Company description
NVIDIA Corporation is a multinational technology company that specializes in designing and manufacturing advanced graphics processing units (GPUs), as well as related software and hardware technologies. Founded in 1993 by Jensen Huang, Chris Malachowsky, and Curtis Priem, NVIDIA has established itself as a prominent player in the field of visual computing and artificial intelligence. Over time, NVIDIA's GPUs have found applications in numerous other domains, including professional visualization, data centers, autonomous vehicles, and scientific research.
In addition to GPUs, NVIDIA has developed a range of complementary technologies. CUDA (Compute Unified Device Architecture), a parallel computing platform and programming model that enables developers to leverage the immense computational power of NVIDIA GPUs for general computing tasks. The company’s deep learning and AI solutions, such as NVIDIA Tesla platform and the CUDA Deep Neural Network Library (cuDNN), have contributed to significant advancements in areas like ML, computer vision and natural language processing. NVIDIA has also expanded its product portfolio to include system-on-a-chip (SoC) solutions. NVIDIA is well-positioned to be a key player in shaping the future of technology and computing.
General outlook
Nvidia was recently part of a rally which brought the price up by over 20%, making the company reach $1 Trillion of market capitalization. Even if tech companies show a great potential for the future, due to the AI influence, they end up growing really fast in a macroeconomic environment which is not really favorable and has still a lot of turbulence to go through. Market expectations are too optimistic about the interest rates and probably this will be noticed soon.
Despite outperforming during the pandemic challenges of 2020–21, the IT industry was the driving force for significant stock market falls in 2022. How to weather a future economic slump by cutting expenses, improving efficiency, and raising revenues is currently a big concern for software companies. Many people are probably searching for strategies to stay creative and develop a strong competitive position for the future at the same time.
Global problems confront the technology industry, ranging from geopolitical tensions to supply chain uncertainty, continued semiconductor worries, raw material shortages, and the implementation of new legislation and trade restrictions. All of these challenges are expected to be at the top of the priority lists of many important digital companies in 2023, as they reevaluate partnerships, suppliers, and the markets in which they operate.
With over 80% of digital components manufactured in Asia, the dependability and timely supply of parts and components pose a significant risk to technology companies.
The major technology corporations rely on China for hardware for their servers, storage, and networking devices. Given the supply chain threat posed by China's COVID difficulties and continued trade tensions, IT executives should consider expanding their manufacturing operations to other nations.
In response to macroeconomic challenges, tech behemoths are intensifying their forays into new industries.
Health care is an excellent example of this convergence: IT firms are bringing greater efficiencies and innovation to a system that is ready for digital transformation.34 The worldwide digital health market, estimated at US$211 billion in 2022 and predicted to reach US$1.5 trillion by 2030, represents a massive potential opportunity for tech behemoths to expand further.35 The Big Five36 made over $3 billion in announced venture capital investments in health care in 2021, and activity in 2022 may exceed that figure.
Investments in digital-health businesses are expected to reach $57 billion in 2021, up 79% from the previous year.
Liquidity
Liquidity has had a general positive growth after the GFC, apart from 2016 when it dropped suddenly probably due to the hard drive shortage, as well as in 2020 due to the general lockdown. We know that the current ratio divides the current assets by the current liabilities, and the quick ratio divides the cash and cash equivalents and the accounts receivable by the current liabilities. Both values are really high, even in 2016 and 2020, when they are far above 1.5-2 which are generally considered optimal values. However sometimes these values are too high, considering that they reached almost 10 before Covid-19, meaning that the company had too much cash and could have invested even more, without creating a dangerous situation, given also the interest rates at historic minimum. Even the debt to equity ratio shows financial health for the company, standing around 0.5, which means that the company has half the debt in relation to shareholders equity and it is not too leveraged. This is really positive considering the macroeconomic scenario we currently are, where the cost of debt is skyrocketing.
Profitability
To evaluate the profitability of the company, we have identified four key financial indicators crucial for assessing its financial health over the last five years. These indicators include Return on Equity (ROE), Return on Invested Capital (ROIC), net revenue, and EBIT margin. From the results we found it is clear that the company is financially stable and has stable positive returns.
ROE (Return on Equity): ROE is an important indicator that measures the profitability of the company, from the investments made by its shareholders. We can see how it started negative in the period just after the GFC with a -14%, but it went back in positive territory not long after that, reaching even values of 55% in 2018 and not going under 30% in the last 5 years, even during the great lockdown.
Return on Invested Capital (ROIC): ROIC measures the profitability of a company's investments, both from shareholders and debt holders. It assesses the return generated from all invested capital, including equity and long-term debt. It followed almost the same path as the ROE, just with lower peaks in 2018.
EBITDA Margin: EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margin is a profitability metric that shows the company's operating performance by measuring the proportion of EBITDA to its net revenue. It provides insight into a company's ability to generate operating profits before considering interest, taxes, and non-operating expenses. On average it has always been on positive values, sitting around 30%, which is really impressive and denotes a really high margin
Net Revenue: Net revenue refers to the total revenue generated by a company after deducting any discounts, returns, and allowances. We see that until 2016 the net revenue has been “low”, under $1 Billion, while recently it has skyrocketed, reaching $10 Billion in 2022.
Stock Valuation
The Discounted Cash Flow (DCF) model is a valuation method used to estimate the intrinsic value of an investment or a company. It calculates the present value of the projected cash flows generated by the investment or company over a specific time period. The other main component we need is the WACC, which is essential to discount the projected cash flows.
Due to the rising interest rates we computed the WACC at around 10.9%, which is a really high value, but considering the macroeconomic scenario we are currently in it is fair. For the risk free rate we took the 10Y Treasury bill which is currently 3,85% and then we added the usual spread for A- bond, which is the rating from S&P for NVIDIA bonds in order to get the cost of debt, then we also accounted for the tax shield, given a 14% tax rate. For what concerns the cost of equity we adopted the CAPM, assuming a 4,3% for the equity risk premium, which is quite conservative assuming the scenario we are currently in.
Interesting to notice is the capital structure of NVIDIA, which relies almost exclusively on equity, with a gearing of 0.02.
Then we had to estimate the revenue growth of over 22% each year, with a particular focus on next year growth which stands around 50%. The average EBIT should stand at around 35-40% of the revenue. Depreciation and amortization are expected to grow a bit, but not as fast as the revenue, we assumed that the same will also happen to capital expenditures, while for the change in net working capital we relied on a stable growth, proportional to the revenue.
This can be resumed as:
The value you can see above is quite far from the current price at which NVIDIA is traded, almost 40% down, this is really far.
To see the reasons why market valuation and our valuation are quite far apart we should investigate the other assumptions made, that concern the terminal growth rate, which is necessary to understand what will happen to the cash flows after the end of our estimations. For this case we assumed a TGR of 6.5%, which is generally a really high value and here it should account for the opportunities for NVIDIA to develop his business in the future. However this metric is impossible to be calculated with accuracy, differently from the WACC, which could be inferred from some data to have a confidence interval. To overcome this problem we also prepared a sensitivity analysis, in order to understand what should happen to the target price, given a change in the WACC or in the TGR.
This table shows how the current market price either implies a different estimation of revenue growth and FCF growth, which from our point of view is quite unsustainable, since we are already expecting a 3x growth in revenue in the next 5 years, even considering 2022 stop it is quite utopic, or a different WACC or even a different TGR. Maintaining the same WACC from our estimation it would need a TGR of 8.5% which would be really impressive, since the rate of 5% represents the growth of the world economy it means that it will outpace it forever and it is really difficult. We still set this value at 6.5% because we know that in the really long run it will not outpace the world economy, but the really long run has a very small weight on the result, so in the next 10-15 years it is possible for NVIDIA to grow faster than the market. However 9% is almost impossible, being double the speed of the world economy, therefore, given this WACC the highest value we can accept is around $260 per share, and it is already extreme. If we assume that the WACC is not exact we see how the market is pricing, for a 6,5% TGR, a WACC of 9.2%, and for our view this is a bit too low. Combining a margin of error in both the assumptions, the most credible pricing that the market is assessing is based on a 7% TGR and a 9.4% WACC, or a 6.5% TGR and a 9% WACC. This analysis is really sensible to change in WACC, since for every 0.50% the target price increases or decreases by $50. The range from a conservative and an ambitious analysis would be between $230 and $350, still below what is being paid by the market at the moment.
Multiples Analysis
Multiple analysis, also known as valuation multiples or comparable company analysis, is a financial research technique that compares the worth of a firm to similar companies in the same industry or market. It entails assessing a company's relative valuation using multiples such as the price-to-earnings (P/E) ratio, the price-to-sales (P/S) ratio, or the enterprise value-to-EBITDA (EV/EBITDA).
It's important to note that multiple analysis has its limitations. It relies on the availability and accuracy of comparable company data, assumes that the comparable companies are truly similar to the target company, and does not consider the specific circumstances or qualitative aspects that may affect the target company's value. Therefore, multiple analysis is often used in conjunction with other valuation methods to provide a more comprehensive assessment of a company's value.
Currently the P/E ratio, which is the most commonly used to compare companies from the same industry, which is currently around 33 (which is really high compared to other sectors) and shows how NVIDIA is in a league of its own, and even if we compute the same ratio with values from next year's earnings it still looks quite off. Even P/S looks a bit off the path of the industry, being 38 for NVIDIA and the average of the technology industry is less than 10. Next we see how the price is still too high even compared with the book value, giving a value of 47, which is more than 3x the industry average (13).
Last multiple we take into account is the EV/EBITDA, which is one of the most important metrics to understand the intrinsic value of a company and it is used also in the discounted cash flow valuation. This has a value of around 150, which is 6 times higher than the average for the information technology industry (23).
Risks
Market Competitors: NVIDIA faces competition from other semiconductor companies such as AMD, Intel, and Qualcomm. Intense competition might reduce NVIDIA's market share and negatively harm its financial performance.
Technological Advances: NVIDIA faces a risk due to the continuously growing nature of technology. If a competitor develops superior or more cost-effective technologies, NVIDIA's ability to sustain its competitive edge may be jeopardized.
Supply Chain Disruptions: NVIDIA manufactures its goods using a complicated worldwide supply chain. Supply chain disruptions, such as component shortages, natural disasters, or geopolitical events, can have an impact on manufacturing capacities, product availability, and cost.
Economic Conditions: Changes in the global economy can have an impact on consumer spending and company investments. Demand for NVIDIA's goods, particularly high-end graphics cards and data center solutions, may fall during economic downturns or recessions.
Regulatory and Legal Issues: NVIDIA works in multiple nations and is subject to regulations and laws governing intellectual property, competition, and data privacy. Compliance concerns or legal challenges may result in cash penalties, brand damage, or restrictions on business activities.
Partners: NVIDIA works with a variety of partners, including original equipment manufacturers (OEMs) and software developers. Any challenges, disagreements, or changes in these collaborations could jeopardize NVIDIA's ability to properly supply its goods or services.
Shifting Industry Trends: Changes in consumer tastes, such as a shift toward cloud-based computing or improvements in artificial intelligence (AI) technology, might have an impact on demand for NVIDIA's products. To stay relevant, the organization must adapt to changing industry trends.
Intellectual Property Infringement: NVIDIA invests considerably in research and development to maintain its technological advantage. However, there is always the possibility of intellectual property infringement or unlawful use of NVIDIA's innovations, which might jeopardize the company's competitive advantage.
Piotroski Score and other ratios
The Piotroski Score, commonly known as the F-Score, is a financial indicator devised by Joseph Piotroski, a Stanford University accounting professor. It is used to examine a company's overall financial health and financial strength. The score is determined using certain accounting criteria from a company's financial statements and is based on a nine-point scale.
The Piotroski Score is made up of nine independent criteria, each with a value of 0 or 1. The criteria are based on the financial performance and basic indicators of the organization. The higher the score, the better the financial position of the organization.
The nine criteria are divided into 3 groups:
Profitability: this includes a positive Return on Assets, a positive Operating Cash Flow, a growth in the Return on Assets from last year and the OCF/ total assets higher than ROA. For Nvidia and for this category NVIDIA looks very strong, gaining 4 points, even if the growth of ROA is really small.
Leverage, liquidity and source of funds: this includes a reduced leverage ratio from last year, a growth in the current ratio and the stability of the number of shares. Here NVIDIA gets only one point from the reduced leverage.
Operating efficiency: including a growth in the gross margin and in the asset turnover ratio. Only the asset turnover ratio has been growing so it gets only one point.
The final value for the Piotroski score is 6, which means that the company is fairly solid and does not have any relevant danger.
The Sloan Ratio, also known as the Accruals Ratio or the Quality of Earnings Ratio, is a financial metric used to assess the quality of a company's earnings. It measures the proportion of a company's net income that is driven by accruals rather than cash flows.
A higher Sloan ratio shows that a greater share of the company's net income comes from accruals, which are non-cash accounting adjustments made to match revenues and expenses. Accounts receivable, accounts payable, and inventory are examples of accruals. A high Sloan ratio shows that the company's declared earnings are less stable or sustainable, indicating a larger reliance on accruals rather than actual cash flows. This could raise questions about the company's profits quality and potentially indicate financial manipulation or aggressive accounting methods.
A lower Sloan ratio, on the other hand, implies that a less share of the company's net income is generated by accruals, implying a higher level of earnings quality and reliability. This metric shows how NVIDIA’s net income is really reliable, having a lower value than the average Information Technology industry.
The Altman Z-Score is a financial metric developed by Edward Altman in 1968 as a way to predict the likelihood of a company going bankrupt within a specific time frame, usually within two years. The Z-Score uses a combination of multiple financial ratios to assess the financial health and solvency of a company. The Altman Z-Score incorporates five financial ratios, each weighted and combined to calculate the final Z-Score value. Generally a value higher than 3 is considered healthy and the Information Technology industry is just below that, with a score of 2.8, while NVIDIA stands on top with 33.5, which means that it is almost impossible to go bankrupt.
The Beneish M-Score, created by Messod Beneish, is a financial model to identify potential financial statement fraud by firms. It is designed to detect earnings manipulation, specifically aggressive accounting procedures that may be utilized to increase reported results. The Beneish M-Score calculates the final M-Score rating by combining eight financial ratios. Generally a ratio below -1.78 is considered a good value and NVIDIA confirms its stability with a value of -2.87, in line with the Information Technology industry of -2.66.
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