Nvidia has become something of a combination of the Taylor Swift and Shohei Ohtani of the stock market. They’re charming, constantly hitting the ball out of bounds, literally and figuratively, and attracting millions of eager fans who pay to soak in their magic. Like Swift and Ohtani, Nvidia has amassed some impressive stats. Investors eagerly traded far more shares than any other company, creating a market capitalization of $2.5 trillion in just 10 months. In one year, Nvidia has become a true star.
But the analogy to the entertainment industry falls apart when it comes to what fans are paying for. While Swift and Ohtani followers buy expensive tickets for a few hours of frenzied fun, NVIDIA investors want their money back and then some. A closer look at the data shows that long-term investors are unlikely to get the returns they expect by buying stocks at recent prices.
This analysis is based on economic profit, also known as Economic Value Added (EVA), a fundamental measure that avoids accounting distortions that public companies must use. It centers around capital, the cost of capital, and how well a company uses that capital to generate profits. Research shows that this method of analysis is more predictive than looking at earnings per share.
An economic benefits analysis compiled by ISS EVA of Institutional Shareholder Services at Fortune’s request shows that NVIDIA is a superstar in every respect. You don’t need to be a financial expert to understand these numbers. Over the past four quarters, Nvidia’s return on equity has been 140% and its cost of capital has been 9.3%. “It’s amazing,” said Bennett Stewart, one of the pioneers of economic benefits analysis. “It’s hard to see how you can achieve a return on capital that is much higher than that.”
Here’s how Nvidia makes amazing profits. ISS calculates EVA data for 21,000 publicly traded companies around the world and reports that Nvidia’s profitability is in the 100th percentile. This does not mean that Nvidia is in the top percentile (or 99th percentile). This means that Nvidia may outrank any of the other 21,000 companies, or may be affiliated with some of them.
But these remarkable numbers reflect the past, and stock prices are based on the future. So the key question for investors is: What are the chances that NVIDIA will perform well enough in the future to justify its stock price (recently around $136)? EVA can help answer that question .
We asked ISS EVA to calculate how much NVIDIA would need to increase its economic profits each year over the next 20 years to justify its recent stock price. The answer is 21.4%. Nvidia must increase its economic profits by 21.4% each year for 20 years. If you can’t do that, the stock price is too high these days.
So, can it be done? No one knows for sure, but here are some numbers to give you some context.
· Nvidia’s economic profit for the past four quarters was $46.2 billion. To justify recent stock prices, its economic profits would need to increase to $2.2 trillion in 20 years alone.
· The highest economic profit earned by a company in the past 12 months was $202.7 billion, achieved by Saudi Arabian Oil Company in 2022.
· The highest economic profit ever made by a technology company is Apple’s $92.8 billion.
And then there are the facts, which are based not on mathematics but on real-world experience. When the numbers get very large, it becomes difficult and eventually impossible to increase them by a large percentage each year.
This isn’t just a theory. This type of EVA analysis has proven to be prescient, showing large gaps between a company’s stock price and the performance needed to achieve it.
A 2023 Fortune analysis found Tesla stock to be overvalued at $210. The stock price fell to $138, but due to the stock’s volatility, I warned it could go above $210, which it did (recently $247). Many Wall Street analysts expect the stock to decline further, falling further from its peak of $414.
In 2021, Fortune published an EVA analysis showing that Amazon’s stock price was unreasonably high. Investors who bought at that price regret it. As we write this, the stock is at the price it was when the analysis was published more than three years ago, or $186.
Just before the infamous AOL-Time Warner merger was announced in 2000, Fortune published an EVA analysis showing (accurately) that AOL stock was impossibly overvalued. This stock was the currency AOL used in its acquisition of Time Warner, and the following article concludes that the deal was doomed, which it proved to be.
Nvidia is fine. It’s showing great performance. But people who have recently bought stocks are taking on a bigger risk than they realize. They’re betting that Nvidia will continue to do great things for 20 years. In theory it’s possible. In fact, you might have better odds if you bet on Taylor Swift and Shohei Ohtani being top performers for the next 20 years.
