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 to justify the purchase of shares at these valuations?
“The question of the valuation of a title is quite subjective”, launches the chief investment officer of the firm Cote 100, Philippe Le Blanc.
Ultra-large-cap tech stocks are getting “some excitement” 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.
PHOTO JOSH EDELSON, FRANCE-PRESSE AGENCY
Apple’s Vision Pro virtual reality glasses were introduced to the public on June 5.
Can we 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 2.8 trillion? he wonders. This would translate to a market value of 11.4 trillion, without 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 is difficult to believe that the title will offer very attractive returns in the years to come. “Time will tell,” he said wisely.
Portfolio manager Bill Mitchell, of the Montreal firm Gestion Palos, reminds us that investors have always been willing to pay high multiples for growth.
“Particularly in the tech sector,” he says.
PHOTO DOMINICK GRAVEL, THE PRESS
Bill Mitchell, of the Montreal firm Gestion Palos
“If you compare Nvidia’s valuation ratios to 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, will not have high price-earnings ratios because things are rather stable in their sectors of activity”, says Bill Mitchell.
The Nvidia case
Bill Mitchell adds that if Nvidia’s sales and profits explode – and this is 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?
The example of Nvidia
Last year profit: 4.4 billion
Number of shares outstanding: 2.5 billion
Earnings per share (4.4/2.5): $1.76
Stock price: $380
Profit Multiple ($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 “norm” of the S&P 500 index is closer to 15 to 20 times. The question is whether this will happen and whether it is reasonable to believe that the anticipated growth will be sustainable, and for how many years. If the growth rate were to prove to be very high, as expected, the stock could do well on the stock market.
“One of two things,” says Bill Mitchell. Either earnings rise significantly to drive down the ratio, or the stock price falls to drive down the ratio. »
Nvidia’s assessment is a little crazy. She is extreme. Clearly, investors believe the multiple is justified because Nvidia has the best chips, because demand is out of the ordinary, and because its customers are solid companies like Microsoft, Google, Meta, and not customers expected to disappear.
Bill Mitchell, of the Montreal firm Gestion Palos
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. »
PHOTO DADO RUVIC, REUTERS ARCHIVES
Smart phone displaying the Intel logo
Montreal-based asset manager Claret was a long-time Intel shareholder in the 1980s and 1990s. We thought there would be no one capable of beating Intel,” says Claret’s 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.
The limits of growth
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 forge rational reasoning about what is going to happen,” he says.
“You can’t justify buying a stock at 100 times its profits other than thinking that profits will double, triple and quadruple. It would then be an exceptional company. There is 1 in 10,000. Identifying it is a stroke of luck. »
NVIDIA CORP PHOTO, SUPPLIED BY REUTERS
Nvidia is a leader in the design of graphics processors, graphics cards and graphics chips for PCs and game consoles.
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- 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 one year. If Microsoft’s assessment is generous, Nvidia’s is doubly generous! »
According to Alain Chung, it’s more in the realm of speculation than investment. “All I can say to those 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. »
Some numbers
40
In all, 40 of 49 analysts taking an interest in 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.
53
Analyst Srini Pajjuri of Raymond James predicts Nvidia’s revenue will double to $53 billion in fiscal 2025.