Nvidia: Can it fend off the barbarians at the gate? Nvidia: Can it fend off the barbarians at the gate? Nvidia: Can it fend off the barbarians at the gate?

Nvidia: Can it fend off the barbarians at the gate?

Equities 7 minutes to read
Peter Garnry

Head of Equity Strategy

Key points

  • Founded in 1993, introduced the GPU in 1999, and launched the CUDA Toolkit in 2006, leading to breakthroughs like the AlexNet neural network in 2012 and real-time ray tracing with the RTX platform in 2018.

  • Consistently invested around 25% of revenue in R&D, leading to significant technological advancements and positioning Nvidia ahead of competitors.

  • Revenue grew from $3.4bn in FY09 to projected $143.2bn in FY26, driven by gaming, Bitcoin mining, and AI advancements like ChatGPT.

  • Leveraged outsourced manufacturing with TSMC and developed a strong software ecosystem with CUDA, resulting in high ROIC and low CAPEX needs.

  • Faces risks such as supply chain disruptions, market competition, and regulatory challenges, while striving to maintain technological leadership and market dominance.

How did Nvidia become a quality company?

The rise of Nvidia is fascinating as it is not an entirely new company as it was founded in 1993 with an idea of creating 3D graphics cards for gaming and multimedia markets. In 1999, Nvidia announces the GPU, the graphics processing unit, which begins the era of reshaping the computing industry. Very early on, Nvidia sees, and maybe inspired by Steve Jobs full integration thinking, that it is about creating an ecosystem to not only add value to clients, but increase their switching costs. This leads to the development and launch of the CUDA Toolkit in 2006 which opens parallel processing capabilities of GPUs leading to the breakthrough AlexNet neural network in 2012. In 2018, Nvidia reinvents computer graphics with the RTX platform which is the first GPU capable of real-time ray tracing (which is a method of graphics rendering that simulates the physical behaviour of light).

All this innovation laid the seeds for the high quality company Nvidia is today. A quality company creates over time deep moats that are difficult for the competition to overcome and Nvidia’s intensive R&D spending over the years was the marker for this. Nvidia spent on average around 25% or more in the years leading up to the beginning of the fiscal year 2017. That represents R&D intensity that is far above the direct competition and multiples above the average company in this world. It was the high R&D spending that made Nvidia look bad on return on invested capital (ROIC) for many years making it looking less like quality in the short-term. This is an important lesson for investors. High revenue growth and high R&D spending in percentage of revenue are two important markers of future success.

Incredible development in fundamentals

Nvidia saw the future earlier than anyone else and was thus well positioned to take advantage of the major shifts in the computing industry towards parallelisation and advancements in machine learning. When you look at the historical revenue trend it is clear that the fiscal year 2017 that ended in January 2017 is the moment when things changed for Nvidia. Up until this point Nvidia had made the majority of its profits from selling GPUs used for gaming which was high growth industry, but not on the scale we see today.

In 2016, two trends began to evolve fast. Bitcoin was exploding higher and with that fat profits for Bitcoin miners that needed more and more GPUs to crunch the numbers to unlock Bitcoin in the validation process embedded in the Bitcoin ecosystem. Simultaneously, the machine learning community saw major advancements to the tune in 2016 that Roger Parloff said the “deep learning revolution” built on Nvidia’s GPUs had transformed the AI industry. While the AI and machine learning community was growing GPU demand fast it was significantly eclipsed by the Bitcoin mining demand for GPUs. When Bitcoin lived its second “ice age” during 2018 it was immediately seen in demand for GPUs and Nvidia’s results for the FY19 (ending January 2019, so covering the 11 months of 2018).

As Nvidia was wounded a new dramatic event happened as the world was catapulted into its biggest pandemic in modern time in early 2020. Initially, demand came down for everything including GPUs, but when the vaccine was published in late 2020, everyone got scared of inflation that was to skyrocket in the 2021. Bitcoin was seen as a potential safe-haven against inflation and the millions of new hobby investors joining financial markets during the lockdowns speculated on everything for a quick buck including Bitcoin. With prices soaring demand for Nvidia’s GPUs took off like nothing it had seen before with revenue in FY22 jumping to $26.9bn up from $16.7bn in FY21. At this point investors were getting Nvidia on the radar.

In late 2022, the next event happened that is today defining the company. OpenAI launched ChatGPT on 30 November 2022 taking the world by a surprise. For the first time there was a useful consumer interface with a large language model (LLM) that could process questions and return useful answers to a wide range of domains. The technology sector immediately saw the potential of this AI technology and investments in LLMs rose by nothing we have seen in a generation lifting Nvidia’s revenue to $60.8bn in FY24 up from $27bn the year before. In 15 years, Nvidia has lifted its revenue from $3.4bn to $60.9bn and is projected to deliver FY25 revenue of $113.8bn and then $143.2bn in FY 26.

When we talk about a quality company the ultimate yardstick is ROIC. After the FY16, the decades of intense R&D spending is paying off with the ROIC quickly jumping from just above 10%, which is fairly average, to the 30-40% range which is superb. In its latest fiscal year, the ROIC rose to staggering 82% far eclipsing the cost of capital for Nvidia. This is the main explanation for the strong share price performance. The high ROIC and low need for capital expenditures (CAPEX) is magic ingredients for strong stock returns. Over the past 15 years Nvidia has only invested $8.2bn in CAPEX, this of course excludes the cumulative R&D spending of $42.5bn, but those investments the company has reached a revenue level above $100bn per year and free cash flows to shareholders of estimated $57bn this year. This is just staggering numbers.

The secret sauce and share price performance

The low CAPEX needs are one of the secret sauces of Nvidia because it reduces how much capital Nvidia must reinvest into the business. Nvidia designs and develops the IP for its advanced AI chips, but it gets TSMC to manufacture its GPUs which effectively means that Nvidia’s has outsourced the capital intensive part of the business to the world’s leading semiconductor foundry business. This is one of the key ingredients of its secret sauce.

Another ingredient is all the software that Nvidia has developed over the years to speed up researching and development of applications using its GPUs with the CUDA Toolkit platform as the crown jewel. This is the deepest point of Nvidia’s moat and the one Sam Altman has openly said is what the industry wants to change by developing joint alternative.

One thing is a high ROIC for generating strong shareholder returns, but sometimes a business can have a high ROIC but being in a low growth industry. An example of this is Walmart. It has consistently a ROIC of around 12% compared to a cost of capital of 7%, but revenue is only growing modestly above the US inflation rate. Returning to Nvidia, its revenue is growing very fast which is reflected in its invested capital which is essentially all the capital Nvidia is deploying to run its business. Nvidia’s invested capital is growing very fast and approached close to $50bn in the recent fiscal year. This is the ultimately engine for high shareholder returns. An expansion of ROIC combined with high or even increasing growth rates.

The ultimate indicator of Nvidia’s success has been its share price performance. Nvidia’s total return has been 35.6% annualised since December 2003 compared to 7.9% for the MSCI World over the same period. The semiconductor industry group has delivered 13% annualised in the same period. The outperformance is probably the greatest over this 20-year period. The past is obviously not an indicator of future performance.

The main question for investors is whether Nvidia will turn out to be an enduring company that can fend off competition for years and become as powerful as Apple and Microsoft. Time will tell and the only thing we know from history is that no company remains at the top forever. Competition or technological change will eventually disrupt everyone.

Barbarians at the gate

Jeff Bezos, the founder of Amazon, is quoted for saying that “your margin is my opportunity” which can be interpreted in multiple ways. In retailing it can be mean cutting out one layer in the distribution network. In technology it can also mean that if a critical supplier is earning a fat margin then there is a lot of money to be saved for finding a cheaper alternative. This is exactly what might be brewing in the GPU industry.

It is no secret that many US technology companies are pursuing their own purpose-built AI chips just like Apple developed their own M1 chip. If you can develop the design and IP for the AI chip you can get TSMC to manufacture the AI chip. But as we described in the beginning the AI industry is not only about hardware, but also about the software. Nvidia’s CUDA Toolkit is a development environment for creating high-performance GPU-accelerated applications. Even if you find an alternative AI chip you need specialized software for making your applications.

As the FT writes today competition in the AI development environment is coming for Nvidia’s lunch as Meta, Microsoft, and Google are collaborating on the development of Triton which will be able to run on a large range of AI chips. Whether these US technology companies can build a good enough alternative time will tell, because Nvidia has invested billions over the years in nicely integrated software. So while competition is coming for Nvidia it might be that Nvidia’s moat is too deep to overcome and that Nvidia just is the next new natural “monopoly” such as Microsoft and Apple.

Source: Nvidia investor presentation

Existing or potential new investors in Nvidia should consider what we regard as the three most obvious risk factors highlighted below.

  • Supply chain disruptions – GPU manufacturing sits on a complex global supply chain. Any major disruption, whether due to geopolitical tensions (such as trade wars or sanctions), natural disasters, or pandemics, can lead to shortages of critical components, delayed production, and increased costs.

  • Market competition and technological change - The semiconductor and GPU markets are highly competitive, with major players like AMD, Intel, and new entrants continually striving to innovate. Failure to keep up with technological advancements or to anticipate market trends could result in losing market share. Additionally, new disruptive technologies could render Nvidia's current products less relevant.

  • Regulatory and legal challenges – GPUs have become a key technology in the technology arms race between the US and China. This could lead to export controls by the US government which would limit their revenue outlook in China. Nvidia could also face antitrust regulation in the future if regulators find its ecosystem prevents innovation and competition.

What defines a quality company?

Quality companies can be defined in many different ways just like value. MSCI, which is world’s largest equity index provider, has defined it using three fundamental variables return on equity, debt to equity, and earnings variability. This definition makes sense because it can be applied to all companies regardless of which sector they are part of. The definition puts emphasis on profitability relative to the deployed equity, leverage ratio (less debt leverage relative to equity is good), and finally the predictability of the business with less variance in earnings being a good thing. In our past equity research we have also found that the lower earnings variability a company has the higher its valuation becomes, so this is a quality marker.

In our equity research note Top quality companies and how to decode their traits we focused on return on invested capital (ROIC) relative to the cost of capital (WACC) as the key measure to identify quality. Next we explained, that around half of those companies with the highest ROIC see their ROIC falling from the top to outside the top over three years due to competition or changing technologies. This is the quality trap that investors need to avoid. It is about finding enduring quality. The “7 Powers” framework is a good approach to analyse whether a company has enduring characteristics or not. Finally, a company can have a stable spread in ROIC minus WACC with a ROIC not in the absolute top and still be a phenomenal stock for shareholders. All it requires is that the business can invest a lot into the business. Historically, Walmart was exactly such a case.

The interesting thing about researching quality companies is that you cannot put it all into a formula. You must apply discretionary thinking about the business, its products, the company’s strategy, the industry drivers, technologies strengthening or weakening the business, because in the end the big returns about changes in expectations for the company.

Haftungsausschluss

Die Unternehmen der Saxo Bank Gruppe sind jeweils reine Ausführungsmakler und bieten Zugriff auf Analysen, über die Personen auf der oder über die Website verfügbare Inhalte ansehen und/oder nutzen können. Dieser Inhalt ist nicht dazu bestimmt, den reinen Ausführungsdienst zu ändern oder zu erweitern, und ändert oder erweitert ihn auch nicht. Der besagte Zugriff und die besagte Nutzung unterliegen jederzeit (i) den Nutzungsbedingungen, (ii) dem vollständigen Haftungsausschluss, (iii) der Risikowarnung, (iv) den Einsatzregeln und (v) den Hinweisen zu Saxo News & Research und/oder dessen Inhalten, zusätzlich (falls zutreffend) zu den Bedingungen für die Nutzung von Hyperlinks auf der Website als Mitglied der Saxo Bank Gruppe, über die der Zugriff auf Saxo News & Research erfolgt. Die besagten Inhalte dienen daher lediglich zu Informationszwecken. Insbesondere ist es von keinem Unternehmen der Saxo Bank Gruppe beabsichtigt, Beratung zu erbringen oder zu unterstützen oder dass sich Personen auf eine solche Beratung verlassen; ferner sind die Inhalte nicht als Aufforderung oder Anreiz für die Zeichnung oder den Verkauf oder Kauf irgendeines Finanzinstruments auszulegen. Sämtliche von Ihnen durchgeführten Handelstransaktionen oder Investitionen müssen auf Ihrer eigenen unaufgeforderten, fundierten und selbst bestimmten Entscheidung beruhen. Daher trägt kein Unternehmen der Saxo Bank Gruppe die Verluste und kann auch nicht für Verluste haftbar gemacht werden, die Ihnen infolge einer Anlageentscheidung entstehen, die Sie aufgrund von über Saxo News & Research verfügbaren Informationen treffen, oder für Verluste, die Ihnen infolge der Nutzung von Saxo News & Research entstehen. Erteilte Orders und ausgeführte Trades gelten als für das Konto des Kunden bei demjenigen Unternehmen der Saxo Bank Gruppe erteilt bzw. ausgeführt, das in der Jurisdiktion tätig ist, in der der Kunde wohnhaft ist und/oder bei dem der Kunde sein Handelskonto eingerichtet hat und führt. Saxo News & Research enthält keine von der Saxo Bank Gruppe angebotene, empfohlene oder unterstützte Finanzberatung, Anlageberatung, Steuerberatung oder Handelsberatung oder Beratung irgendeiner anderen Art (und es ist auch nichts so auszulegen, dass Saxo News & Research eine solche Beratung enthält); ferner ist Saxo News & Research nicht als Aufstellung unserer Tradingkosten oder als Angebot, Anreiz oder Aufforderung für die Zeichnung, den Verkauf oder Kauf irgendeines Finanzinstruments auszulegen. Soweit irgendein Inhalt als Anlage-Research ausgelegt wird, müssen Sie beachten und akzeptieren, dass dieser nicht in Übereinstimmung mit den rechtlichen Anforderungen zur Förderung der Unabhängigkeit von Anlage-Research erstellt wurde und dass er daher gemäss den einschlägigen Gesetzen als Marketingkommunikation angesehen werden würde.

Bitte lesen Sie unsere Haftungsausschlüsse:
Mitteilung zum unabhängigen Anlage-Research (https://www.home.saxo/legal/niird/notification)
Vollständiger Haftungsausschluss (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Vollständiger Haftungsausschluss (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Schweiz

Saxo kontaktieren

Region auswählen

Schweiz
Schweiz

Wertschriftenhandel birgt Risiken. Die Verluste können die Einlagen auf Margin-Produkten übersteigen. Sie sollten verstehen wie unsere Produkte funktionieren und welche Risiken mit diesen einhergehen. Weiter sollten Sie abwägen, ob Sie es sich leisten können, ein hohes Risiko einzugehen, Ihr Geld zu verlieren. Um Ihnen das Verständnis der mit den entsprechenden Produkten verbundenen Risiken zu erleichtern, haben wir ein allgemeines Risikoaufklärungsdokument und eine Reihe von «Key Information Documents» (KIDs) zusammengestellt, in denen die mit jedem Produkt verbundenen Risiken und Chancen aufgeführt sind. Auf die KIDs kann über die Handelsplattform zugegriffen werden. Bitte beachten Sie, dass der vollständige Prospekt kostenlos über die Saxo Bank (Schweiz) AG oder den Emittenten bezogen werden kann.

Auf diese Website kann weltweit zugegriffen werden. Die Informationen auf der Website beziehen sich jedoch auf die Saxo Bank (Schweiz) AG. Alle Kunden werden direkt mit der Saxo Bank (Schweiz) AG zusammenarbeiten und alle Kundenvereinbarungen werden mit der Saxo Bank (Schweiz) AG  geschlossen und somit schweizerischem Recht unterstellt.

Der Inhalt dieser Website stellt Marketingmaterial dar und wurde keiner Aufsichtsbehörde gemeldet oder übermittelt.

Sofern Sie mit der Saxo Bank (Schweiz) AG Kontakt aufnehmen oder diese Webseite besuchen, nehmen Sie zur Kenntnis und akzeptieren, dass sämtliche Daten, welche Sie über diese Webseite, per Telefon oder durch ein anderes Kommunikationsmittel (z.B. E-Mail) der Saxo Bank (Schweiz) AG übermitteln, erfasst bzw. aufgezeichnet werden können, an andere Gesellschaften der Saxo Bank Gruppe oder Dritte in der Schweiz oder im Ausland übertragen und von diesen oder der Saxo Bank (Schweiz) AG gespeichert oder anderweitig verarbeitet werden können. Sie befreien diesbezüglich die Saxo Bank (Schweiz) AG von ihren Verpflichtungen aus dem schweizerischen Bank- und Wertpapierhändlergeheimnis, und soweit gesetzlich zulässig, aus den Datenschutzgesetzen sowie anderen Gesetzen und Verpflichtungen zum Schutz der Privatsphäre. Die Saxo Bank (Schweiz) AG hat angemessene technische und organisatorische Vorkehrungen getroffen, um diese Daten vor der unbefugten Verarbeitung und Offenlegung zu schützen und einen angemessenen Schutz dieser Daten zu gewährleisten.

Apple, iPad und iPhone sind Marken von Apple Inc., eingetragen in den USA und anderen Ländern. App Store ist eine Dienstleistungsmarke von Apple Inc.