Semiconductors Chips: Why Owning Nvidia’s Stock Seems Like The Answer To Every Question?

As we tried to make clear above, the "Age" of artificial intelligence is already all around us.

From the algorithms that drive Google's search product (or determine Alphabet's share price!) to the content (or advert) recommendations made for us by Netflix or TikTok or Twitter.

If we already live in an world satiated with artificial intelligence it is not too shocking that it is a major theme for investors.

We thought that, after talking about some of the high level themes above, we would instead turn to how the financial world thinks about artificial intelligence at present, and how it is changing.

This keen interest has traditionally broken down, generally speaking, along two different themes:

  1. Bigger is better and....

  2. During a gold rush, sell shovels.

These two aphorisms actually end up with two rather different set of companies - with one large exception (see below).

The "bigger is better" crew relates to scale. Artificial intelligence works best with serious scale. Greater scale allows for more and deeper/better quality data and it is the data that - at least in theory - should a better class of artificial intelligence models and predictive capacities.

This means that the gains from this nascent technology largely accrue to very, very big companies. It is also one that raises problems for investors and regulators alike.


Well, naturally, these groups use those gains to invest in their businesses, including their artificial intelligence operations and try to expand both the quality of their forecasting and the amount of data they can , and rinse and repeat their way to greater profits.

This is already happening.

Over the last six months, around 70% of the return in the S&P 500 can be attributed just four (4!) companies: Microsoft, Apple, Nvidia and Google.

That is quite a stat.

It underlines one of the key points made by Kissinger et al and also by other analysts and market observers:

Many firms and products are already reaping the rewards of AI.

You may have noticed this situation but you might not have understood just how powerful and absurd that the scale (and attendant profits) of those who harness these capabilities can achieve.

This also creates a bizarre and perhaps dangerous feedback loop where you use the scale and power law of technology to become large and then use artificial intelligence models and systems to make that size stratospheric and also insinuate yourself into the new reality being created by the technology.

It took awhile but investors have noticed and now furiously bid up these shares to incredible valuations and create a challenge for policymakers, regulators and investors alike.

  • When it comes to shovels, the situation is rather different.

You may have noticed that one of the firms above is not like the others. Nvidia is a hardware maker. Nvidia (NVDA) designs and manufactures graphics processing units (GPUs) and microprocessors for computing platforms, including for high-end gaming PCs.

In other words, its an AI shovel maker extraordinaire.

  • Nvidia's value has soared for years. The stock is up 130% YTD and some expect it to have a trillion dollar market cap by next year.

  • Even if that doesn't care to pass there is no question that it is one of the most innovative and strategically important companies in the world.

Nvidia is gaining from its ability to supply the very best quality shovels to several different sectors that are poised to do well in an age of artificial intelligence: gaming, media, cryptocurrencies, data centers and even autonomous vehicles.

In fact, their semiconductor shovels are so prized that in some cases they are increasingly hard to find. 

You know things have changed in the economy when the modern day version of a Tickle Me Elmo is an Nvidia graphics card.

It is hard not to be attracted to owning the chip maker:

  • Despite the semiconductor shortage, the company has booked record revenue of 6.5 billion. 68% above its 2nd quarter of 2020.

  • It invests a ton of capital in new products and developments. Nvidia continues to innovate and enter new areas of business via its own internal development and well placed acquisitions.

  • It is also benefiting from its strategic importance. The US is determined to invest in US chip production and also protect strategically important companies. It is tough to come up with a more important American company.

  • And the tailwinds from the money and interest in artificial intelligence means that selling high priced AI shovels suggests that

So, Nvidia is gaining from two heavily interconnected trends:

  1. Incredible demand for semiconductor chips of all types brought about by consumers and companies being very flush and demand being high for all manner of goods.

  2. And they are also gaining profits for their ability to produce the most sophisticated and highly advanced types of chips that are not only critical for many industries but also increasingly strategic for countries as well as companies. They have a stranglehold of a key input for all sorts of types of technology.

This probably accounts for why its price vs earnings ratio has risen to an eye watering 90 (which is roughly 3x its 5 year average of around 30). That means it is a very, very expensive stock. Ludicrously expensive.

So, what should you do? Should you join the rush and own one of the most dynamic, innovative and strategically vital companies on earth?

Or are you buying at the very top (or ~10% of it)

It is very possible.

Read below for what could finally make companies like Nvidia - relatively - less attractive to investors in the quarters to come and lead a shift away from these "big" growth companies.


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