Nvidia's stock has climbed as Wall Street bets on A.I. Why investors say its promise is worth the premium

Published Thu, Mar 30 202312:25 PM EDTUpdated Thu, Mar 30 20234:37 PM EDT

Wall Street in recent weeks can't seem to stop raving about Nvidia as the investing community attempts to capitalize on the artificial intelligence trend. That praise has translated to a breathtaking performance for the shares — up nearly 86% this year and on pace for their best quarter since 2001 — after a 50% tumble in 2022. The stock's gains have been helped by the market's rotation back into technology stocks after one of the worst years for the sector in over a decade, but the booming demand for AI capabilities in the wake of ChatGPT's showstopping debut has been the main catalyst. Supporters say Nvidia's early focus on graphics processing units, or GPUs, enabled the company to build an efficient chip well worth the price, and provided it with a head start over its competitors that should enable the chipmaker to maintain its dominance as AI develops. Many have equated generative AI to the launch of the internet or cloud computing, with some viewing ChatGPT as AI's "iPhone moment." As the technology develops it will usher in a swath of new economic opportunities. As the market expands, so will the opportunities for Nvidia, and that's why some people think there is still room for further upside in its stock. A recent forecast from Goldman Sachs projects that the broadest definition of AI could generate about $7 trillion in global economic growth over the next 10 years. Bernstein calculated in a recent note that ChatGPT could spark a new market generating " ten of billions " annually. "It's not necessarily a negative for Nvidia," said Raymond James analyst Srini Pajjuri. "The pie is expanding, even if they lose a little bit of share, they'll still grow very rapidly." NVDA YTD mountain Nvidia shares so far this year Nvidia's stock is trading at a forward price-to-earnings ratio of roughly 58 times. Just last year, its valuation stood at roughly 26 times. The contrast is even sharper when one considers the multiple for the S & P 500 sits at an average of roughly 3 times. This is stoking concern over whether Nvidia is worth the premium investors are paying. Building unmatched AI dominance Data from New Street Research suggests the company already accounts for as much as 95% of the market for GPUs, which create images and graphics and can be used for machine learning. Hundreds of these chips are typically needed to train many emerging AI models. Nvidia sharpened its skills in GPUs through its investments in the gaming industry a little over two decades ago . It's paying off now as AI explodes. "They saw generative AI as potentially a really big deal, and they saw this years ago when the rest of us were just kind of ignorant about what generative AI could put into the world," said Karl Freund, principal analyst at Cambrian-AI Research. Generative AI refers to systems that can generate text or image responses and is commonly associated with large language models, including ChatGPT. The focus on Nvidia's capabilities in this area have only grown since it unveiled new AI technologies at its GTC conference on March 21. This included its CUDA Quantum software and computing platform , which can be used for programming GPUs. Following the conference, Goldman Sachs called the chipmaker a "key AI enabler," while Bank of America said Nvidia's AI dominance could "reshape the existing tech industry." "Bottom line: NVIDIA continues to be 1-2 steps ahead of its competitors in accelerated computing silicon/systems, software, and ecosystems," wrote JPMorgan's Harlan Sur. A first mover advantage While competitors such as Advanced Micro Devices and Intel are attempting to compete with the juggernaut, Nvidia's lead will make it difficult to replicate or rival. Freund expects Nvidia will account for 90% of the total market share long term, with its competitors sharing the rest. That's in part because along with the hardware and software, Nvidia offers the engineers and relationships with both end users and research organizations, which could stunt competitor plans from the get-go, Freund explained . "It's hard for me to imagine how anyone can catch up," he added. That software, commonly referred to as CUDA, comes with a massive ecosystem of developers, explained Raymond James' Pajjuri. That ecosystem continues to grow with AI and creates a "barrier to entry" for companies looking to break into the space. This first-mover advantage is critical. Because so many engineers are already using Nvidia's software, some companies may face resistance if attempting to transition to a new language, said Pieran Maru, an investment analyst at global asset management firm GAM Investments. He said he has trimmed back some of his overweight positioning in Nvidia in recent weeks given the sharp run-up in shares. But he said, even with the high valuation, he continues to bet on the stock due to its focus on disruptive growth. Paul Meeks, a portfolio manager at Independent Solutions Wealth Management, refrains from giving it top weighting in his portfolio due to the steep P/E, but views its AI participation as a "slam dunk" and a "top of the class" enabler. "Stock's a little bit expensive, but also remember, the stock was so badly beaten last year, that even if you come up 80% off the bottom, we're still way, way below where it once peaked in the golden days," he said. Nvidia's forward P/E ratio peaked at roughly 65.5 times in November 2021, right around the time the Nasdaq Composite hit its all-time high. Last year, the stock closed as low as $112.27 a share in October. But the steep price point isn't for everyone. Rather than betting on Nvidia, FBB Capital Partners' Michael Brenner owns Taiwan Semiconductor and ASML , names involved in Nvidia's supply chains that should benefit secondarily from the growing market. Regardless, Wall Street is standing by the chip giant, with Bernstein's Stacy Rasgon lifting his price target on shares to $300 in a recent note to clients. The new target represents 11% upside from Wednesday's close. Rasgon acknowledged that shares are expensive but highlighted a large runway of opportunity offering an "upward bias." "Many investors continue looking for the 'best' way to play these AI themes, and we struggle to come up with a better way than this at the moment, we remain buyers even here," he wrote. — CNBC's Michael Bloom contributed reporting.