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Christopher Ganatti, CFA
NVIDIA’s (NVDA) recent earnings announcement was truly historic. It’s unlikely that any company will change its earnings forecast next quarter from about $7 billion to about $11 billion. Nvidia’s market capitalization hits vaunted $1 The trillion level is something few companies have ever achieved.
Did I miss it?
Aswas Damodaran, a professor at New York University who is famous for his valuation research, put forward an argument as to why the $1 trillion valuation can’t be rationalized, even though he appreciates Nvidia as a company.
Professor Damodaran estimates that NVIDIA has about 80% share of the AI semiconductor market, and its market value is currently around $25 billion. Using bullish assumptions that may not be accurate, he expects the AI semiconductor market to grow to $350 billion within a decade. If Nvidia took his 100% of future market share (albeit a bold assumption), Damodaran’s valuation would be: Still about 20% lower than current prices.
Nvidia is essentially a hardware company. I can see they’re trying to harden the software, but that’s not the main driving force. Other companies that have reached the $1 trillion market cap level are software companies with network effects that draw huge numbers of end users into the ecosystem. These software businesses have many ways to generate revenue from new products and services.
Damodaran’s valuation won’t necessarily lead to an immediate drop in stock prices, but it may be difficult to sustain the momentum of a comeback with the same enthusiasm.
Nvidia products don’t work in a vacuum
WisdomTree spends a lot of time focusing on AI megatrends. Nvidia’s products do not exist in a “standalone” format, as they are plugged into a cabinet that contains other hardware that works in tandem. If the AI semiconductor market grows as many expect, many companies will benefit.
Nvidia cannot manufacture semiconductors end-to-end on its own. Taiwan Semiconductor Manufacturing Co., Ltd. (TSM) is part of this puzzle. The entire semiconductor value chain exists, all are needed, and each link earns a different size slice of the economic value pie.
Figure 1 shows various companies involved in generative AI since the launch of ChatGPT.
- Alphabet (GOOG), Meta (META), and Microsoft (MSFT) represent companies developing large-scale language models (LLMs) that give users direct access to generative AI. Disappointment with the company’s commitment to the Metaverse left Meta devastated in his 2022, but AI and cost savings are helping the company in 2023. Alphabet and Microsoft are at the heart of the generative AI battlefield. While Microsoft has won the cloud computing battlefield so far with its Azure platform, it will be very difficult for Alphabet’s Google to win in Internet search.
- It’s interesting to compare Nvidia with Samsung (OTCPK:SSNLF) and SK Hynix. Running AI models, especially large AI models, requires memory, and Samsung and SK Hynix are in the realm of memory chips. At least in recent years, the excitement across the semiconductor market has fluctuated. Now, in the midst of the explosion of generative AI, graphics processing units (GPUs), led by Nvidia, are all the rage.
- Synopsys (SNPS) and TSMC represent an important and necessary value chain effort for semiconductors. Nvidia chips cannot be made in a vacuum. Synopsys provides the necessary electronic design automation capabilities, but TSMC is one of the few companies with a sufficiently advanced manufacturing process to produce Nvidia’s cutting-edge chips.
Figure 1: Revenues across the AI ecosystem have changed since the launch of ChatGPT
AI covers a lot of things, and they’ve been exciting at different times
Is AI overhyped? Gartner’s (IT) Hype Cycle characterizes one way to look at new technology. In the short term, excitement leads to money flow. Share price and valuation benefit. At some point, there is usually a high volume of selling and a harsher returns environment as it is realized that true success, growth and adoption will take time.
Finally, there is also the perception that pessimism is not very appropriate either, as technology is still important and still in use, so growth rates and earnings tend to be more reasonable.
See the AI hype cycle plot in Figure 2.
AI is not a single entity. Today we think of this as ChatGPT, LLM, or Generative AI, but other areas and capabilities still exist and just haven’t grabbed the headlines in the same way.
- Generative AI and underlying models may be approaching the peak of inflated expectations.
- Excited about self-driving cars these days? Well, that may be part of why self-driving cars are nearing the valley of disillusionment.
- Computer vision has been around for quite some time and is on its way up the “slope of enlightenment.”
The hype cycle is not an exact science. Any discipline on this chart could produce any kind of return, positive or negative, going forward. It’s really just a tool that helps put all these different topics on a broader continuum. The only thing we know for sure is that no topic will always generate the same level of excitement or pessimism.
Figure 2: Artificial Intelligence Hype Cycle, 2022
Bottom Line: Looking at the AI Ecosystem as a Whole Can Reduce Risk for Single Companies
The Hype Cycle diagram shows that different applications of AI are at different points of adoption, excitement, and development. No one can know the future with certainty, but we believe growth is happening in all these areas. While the world is currently obsessed with generative AI, it was just as excited about self-driving cars a few years ago. Progress is happening, even if it’s not reflected in every headline.
WisdomTree has an extensive AI index to capture these trends. Professor Damodaran said that while NVIDIA’s valuation has skyrocketed, his AI index in WisdomTree hasn’t changed much after his NVIDIA surge. The entire AI ecosystem defined by WisdomTree is independent of the actions of any particular company.
Figure 3: How broader approaches to artificial intelligence companies are less susceptible to Nvidia’s current high valuations (as of June 5, 2023)
AI has the potential to impact every industry. This is why WisdomTree has built a broad ecosystem-oriented approach rather than focusing on a single stock.
For those wanting to dig deeper, consider the WisdomTree Artificial Intelligence & Innovation Fund (WTAI) and research for more information on how stock baskets can provide exposure to various AI activities. Good.
IMPORTANT DISCLOSURES AND RISKS RELATED TO THIS ARTICLE
For a complete list of the Fund’s holdings, please click here. Holdings are subject to change.
The WisdomTree Artificial Intelligence & Innovation Index is designed to measure the performance of companies primarily involved in artificial intelligence and innovation.
Investing involves risks, including the possibility of loss of principal. The fund invests primarily in companies whose investment themes are artificial intelligence (AI) and innovation. Companies working in AI can typically face intense competition and rapid product obsolescence. These companies also rely heavily on intellectual property rights and could be adversely affected by the loss or impairment of those rights. Additionally, AI companies typically invest heavily in research and development, and there is no guarantee that the products and services they produce will be successful. Companies that develop technology that uses innovation to replace old technology or create new markets may not succeed. The Fund will not attempt to outperform the Index or take a defensive position in a down market by investing in securities included in or representing the Index, regardless of investment merit. The composition of the index is controlled by the Index Committee and the index may not perform as intended. For specific details regarding the Fund’s risk profile, please read the Fund’s prospectus.
Christopher Gannatti, CFA, Global Head of Research
Christopher Gannatti joined WisdomTree in December 2010 as a Research Analyst, working directly with CFA® Research Director Jeremy Schwartz. In January 2014, he was promoted to Associate of Research His Director of Research, responsible for leading a diverse group of analysts and strategists within his team for extensive research at WisdomTree. In February 2018, Christopher was promoted to Head of Research, Europe, and based in WisdomTree’s London office, was responsible for all of WisdomTree’s research activities in the European market, as well as supporting the UCIT platform globally. In November 2021, Christopher was promoted to Global Head of Research and is currently responsible for numerous communications on global investment strategy, particularly in thematic equities space. Christopher came from Sir Abbett to Wisdom Tree, where he worked as a regional consultant for four and a half years. Christopher received his MBA in Quantitative Finance, Accounting, and Economics from New York University’s Stern School of Business in 2010 and a BA in Economics from Colgate University in 2006. Christopher holds the title of Certified Financial Analyst.
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Editor’s note: The summary bullet points for this article were chosen by the editors of Seeking Alpha.
