This week, NVIDIA presented their full year earnings, and their numbers blew the door off its hinges. Over the span of a year, their revenues more than doubled from $26.97 billion to $60.92 billion, and their net profit increased from $4.37 billion to $29.76 billion. NVIDIA is in outer space right now, while AMD and Intel are still building their spacecrafts.
Lessons About Valuing Companies
NVIDIA's financial performance provides a great lesson on what goes into valuing a stock. Over the last year, their stock price has tripled to $788, which is 66 times their net income. According to the Wall Street Journal, the S&P 500 is currently valued at 23 times its net income, so NVIDIA is selling for triple the market's average.
Investors who focus solely on financial ratios, like price to earnings or price to free cash flow, risk missing out on big winners like NVIDIA because they automatically pass on companies they perceive to be expensive based on the company's current financial metrics. But a high ratio should not make us think a stock is overpriced, and a low ratio should not make us think it is cheap. Knowing the details of a company and its standing within its industry is how we can determine if a stock is cheap, reasonable, or overpriced.
According to the NYTimes, Amazon's stock price in January 1999 was 40 times its annual sales. Someone focused on Amazon's 40x sales multiple would have believed the company was overpriced and ignored one of the greatest game changing companies of all time. Over the next 25 years, Amazon's sales increased ~4,300 times, and now the company sells for ~3 times its sales.
Price to Sales Ratio = Price ÷ Annual Sales
With the price to sales ratio, if a company's sales increase faster than its stock price, the price to sales ratio will decline. Amazon's stock price has increased ~15% per year since 1999, and their sales have increased ~40% per year, making their price to sales ratio decrease from 40 to 3.
Today, NVIDIA is selling for 32 times its sales. The company's gross, operating, and net margins are 72.7%, 54.1%, and 48.8%, respectively. Their close competitor, AMD, has gross, operating, and net margins of 46.1%, 1.8%, and 3.8%, respectively. AMD is selling for ~13 times its sales.
NVIDIA deserves a premium price to the market and their competitors. How much of a premium? Only by studying the company and praying will an investor know the answer to this question.
Look at these numbers from NVIDIA. They're insane!
Conclusion
I want to be clear. I am not suggesting that NVIDIA is a good buy at $788 per share. The company might be overvalued, and investors who own the stock could end up losing their money soon.
The point I want to emphasize today is the importance of not being lazy by just looking at one or two metrics and thinking that qualifies as us doing our homework. We must spend time studying the company before opining on its true value.
Stay strong, stay blessed, and God willing, I will see you next week.
Poor is he who works with a negligent and idle hand,
But the hand of the diligent makes him rich.
Proverbs 10:4 AMP
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