Here’s why Nvidia is a compelling stock when compared with the rest of the ‘Magnificent Seven’

In an article last Wednesday following the company’s earnings report, MarketWatch’s Emily Bary observed that investors seemed to have become numb to the continuing flow of incredible growth numbers from Nvidia
NVDA.
The company reported a blowout set of numbers for sales and earnings late on Tuesday, only for its stock to fall 2% the following day.

Read: Nvidia’s big beats don’t wow like they used to — but here’s the good news for the stock

A low price for a stock that has tripled this year

The forward price-to-earnings valuation for Nvidia’s stock appears to be relatively low. The shares closed at $477.76 on Friday and traded for 25.3 times the consensus earning estimate among analysts polled by FactSet of $18.91 a share for the next 12 months. In comparison, the S&P 500 information-technology sector

trades for a weighted 26.2 times its combined forward earnings estimate. And the sector is expected to grow its earnings at a slower rate over the next two years.

In a note to clients last week, Bernstein analyst Stacy Rasgon noted that Nvidia’s stock wasn’t pricey, but added: “We understand the nervousness given how quickly numbers are rising, but in our opinion [Nvidia] itself remains the best way to play the burgeoning [artificial-intelligence] theme.”

Worry over Nvidia’s recent success may spring from the financial media’s tradition of focusing on year-over-year comparisons of results. Nvidia reported sales of $18.12 billion for its fiscal third quarter, which ended Oct. 29. This was more than triple the figure for the year-earlier quarter, but it was a far less lofty 34% increase from the previous quarter. The company’s quarterly profit came in at $9.24 billion, up from $6.19 billion the previous quarter and $680 million a year earlier. The company has essentially created the market for graphics processing units used by data centers to build up the artificial-intelligence power they need to support corporate clients’ own AI build-out.

All estimates that follow are for calendar years, because a good percentage of publicly traded companies report fiscal years that don’t match the calendar. Nvidia is one example.

Before looking at the semiconductor industry, here is a comparison of forward price-to-earnings and price-to-sales ratios for Nvidia and for the other six companies in the “Magnificent Seven” group that have driven the S&P 500’s gain this year, along with the S&P 500 information-technology, communications-services and consumer-discretionary sectors and the full index.

Nvidia is, of course, in the IT sector, as are Apple Inc.
AAPL
and Microsoft Corp.
MSFT.
Amazon.com Inc.
AMZN
and Tesla Inc.
TSLA
are in the consumer-discretionary sector, while Alphabet Inc.
GOOGL
and Meta Platforms Inc.
META
are in the communications-services sector.

First, here are forward price-to-earnings ratios and expected compound annual growth rates for earnings per share from 2023 through 2025:

One benefit of a forward focus is that it bakes in Nvidia’s incredible 2023, as the company has been at the forefront of the data centers’ AI build-out so far. Nvidia’s forward P/E stacks up reasonably within the group of seven companies, especially when considering it is expected by analysts to grow its profits much more quickly than most of the others over the next two years. Amazon ranks second by expected EPS CAGR through 2025; however, its forward P/E is a higher 42.5.

Now let’s take a look at forward price-to-sales ratios and expected sales CAGR through 2025 for the group, sectors and full S&P 500:

Profit margins

That price/sales ratio is very high for Nvidia. One reason for this is that the company has been running such a high profit margin on its AI GPUs. Take a look at gross margins and operating margins for the Magnificent Seven group’s most recent reported quarters:

A company’s gross margin is its net sales, less the cost of goods or services sold, divided by sales. Net sales are sales minus returns and discounts, such as coupons. The cost of goods or services sold includes the actual costs of making the items or providing the services. It is a useful measurement of pricing power, and a combination of an expanding gross margin and increasing sales is a good sign.

A company’s operating margin goes further, subtracting more overhead and other expenses that aren’t directly related to the production of goods and services sold. It is, essentially, earnings before interest and taxes, divided by sales.

One reason Nvidia’s price/sales ratio is so high, relative to its P/E ratio, is that its profit margins have been so high this year.

Analysts’ opinions of the Magnificent Seven

Here’s a summary of analysts’ ratings and price targets for the group:

Nvidia ranks second to Amazon for the percentage of buy or equivalent ratings among the dozens of analysts working for brokerage firms polled by FactSet. But it also has the most bullish consensus price target.

A related idea: Micron’s stock might be an excellent play for AI investors who want to diversify beyond Nvidia