otherwise noted.
The Destra Multi-Alternative Fund that is sub-advised by Validus invests in NVDA. Securities highlighted or discussed in this blog have been selected to illustrate Validus’s investment approach and/or market outlook and are not intended to represent any strategy or portfolio performance or be an indicator for how strategy or portfolio have performed or may perform in the future. Each security discussed in this blog has been selected solely for this purpose and has not been selected on the basis of performance or any performance-related criteria. The securities discussed herein do not represent an entire portfolio and, in the aggregate, may only represent a small percentage of a strategy or portfolio holdings. The strategies and portfolios are actively managed, and securities discussed in this blog may or may not be held in such strategies or portfolios at any given time. These individual securities do not represent all of the securities purchased, sold, or recommended and the reader should not assume that investments in the securities identified and discussed were or will be profitable. Nothing in this blog shall constitute a recommendation or endorsement to buy or sell any security or other financial instrument referenced in this letter.
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