Nvidia’s huge valuation could allow other companies to surpass it, making it ripe for exit.
Nvidia hit a $3 trillion market cap earlier this year, an impressive feat considering it was about a tenth of its size two years ago. The emergence of generative artificial intelligence (AI) has drawn investors to the stock as the company leads the way in graphics processing equipment essential to AI.
However, due to slower growth, Nvidia could fall due to its huge valuation. Such a decline would pave the way for other stocks to achieve higher market capitalizations in five years. Given trends across the tech sector, these two stocks could certainly outperform.
taiwan semiconductor
I chose Taiwan Semiconductor Manufacturing Company (TSM 0.94%) Given its relationship with Nvidia and its peers, it may raise some eyebrows. As a leading manufacturer of advanced semiconductors, TSMC (abbreviation) plays an essential role in bringing AI to the world.
Unfortunately for TSMC shareholders, the company has so far not benefited from the premiums that have helped customers like Nvidia. For reasons that aren’t clear, fab companies don’t typically trade at high valuations. TSMC also operates in the geopolitically contentious region of Taiwan, which some investors have avoided for fear of invading Taiwan.
Nevertheless, the market may not have properly assessed this risk. First, China also relies on TSMC chips, which should make invasion less likely. And since TSMC makes its chips in Taiwan, it stands to reason that its largest customers also face this risk, but the market seems to be ignoring such a possibility in Nvidia’s case.
Additionally, if investors start discounting Nvidia, valuations could tip in favor of TSMC. Currently, the former is selling at a price/sales (P/S) ratio of 31 times, far exceeding TSMC’s 12 times.
Still, TSMC also makes AI chips for companies like Advanced Micro Devices and Qualcomm. Therefore, even if Nvidia continues to dominate, this competition could hurt pricing and lead to lower revenues and multiple compressions.
In comparison, TSMC’s market capitalization is around $900 billion. Therefore, if the P/S ratio were to double and become half of Nvidia’s, TSMC’s market capitalization would be even larger. This doesn’t take into account the revenue growth that will benefit both companies over the next five years. However, this shows that Nvidia may not be as far ahead of TSMC as it seems.
TSMC could easily be well-positioned to soar ahead of its more prominent customers as Nvidia realizes more of the impact of its potentially unsustainable valuation.
tesla
Investors are probably familiar with electric vehicle (EV) maker Tesla (TSLA 3.91%) Perfect for that car, or perhaps its battery technology. With a market capitalization of $835 billion, it is currently the smallest of the Magnificent Seven stocks.
Tesla Solar Roof and Powerwall have growth potential, but that product category accounted for less than 12% of revenue in Q2 2024. It also accounts for 7% of the more than 830,000 vehicles sold by the company in the first half of 2024. It will decline from 2023.
The savior may be Autopilot, an autonomous driving technology that continues to make significant advances. For now, it still requires human oversight, but Tesla and its supporters envision turning it into a profitable subscription business once it achieves full autonomy.
This potential is so strong that ARK Invest’s Cathie Wood believes this technology will account for around 90% of profits by 2029. According to her calculations, the price of Tesla stock would then be $2,600 per share, an increase of about 10 times. Market capitalization is 8.4 trillion dollars!
In such a scenario, comparing Tesla and Nvidia’s valuations would likely become irrelevant. The EV maker’s P/E ratio is 73 times, while the chip maker’s earnings multiple is higher than 57 times. Still, even if Tesla stock were to return to Nvidia’s P/E ratio, a 10x increase would give it a market cap of $6.5 trillion, far larger than Nvidia’s current size.
Finally, as mentioned earlier, NVIDIA may experience multiple compressions as competitors eat into some of its market share in the AI chip market. Tesla’s self-driving opportunity hasn’t really begun yet, so even if it’s partially successful, its stock could skyrocket enough to overtake Nvidia.
Will Healy holds positions at Advanced Micro Devices and Qualcomm. The Motley Fool has positions in and recommends Advanced Micro Devices, Nvidia, Qualcomm, Taiwan Semiconductor Manufacturing, and Tesla. The Motley Fool has a disclosure policy.
