5 Reasons Nvidia Could Generate Strong Returns Over The Next Decade

Jun. 11, 2018 2:11 PM ETNVIDIA Corporation (NVDA)63 Comments17 Likes

Summary

  • Nvidia has been one of the hottest stocks on Wall Street and for good reason.
  • The company is a founder-led innovation dynamo that continues to create the most advanced hardware that serves as the core of the tech of tomorrow.
  • There are five reasons why I now consider Nvidia my favorite tech dividend stock. One that's likely to keep crushing the market for the next decade at least.
  • Best of all the company is actually about 25% undervalued which means I can finally recommend this must-own future tech legend.
  • That being said there are important risks that could derail any Nvidia investment you should be aware of.

(Source: imgflip)

Long time readers know that the cornerstone of my retirement dividend growth portfolio strategy is "the right company at the right price." That basically means that I'm looking for world-class companies, with major long-term growth catalysts, but trading at a reasonable valuation.

That's because a study out of Yale found that between 1881 and 2016 the single biggest determinant of long-term total returns (on a rolling five- to 30-year time horizon) was the starting PE ratio. In other words even the best companies can make terrible investments if you grossly overpaid.

ChartNVDA data by YCharts

This is a big reason that I, and many other value focused investors, have been wary of buying Nvidia (NASDAQ:NVDA) which has become one of the hottest stocks on Wall Street.

However as Lord Maynard Keynes (father of modern macroeconomics) famously said "when the facts change, I change my mind." Over the last few quarters as I learned more about Nvidia I have become ever more impressed with its numerous competitive advantages including its industry leading management team, deep intellectual property portfolio, and its ability to innovate bleeding-edge hardware at a highly-consistent pace.

In fact there are now five reasons I consider Nvidia my favorite tech stock and a must own position in my own portfolio. One of those reasons is that after further valuation modeling I now conclude that the company is actually not just reasonably priced, but about 25% undervalued. Best of all it has the potential to generate about 22% annual total returns over the next decade which would be nearly three times what the broader market is likely to achieve.

Nvidia's Amazing Growth Engine Continues Firing On All Cylinders

Founded in 1993 Nvidia has been a leading pioneer in the semiconductor industry. In fact in 1999 it literally invented the Graphics Processing Unit, or GPU. This has given Nvidia a major lead in intellectual property (patents), which expire between 2016 and 2034. Nvidia has come to dominate the gaming GPU market-commanding about 70% market share because it's constantly improving its offerings and updating its drivers faster than major rival Advanced Micro Devices (AMD). These gaming GPUs sell for between $150 and $1,000 for the top end models and generate gross margins of about 60%.

(Source: Nvidia Investor Presentation)

Recently Nvidia has been benefiting from strong growth in eSports as well as massively multiplayer games such as Fortnite and PlayerUnknown's Battlegrounds (PUBG). These are battle royale style games in which up to 100 players from all over the world can partake in a Hunger Games-like battle where the goal is to be the last one standing. According to CEO Jensen Huang:

As you probably know, Fortnite and PUBG are global phenomena. The success of Fortnite and PUBG are just beyond comprehension, really. Those two games are a combination of Hunger Games and Survivor and has just captured imaginations of gamers all over the world." - Jensen Huang, CEO

While initially a PC gaming chip maker Nvidia has been able to turn its GPUs into the preferred hardware for computer acceleration that's now at the cutting edge of numerous tech megatrends including:

  • Cloud computing
  • Artificial intelligence
  • Autonomous cars
  • The internet of things (IOT)
  • Factory automation
  • Super computing

The majority of its sales are still from PC gaming but the company is fast becoming more diversified over time thanks to massive sales growth in other business units.

(Source: Nvidia earnings release)

  • Gaming: 54% of revenue growing at 68% YOY
  • Datacenter (cloud computing, artificial intelligence): 22% of revenue growing at 71% YOY
  • OEM and Intellectual Property (patent licensing and crypto mining rigs): 12% of revenue growing at 148% YOY
  • Professional Visualization (3D rendering, special effects, computer aided design): 8% of revenue growing at 22%
  • Auto (infotainment and autonomous car tech): 5% of revenue growing at 4% YOY

Note that this past quarter Nvidia reported $289 million in cryptocurrency-related GPU sales which was categorized under its OEM and IP business unit.

The automotive division has yet to achieve strong growth because up until now the company's Tegra-based processors have been mostly used for automotive infotainment systems (about 8 million cars). The company is laying the groundwork for a massive increase in auto sales in the coming years as driverless cars start hitting the market.

Metric

2017 Growth

Q1 2018 Growth

Revenue

40.6%

65.6%

Net Income

82.9%

145.4%

EPS

87.5%

150.6%

Free Cash Flow/Share

87.6%

495.0%

Dividend

16.3%

7.1%

(Sources: earnings releases, Morningstar, Gurufocus)

Last year Nvidia put up spectacular growth numbers in both its top and bottom line. That included earnings and free cash flow per share almost doubling. In the first quarter of 2018 (Q1 of the company's fiscal 2019) that growth actually accelerated. In fact Nvidia beat analyst expectations for the 11th consecutive quarter (it exceeded EPS growth expectations by an average of 40% over the past year) with earnings popping over 150% and free cash flow ballooning almost six fold. Free cash flow is what's left over after running the business and investing for future growth. It's what pays for dividends, buybacks, and repays debt.

In the past 12 months Nvidia has generated an impressive $4 billion in free cash flow, of which it paid out just 9% ($350 million) in dividends. That means it retained almost $3.7 billion in FCF to add its already massive cash position of $7.3 billion (net cash position $5.3 billion). This incredible FCF generation is why, despite being a fast growing tech stock that's exponentially increasing its R&D budget, Nvidia has been able to reward income investors with incredibly fast dividend growth.

(Source: Simply Safe Dividends)

And given that the company's 12-month and last quarterly FCF payout ratios were just 9% and 7%, respectively, Nvidia is likely to greatly increase its dividend in two quarters. That's because the company raises its dividend in November of most years.

Management's guidance for Q2 2018 is for $3.1 billion in sales which would represent 39% YOY top line growth. That's basically in line with 2017's growth rate which indicates that Nvidia shows no signs that its massive growth engine is slowing.

However Nvidia's long-term growth thesis doesn't just rest on the strong recent growth. Rather it's built on the company being at the bleeding edge of four major tech megatrends that should provide it with strong growth for the foreseeable future.

Four Massive Growth Catalysts Mean Growth Runway Is Potentially Decades Long

There are four large and interconnected tech megatrends that Nvidia is planning to ride to impressive long-term growth: AI, driverless cars, the internet of things (IoT) and robotics/automation.

(Source: NVIDIA Investor Presentation)

By far the biggest growth opportunity is in AI-driven cloud computing. For example according to CFO Colette Kress by 2023 the AI market will grow about 15 fold to $50 billion, up from $30 billion by 2020. The company already has more than 850,000 third-party developers incorporating its hardware and software into their AI efforts, a figure that's up 72% in the past year.

This highlights CEO Jensen Huang's earlier comment that "We're not a chip company, we're a computing architecture and software company." For example the company recently rolled out its TensorRT 4 AI inference software which Nvidia claims can accelerate machine learning by 190 fold. In other words Nvidia knows that hardware becomes commoditized over time. And so like Apple (AAPL) it wants to provide not just the best hardware but also deeply integrated software platforms that an army of developers can use to create the most useful applications for AI in the future.

According to Morningstar analyst Abhinav Davuluri Nvidia's is likely to see about 50% CAGR datacenter revenue growth over the next five years (66% AI market share by 2021). At which point he expects datacenter to represent about 50% of the company's total sales.

So what makes Nvidia such an AI cloud powerhouse? Simply that its GPUs are much better at processing data meaning that customers can buy fewer servers which saves money. Nvidia's GPU-based systems also are usually much more energy efficient, further saving and reducing total long-term operating costs by between 79% and 86%.

(Source: Nvidia Investor Presentation)

This is why Nvidia's GPUs have been adopted by all the biggest players in cloud including companies such as Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), Alibaba (BABA), Baidu (BIDU), and Tencent (OTCPK:TCEHY).

(Source: NVIDIA Investor Presentation)

In fact today Nvidia's GPUs are serving the needs of more than 2,000 global corporate customers. They are also power 85 of the world's 500 fastest supercomputers. That includes the Summit, which IBM (NYSE:IBM) and Nvidia built together for the US Department of Energy. At 200 Petaflops (200,000 trillion calculations per second) the Summit is the world's-fastest supercomputer by far.

The thing to understand about Nvidia's datacenter and AI cloud business is that the future of the world's economy is going to be all about data.

(Source: Brookfield Infrastructure Partners)

This is both due to the rise of mobile computing, but also things like the Internet of Things, or IOT. Sensors are now being incorporated into both consumer and industrial products that allow for the gathering of real-time data to optimize maintenance, replacement schedules and operations. According to Intel (INTC) by 2020 the number of internet connected devices will increase from 15 billion in 2015 to 200 billion. And by 2025 some analysts are projecting IoT will become a $6.2 trillion global industry.

These devices include driverless cars which CEO Jensen Huang explains is one of the biggest drivers of Nvidia future growth:

"And so the 100 million cars, the countless taxis, all the trucks, all the agriculture equipment, all the pizza delivery vehicles, you name it. Everything is going to be autonomous. And the market opportunity is going to be quite large. And that's the reason why we're so determined to go create that market." -Jensen Huang

(Source: Nvidia Investor Presentation)

Driverless cars are not just the most complex form of the IoT but will generate mind boggling amounts of data. That's both because each vehicle itself will generate over 125 Terabytes of data per year, but also because the cars must communicate both with themselves and highly IoT connected roads. However the ultimate payoff for driverless cars is staggering, with the National Highway Transportation Safety Administration (NHTSA) estimating it could prevent 600,000 US auto accidents per year and save almost 40,000 lives annually (in the US alone).

Nvidia's driving force in driverless cars is currently the Drive Pegasus driverless car platform which involves two Tesla V100s and two Xavier Tegra systems on a chip, or SOC. This system is capable of incorporating 360 degree camera views, LIDAR, and other sensors, and crunches 320 trillion calculations per second. All with hardware that can easily fit in a small fraction of the trunk of a car.

(Source: Nvidia Investor Presentation)

Already Nvidia has partnered with 370 automotive companies (throughout the industry supply chain), and that figure is growing fast. This is largely why management expects that the driverless car market will balloon in size to $60 billion by 2035 as 230 million cars, robo-taxis, and automated delivery vehicles hit the market.

(Source: Nvidia Investor Presentation)

Nvidia wants to continue boosting the processing power and efficiency of its chips (goal is 1,000-fold increase in power by 2025) in order to maximize the competitiveness of its driverless car offerings. Specifically the company is shooting to be the lowest cost hardware/software producer for fully autonomous level 5 vehicles. These are cars that can fully drive themselves in all geographic and environmental conditions without a human.

(Source: Nvidia Investor Presentation)

Nvidia is aiming to make its AV systems the lowest cost solution for the industry. That means that even factoring in the higher upfront cost of its premium chips the overall long-term operating cost will be 80% less than its competitors.

Morningstar expects 28% CAGR revenue growth in automotive over the next five years. That seems like a reasonable projection given the potential size of the market. One that will then proceed to go parabolic and increase almost 10 fold to $60 billion by 2035 as driverless car adoption hits its stride.

Finally we can't forget the huge potential for IoT in the form of automation and robotics. Currently management estimates that about 10% of the world's factory production is automated.

(Source: Nvidia Investor Presentation)

So Nvidia designed the Jetson TX-2 platform, a high-performance, low-power computer chip system that can deliver advanced AI for robots, drones and smart cameras. The TX-2 also is connected by the IoT to Nvidia's Metropolis system. This is a pilot project to test the company's AI-driven platforms in municipal environments specifically for optimizing safety (crime and terrorism prevention). It also can be used for optimizing public services such as trash pickup and road repair and maintenance.

The point is that Nvidia's growth drivers are all based on fast, efficient and AI-driven data crunching. The deeply integrated nature of these exciting trends provide it immense optionality or the ability to enter new growth markets.

(Source: Nvidia Investor Presentation)

To ensure it can maximize its market share and pricing power Nvidia wants to avoid just being just a hardware company. Rather it has become a vertically integrated one-stop shop for its clients' data analysis and processing needs. All of its products are now part of an integrated ecosystem that includes software, applications, and hardware. This is the approach Apple has taken and found great success in achieving the industry's highest margins and rivers of free cash flow.

(Source: Nvidia Investor Presentation)

In fact today Nvidia is actually more focused on becoming a software company which is why it has more software engineers than hardware focused ones.

So as you can see Nvidia has strong short-term growth catalysts in the form of gaming, but its real growth engine lies in four interrelated tech megatrends that it's currently on the cutting edge of. But in order for Nvidia to make a great investment in the coming decade and beyond we need far more than just potential. We need a highly experienced, innovative, and proven leadership team that can win market share, sustain pricing power, and stay competitive in a fast changing industry.

Industry's Best Management Makes Nvidia An Innovation And Profit Dynamo

The key behind Nvidia's amazing success so far ultimately comes down to its management lead by co-founder and CEO Jensen Huang. Huang has been in the top role since Nvidia's founding and before that worked for LSI Logics and AMD. Huang is widely seen as one of the best executives not just in the industry but in the world. For example in addition to winning several industry specific awards he was Fortune’s Businessperson of the Year in 2017 and Harvard Business Review ranked him No.3 on its list of the world’s 100 best-performing CEOs over the lifetime of their tenure. He's also beloved by his employees who give him a 97% approval rating on Glassdoor.

So what makes Huang the Steve Jobs or Jeff Bezos of his industry? That would be a constant hunger to continue driving ever better products through an incredibly efficient R&D program. This keeps Nvidia at the bleeding edge of technology and constantly one or two steps ahead of its competitors.

(Source: NVIDIA Investor Presentation)

At the same time while Nvidia's R&D budget has been growing like a weed the company has been laser focused on maximizing the sales and bottom line boosting effect of its investments.

For example recently the company unveiled its Tesla V100 processor which is at the heart of its new DGX-2 server which the company dubs an "AI supercomputer in a box." The $399,000 product incorporates 16 Tesla V100s which management claims is as powerful as 300 standard servers built by its rivals. This means that companies can benefit from the same computing power in a device that's 60 times smaller and 24 times more energy efficient.

This means lower long-term operating costs and is a big reason why Nvidia continues to win market share while retaining such strong pricing power. Which when combined with steadily rising economies of scale have resulted in very impressive margin expansion.

(Source: Nvidia Investor Presentation)

In fact in the most recent quarter Nvidia's profitability hit an all-time high.

Company

Gross Margin

Operating Margins

Net Margins

TTM FCF Margin

NVIDIA

64.5%

40.4%

38.8%

36.5%

Industry Average

27.0%

5.8%

4.9%

NA

(Source: earnings release, Gurufocus)

Not just does Nvidia enjoy almost 10 times the net margins of its rivals, but in the past year it was able to convert over one third of revenue into free cash flow. This has allowed the company to continue its short but still impressive (for a hyper growth tech stock) capital return program.

(Source: Nvidia Investor Presentation)

Remember that free cash flow is what's left over after investing for the future, including R&D. The fact that Nvidia is able to generate such rivers of free cash is a testament to management's ability to allocate capital efficiently.

(Source: Nvidia Investor Presentation)

That includes focusing on organic growth over splashy and needle-moving acquisitions. In the tech industry it's very easy to overpay for growth and good company/product integration is highly challenging. In fact the last major acquisition Nvidia did was the 2011 $367 million purchase of Icera to augment its efforts to get into smartphone chips. In 2015 Nvidia ended its efforts to break into the highly commoditized smartphone chip industry and instead decided to focus all its resources on where its tech had an advantage.

Company

Return On Assets

Return On Equity

ROIC

Nvidia

43.8%

65.5%

205.7%

Industry Average

3.6%

7.1%

17.5%

(Source: Gurufocus, CSImarketing)

The result has been nothing short of spectacular with the company generating returns on capital that are sometimes 10 times greater than its industry average. In fact in the most recent quarter Nvidia was one of the most profitable companies in the entire world.

The bottom line is that great companies require great leadership. That means someone with vision, passion, and an ability to steer the company's limited resources to its best uses (skate to where the puck is going). CEO Jensen Huang has increasingly shown himself to be not just one of the industry's best executives, but one of the best CEOs in the world. His constant drive to innovate and be the disruptor rather than the disruptee reminds me of Steve Jobs and Jeff Bezos. It also makes me increasingly confident that Nvidia's growth isn't going to slow anytime soon.

Dividend Profile: Nvidia Appears Poised To Generate 630% Total Returns Over The Next Decade

Company

Yield

TTM FCF Payout Ratio

10 Year Analyst Projected EPS (Dividend) Growth

10 Year Potential Return

Nvidia

0.2%

9%

21% to 22%

21.2% to 22.2%

S&P 500

1.8%

40%

6.2%

8.0%

(Sources: Gurufocus, FastGraphs, Yardeni Research, Multpl)

While I've gotten some flack for even thinking of Nvidia as a dividend stock, the fact that it pays a small but fast-growing dividend at all is a testament to the shareholder friendly nature of the world-class management team.

The key to any good dividend investment is the dividend profile which consists of three parts: Yield, dividend safety, and long-term growth potential. This approach also can be generalized to non dividend stocks as well. That's because it's based on the Gordon Dividend Growth Model which is derived from over 50 years of market studies. The model shows that over time total returns tend to follow the rule yield plus dividend growth. That's because a stock's total returns are a function of three things: Income, earnings/FCF growth, and valuation multiple changes.

Over time multiples tend to be mean reverting or cycle around a relatively fixed point. Thus this long-term model stipulates that a stock's return will actually come down to two things, current income and long-term EPS and FCF/share growth.

Nvidia's current token yield is a result of its share price going parabolic for so many years. However at a trailing 12-month FCF payout ratio of just 9% the dividend is rock solid. It also has room to grow at a ferocious pace should management choose to reward income investors with payout hikes anywhere close to the rate of FCF/share growth.

The other side of the dividend safety coin is the balance sheet. Here Nvidia again stands head and shoulders above its peers.

Company

Debt/EBITDA

Interest Coverage

Debt/Capital

Current Ratio

S&P Credit Rating

Interest Rate

NVIDIA

0.4

86.3

20%

8.5

BBB+

3%

Industry Average

1.8

55.9

30%

2.3

NA

NA

(Sources: Morningstar, Gurufocus, FastGraphs, CSImarketing)

The company has practically no debt ($2 billion, 99.3% of which is fixed rate long-term bonds). More importantly its sky-high interest coverage ratio and very strong investment grade credit rating mean that Nvidia can borrow at rock bottom interest rates if it feels the need to.

Of course with a net cash position of $5.3 billion the truth is that Nvidia has all the growth capital it needs. In fact even backing out the dividend and buybacks planned for this year (at least $1.25 billion worth), Nvidia is likely to see its net cash position climb by well over $3 billion. In the hands of this management team and its sky-high returns on invested capital that's a potent combination for strong long-term earnings and FCF growth.

That growth is ultimately what we're all here to discuss. With a dividend yield that almost rounds to zero Nvidia's total returns over the next decade will come down to how quickly it can grow its bottom line. Currently the analyst consensus is for 21.7% EPS and FCF/share growth over the next decade.

Now of course in the fast-changing tech industry growth projections rise and fall frequently. However given the incredible growth catalysts Nvidia is facing, and the track record of management to execute on opportunities, I'm inclined to believe that Nvidia might indeed increase its EPS and FCF/share by about six fold over the next decade. That in turn would translate into Nvidia potentially beating the S&P 500 by nearly 14%, or almost 200% per year. Or to put another way Nvidia may be capable of generating 630% total returns over the decade compared to about 115% for the broader market.

Valuation: Believe It Or Not Nvidia Is Now Undervalued

ChartNVDA Total Return Price data by YCharts

Charts like this are one of the biggest reasons why so many value-focused investors find it hard to consider Nvidia a good investment. With shares up 75% over just the past year alone how can this company be a good buy?

The answer is that there's no objectively correct method of valuing a stock. You can use any number of backward- or forward-looking valuation techniques and each one will only give you a just a piece of the true puzzle. This is why I like to use a combination of valuation approaches to build a more robust valuation model to lower my risk of overpaying for a company.

The first approach is the total return potential from the dividend profile. Since the simplest investment method is a low-cost index ETF (historically 9.1% total return since 1871 net of expenses), I want to make sure that I can at least beat the market. I also want to achieve my personal hurdle rate of 10%-plus total returns over time. Nvidia certainly has the potential (though not the guarantee) of doing that, and by a wide margin.

The second valuation screening technique I use is comparing the forward PE to its historical norm and estimating what growth rate is baked into the share price. Again the reason for this is because over time multiples are mean reverting and so a long-term average or median PE is a relatively good proxy for intrinsic value.

Company

Forward PE

Implied EPS Growth Rate

20 Year Average PE

Benjamin Graham Fair Value PE

Estimated Fair Value Price

Discount To Fair Value

Nvidia

35.7

13.6%

36.6

47.2

$347

24.5%

(Sources: Gurufocus, FastGraphs, Benjamin Graham)

Currently Nvidia's fast growth has caused its forward PE to actually decline slightly below its historical one (since 1998). More importantly that forward PE indicates that Nvidia shares are priced for about 13.6% long-term (10 year) EPS growth. While it's certainly possible for Nvidia to miss that growth target (more on this in the risk section) I'm confident that Nvidia can beat that hurdle rate. Thus based on this second screening method Nvidia also appears to be a buy.

The final approach I use, which I consider a good one for fast-growing tech stocks, is Benjamin Graham's fair value PE method. Graham is the father of modern value investing and was Buffett's mentor and business school professor at Columbia. Graham had a simple formula for estimating the fair value multiple in order to achieve returns above one's target (discount) rate. That formula is (8.5 + (2X long-term growth estimates))/ discount rate.

In this case that means that assuming you expect Nvidia to generate 21.7% 10 year EPS growth (and use a 10% discount rate) than a fair PE would be 47.2. With the year now half over I use the analyst consensus estimate for 2018 EPS of $7.35 to estimate a fair value for Nvidia of $347 or 24.5% above today's price.

This is a big increase in estimated fair value from my last article. That's a result of the significant increase in projected long-term growth potential over last quarter. Specifically the analyst consensus went from 17% long-term growth to almost 22%. However the point is that if Nvidia is able to achieve (or beat) those long-term projections then investors buying today are likely to earn very strong total returns.

That's why I can now finally recommend (and buy) my favorite tech stock. Of course whether or not you agree with my buy recommendation depends on how you view the company's complex risk profile.

Risks To Consider

Nvidia's growth potential may be amazing because it's currently the clear leader in tech that will power the global economy of the future. However the company still faces enormous challenges living up to Wall Street's steadily rising expectations.

For example I never try to guess where any stock price is going in the short term. This is because investor sentiment is fickle and valuation multiples can swing wildly over any one- or two-year period. Nvidia shareholders face a lot of short-term price risk simply because with 11 straight quarters of beating expectations (and by 40% on average over the past year) any miss could be met with a large scale sell off. What might cause Nvidia to miss its expectations in the near term?

Well currency fluctuations for one thing. Nearly 80% of the company's revenue is generated from outside the US. This means if the US dollar appreciates substantially against its foreign peers the company's local sales could convert into far less revenue, earnings, and cash flow growth.

Chart^DXY data by YCharts

Currency values depend on many factors but two important ones are relative economic growth (compared to other economies) and relative interest rates. Right now the US economy is growing much faster than those in the EU, UK, and Japan. As a result our interest rates are climbing much faster, meaning US-denominated assets have become more attractive to international capital. Thus the US dollar might end up rising for the next year or two, making it harder for Nvidia to live up to its ever-rising expectations.

Another short-term risk is crypto. Crypto mining provided a $289 million boost to Nvidia in the last quarter but according to Huang this trend is now reversing.

"Crypto miners bought a lot of our GPUs during the quarter, and it drove prices up ... and so we're starting to see prices come down. We monitor spot pricing every single day around the world. And the prices are starting to normalize." - Jensen Huang

Specifically this means that the crypto bubble caused a spike in sales of the company's top end GPUs. But with cryptocurrency prices now well off their highs many miners are getting out of the business. This includes selling their rigs on the secondary market, which is why Nvidia says that crypto-generated sales could drop as much as 66% in the next quarter. Now the company is still growing like a weed and crypto is not one of its major growth catalysts. However with Nvidia expectations now so high this slight downturn in revenue growth might be enough to cause the company to miss expectations and see larg-scale, short-term downside volatility.

Of course investing is a long-term endeavor. Which is why I like to use long-term growth projections because over time valuation multiples tend to cancel out and a stock trades purely on the fundamentals. Of course the downside is that guesstimating those fundamentals, in a smoothed out fashion that's required by long-term models, is itself fraught with peril.

Ultimately the best investors can do is try to use the most recent data and trends, along with a wide variety of third-party and management projections, to estimate reasonable growth rates. Then we compare the current multiples against those to see whether or not a stock appears undervalued and offers a good margin of safety. At the moment I conclude Nvidia is indeed undervalued, however that's based on it achieving about 22% EPS and FCF/share growth over the coming decade. What might cause it to miss that mark?

The biggest long-term risk for Nvidia is the nascent form of the industries it's attempting to conquer. Or to put another way the tech world is rapidly changing and we're effectively living in the wild west. Which is why even major customers like Alphabet are trying to eat Nvidia's lunch.

For example at Google's annual I/O developer conference the company unveiled its Tensor Processing 3 AI chip which it claims is eight times faster and more adaptable than last year's model. Alphabet's chip is designed to be more focused on AI deep learning as opposed to GPUs which provide brute force but are not designed with specific functions in mind.

That being said Nvidia claims its new Tensor Core GPU technology is still faster and more flexible than Alphabet's offering, which should maintain its AI cloud edge for now. However the point is that one of the company's biggest clients also is a major rival that's trying to take its specialized needs in house. Facebook also is supposedly thinking about its own specialty built AI chip.

And what about the exciting world of driverless cars? Well, while Nvidia has jumped out to an early lead and is throwing lots of resources into maintaining the business, the company faces giant and well-capitalized rivals. Those include Intel and Qualcomm (QCOM), both of which are betting big on autonomous vehicles and who spent $6.8 billion and $4 billion on R&D in 2017, respectively. That's far more than Nvidia which thus has to rely on its laser-like R&D efficiency to maintain its tech lead.

In 2017 Intel spent $15.3 billion to buy Mobileye, a leading rival of Nvidia's in the AV space. Meanwhile Qualcomm has been struggling to acquire leading automotive chip maker NXP Semiconductors (NXPI) for $44 billion. Now the good news is that I have full confidence in Nvidia management to stay ahead of the competition in terms of both hardware and software integration.

In other words I think with Huang at the helm Nvidia will remain the top quality AV tech leader. However ultimately we have no way of knowing just how much market share it can win in this industry. In fact even the rate or extent of driverless car adoption is highly uncertain.

In the US we have state, local and the federal governments that will need to work out a complex interplay of regulations to make AV a reality. In the rest of the world the same thing will apply. So there's always a risk that driverless cars end up taking longer to hit the market and their adoption may be slower than expected.

And even assuming that AV and Nvidia's cut of that market turns out as expected we can't forget that the margins on driverless car systems are about four and five times smaller than the company's datacenter and gaming businesses, respectively. Or to put another way if AV does grow as expected and Nvidia dominates that industry as it does AI and gaming, then its profitability is going to drop. At least on a relative level.

Ultimately dividends and buybacks are not funded from margins but free cash flow. And with Nvidia's free cash flow likely to keep growing strongly for years, at the end of the day investors can have confidence that the intrinsic value of their shares will keep marching higher. But whether or not the market assigns us valuation multiples that result in our expected returns over time? Well in a fast-changing industry such as this all we can do is focus on the fundamentals and trust in our highly proven founder led management team.

Bottom Line: Nvidia;s Incredible Combination Of World Class Management, Massive Growth Catalysts, And Stunning Profitability Makes It A Must-Own Dividend Tech Stock

I'm sure that some readers will deride me for failing to buy or recommend Nvidia at much lower prices several quarters ago. But as Lord Maynard Keynes said "when the facts change I change my mind." In this case Nvidia's continuing trend of industry-leading hardware innovation and laser-ike execution on numerous tech megatrends has me convinced that the company's growth story is for real. What's more I'm increasingly convinced that CEO Jensen Huang is a truly exceptional corporate leader. One that like Steve Jobs or Jeff Bezos,he can continue to keep Nvidia's growth engines firing on all cylinders for the foreseeable future.

Don't get me wrong - I'm not saying that this hyper-growth stock doesn't have some major challenges ahead. Or that it won't face massive volatility when it eventually disappoints earnings expectations (something that's inevitable). However as long as management can keep its eye on the prize and remain laser focused on its hyper efficient R&D efforts I'm confident that Nvidia is going to be a major market beater over the next decade. Which is why I'm happy to recommend the stock even at these prices and will be initiating a starter position in my own portfolio soon.

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Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.


The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).


I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.


My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.


With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.


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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NVDA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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