𝓤𝓷𝓲𝓽𝓮𝓭 𝓝𝓮𝔀𝓼

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The Nvidia share price was attractive by one key metric even before news of chief executive Jensen Huang’s affair with a suspected spy for China, but they have fallen further this week.

Investors had already been spooked by the Democrats’ ‘blue wave’ win in the US midterm elections, the related risk that data centre building could be slowed and questions over how viable the funding for many AI companies is with interest rates rising.

There comes a point when all the bad news is already reflected in share prices. Correctly identifying this, however, is not easy.

While Nvidia is integral to the development of AI and we are still in the very early stages of that, there are some significant risks that could cause its shares to fall even further.

Are Nvidia shares ‘cheap’ now?

By the most widely used measure, Nvidia shares are now cheap.

The forward price to earnings ratio is the measure of a company’s stock price to its forecasted earnings (profit) per share issued. For example, a company with a share price of £100 and forward earnings per share of £5 has a ratio of 20.

This calculation is the bedrock of how analysts start to assess whether a company is undervalued or overvalued, on a relative basis.

Nvidia’s current forward price to earnings ratio as of 11 November is 12 to 14 times, depending on the specific earnings forecast you use.

To get an idea of how cheap or expensive a company is, you can compare the price to earnings ratio to other similar companies, or the entire stock market.

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The average forward price to earnings ratio for the Magnificent Seven tech giants, which includes Nvidia, Alphabet (Google), Apple, Amazon, Tesla, Meta Platforms and Microsoft is around 22. This is significantly more expensive than Nvidia alone.

If we look at the S&P 500, offering a broad overview of the US stock market, the average ratio is 18 times – so Nvidia is cheap relative to the wider market too.

Why the share price alone doesn’t make a stock cheap or expensive

For all the talk of an “AI bubble” you may hear from your Uber driver, talking heads on the television or friends in the pub, AI stocks have not been going up recently.

It’s true that the share price of Nvidia and other AI linked stocks have risen dramatically over recent years, but they have corrected to significantly lower levels in recent weeks – and earnings have risen over longer terms, too.

Nvidia shares peaked at $233 in early October and as of 11 November are around the $170-175 level. The SOXX ETF, which is a fund composed of all the large AI-linked chipmakers, actually peaked back in June. It is down around 35 per cent since then. That is the opposite of a bubble.

Much of this fall came before news of Mr Huang’s affair, as the whole AI industry saw a price correction during October and early November.

This resulted from a combination of Democrats winning the midterms, fears of restrictions on data centre building, stubborn inflation, rising US interest rates and concern over valuations being too high.

Why Nvidia’s shares are likely to recover

It is very likely Nvidia’s share price will recover – the questions are when and by how much. This will depend on whether the scandal involving Mr Huang is now fully priced in, combined with wider conditions for the global stock market.

We are in the very early stages of AI being integrated into our lives and the global economy. Widespread use of AI is only around three years old, so we are just scratching the surface of where things will be five or ten years from now.

Nvidia’s chips are integral to almost everything that happens in AI, and that is unlikely to change. Markets are highly efficient at pricing news into shares, so everything that is currently known is probably reflected in the fall that has already occurred.

There is a realistic scenario in which Mr Huang makes his apologies for an error in judgement and the scandal blows over. It may well be limited to a personal matter which does not greatly impact his continued running of the company.

Nvidia recently started shipping a new generation of chips called Vera Rubin, which supersedes the wildly successful Grace Blackwell generation. The demand for these is far greater than the supply Nvidia can produce. The company’s software for AI, called CUDA, is deeply embedded in how AI models are developed and run.

The company has already effectively sold as many chips as it can possibly produce over the next couple of years, so with or without Mr Huang it will have hundreds of billions of dollars rolling in. It always has the option to buy its own shares with some of this money too, which can push the price up.

The risks of investing in Nvidia now

Brits are already piling into Nvidia shares, with investors opting to buy the dip. But risks remain all the same.

While a large fall in a company’s share price makes it lower risk than buying after it has been going up for a long time, there is always chance it could go even lower and there are two big risks faced by Nvidia specifically right now.

Firstly, there is the ongoing so-called key man risk. Companies which have one person holding a large proportion of the power over the strategy and important decisions are considered to be a position where them leaving could cause major problems – like Elon Musk at Tesla, for example.

This risk has always been there with Nvidia as everything it has achieved has been led and driven by Mr Huang. He has taken the company from supplying the chips for computer gaming, to focus on crypto mining, before steering it to being the multi-trillion dollar leader in AI chip production. All the top executives at Nvidia report directly to Mr Huang, with no clear corporate hierarchy or succession plan. If he were to step down or be forced out Nvidia’s future would become far less clear.

The separate, but closely related second risk is the possibility of a hefty punishment by regulators or the US government if Nvidia is found to have done something wrong in terms of selling its products to Chinese customers.

America has restrictions in place which forbid its chipmakers from selling the latest versions to China, as the government does not want another country to have more advanced AI. There is no firm evidence of this so far reported, but concerns have been raised by the relationship Mr Huang had with the woman reported to be a spy for the Chinese state.

Investors have to weigh up these risks and potential rewards before buying shares in any company – even when they look as cheap as Nvidia’s do now.

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.