Before we get started, I want to welcome the +101 subscribers who signed up for the “Let’s Analyze” newsletter in the past week! If you would like to join our community, make sure to sign up here:
“It’s the most important stock on Earth.”
That’s how Goldman Sachs’ trading desk described AI chip stock Nvidia (NVDA) last week.
And they had a point; after the stock’s blistering +600% gain since October 2022, Nvidia was now the third largest company in the US.
With a pivotal earnings report hanging in the balance - where Wall Street expected earnings growth of over 400% - investors were rightfully nervous.
And then something amazing happened: Nvidia not only met those lofty expectations but also exceeded them. This sent the stock up by more than 15% in one day, adding $277 billion in market value—the largest single-day gain in history.
But that begs the question: is Nvidia a buy after this latest run?
Nvidia is the “New Tesla”
I see a lot of similarities between Tesla from 2018 to 2022 and Nvidia today.
Back in 2018, Tesla had a market cap of only $50 billion. At that time, skepticism ran high among investors as many doubted the company's path to profitability and its ability to scale production to meet ambitious targets.
Fast forward to today, and it's a textbook case of an underdog transformed into a market behemoth, reshaping the automotive industry and how we think about transportation.
But this didn’t happen overnight; Tesla had to prove the doubters wrong time and time again. This included expectations the company may default on its debt in 2019…
…and questions on whether the company would ever be profitable (a goal Tesla met in 2020):
Despite these lingering questions, Tesla’s share price skyrocketed nearly +2,000% between January 2019 and November 2021:
But this surge wasn’t only due to Tesla’s position as the leader in the burgeoning market for electric vehicles.
Rather, a specific dynamic known as a gamma squeeze supercharged its share price.
And I see a similar dynamic playing out with Nvidia.
A Primer on Gamma Squeezes
Imagine you're playing a game of tug-of-war, but instead of a rope, you're using a rubber band.
Now, this isn't a normal game because every time your team pulls the rubber band towards you, the other team has to grab more rubber band to try and pull back. This makes the rubber band stretch even more.
This is similar to how a gamma squeeze works.
A gamma squeeze happens when the price of a stock moves sharply due to the “hedging activity” of options sellers.
When traders purchase a large number of call options (bets that the stock price will increase), the sellers of those options (often market makers or institutions) hedge their positions by buying the underlying stock to cover potential losses.
This buying can push the stock's price higher, leading to a feedback loop where the rising stock price forces more buying to hedge, further driving up the stock price.
This dynamic was a key reason Tesla’s shares saw such a massive run-up from 2018 to 2022. And it looks like it’s happening to Nvidia as well, which is one reason the stock is rising so rapidly:
Nvidia has overtaken Tesla as the new favorite among options trades. In fact, last week traders placed more then $20 billion in stock-options bets tied to the company:
This type of options buying activity feeds into the gamma squeeze dynamic. And until Nvidia disappoints on earnings - something it hasn’t done in a few years - this will likely continue.
But it’s not the only factor working in Nvidia’s favor.
A Monopoly on the AI Revolution
Nvidia holds an enviable position in the AI market.
Nvidia's Graphics Processing Units (GPUs) give the company a near-monopoly in the AI chip market, much like how owning the only oasis in a desert makes you king of the caravan.
This isn't by chance or mere luck; Nvidia saw the future of computing not just in rendering graphics for video games but in processing the complex algorithms that are the lifeblood of artificial intelligence.
Recommended Reading
Love this infographic?
Tired of boring, text-heavy investing newsletters?
Carbon Finance sends out a weekly newsletter with simple, data-driven visuals that covers the most important headlines in investing.
It’s completely free and only takes 5 minutes to read.
Join thousands of investors and subscribe with the button below
Subscribe to Carbon Finance Here
Their GPUs are the Swiss Army knives of the computing world, able to handle the massive parallel processing tasks that AI demands. This versatility has made them indispensable in data centers, autonomous vehicles, and deep learning applications, effectively making Nvidia the backbone of the AI revolution.
Imagine a gold rush where Nvidia doesn't just sell the shovels but owns the entire mountain. That's their position in the AI chip market.
And despite NVDA’s massive run-up this year, much of these gains are backed by earnings growth. When the market bottomed in October 2022, Nvidia had a market cap of $280bn and a 12-month forward P/E of 32x. Since then, the company has added $276 billion in market cap. Yet its forward P/E ratio remains at only 33x!
And while everyone wants to say Nvidia is emblematic of a new Dot Com Bubble, its gains are nowhere near the craziness we saw with stocks like Cisco (CSCO) in the 1990s:
As I mentioned a few weeks back, tech stocks really are not that expensive. And based on the earnings growth - which is the key factor in stock appreciation - Nvidia’s stock isn’t as “bubbly” as many think.
Bringing it All Together
The combination of Nvidia’s domination of the AI market, it’s not-to-bubbly valuation, and gamma squeeze dynamic boosting its shares, I’d say the stock is still a compelling buy.
And my 117,000 Instagram followers seem to agree on that:
But that doesn’t mean I am buying the stock tomorrow (but if you want to know exactly when I’ll buy in my own portfolio, click here).
For now, I don’t expect this tech bull run to stop any time soon. From a sentiment standpoint, Nvidia shares rose after it released good earnings. This implies the market had not yet priced-in good news for the stock.
When Nvidia shares start to go down on good earnings, that will tell you when we’re at the top.
But it looks like we’ll have to wait a bit longer for that.
And in the meantime, don’t get left behind.
As this bull still has room to run.
Stay safe out there,
Robert