Editors note: On Tuesdays we turn the spotlight outside of Porter & Co. to bring you exclusive access to the research, the thinking, and the investment ideas of the analysts who Porter follows.

My Brother From Another Mother

We’re about as dissimilar as it’s possible to be.

I’m a dyed-in-the-wool American who loves hunting, fishing, and raising a ruckus. If I’m in the room, you’ll know it. I just can’t help myself. He, on the other hand, is a classy, reserved European who quietly observes from afar.

On paper, we’re nothing alike.

But when it comes to investing… that’s another story.

I’ve been studying stocks for close to 30 years. I’ve had countless conversations (well, arguments) about the financial markets and investing with some of the most famous names on Wall Street…

The thing is, only very rarely have I come across someone who thinks about investing, and analyzing companies in almost exactly the same way that I do.

I’m not talking about people who share similar sentiments towards the beauty of capital efficient stocks or the wealth-building power of distressed bonds… I’m talking about someone who “sees” finance the same way I do.

Then, in September my team introduced me to a 20-something-year old investor from Belgium, Pieter Slegers, and when I read his research… when I saw his stock portfolio… It was like looking in the mirror.

As I explained in last week’s Spotlight, as soon as I saw his work I knew I had to introduce him to the Porter & Co. family… and judging by the feedback we’ve got, you guys were blown away by him too.

This week, Pieter from Compounding Quality returns to share his unique take on the world’s “hottest” company, Nvidia.

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Nvidia is one of the best-performing companies in the world.

An investment of $10,000 turned into $33.5 million (!) since 1999.

But is it an interesting stock? Let’s find out.

Nvidia – General Information

• Company name: Nvidia Corporation
• ISIN: US67066G1040
• Ticker: NVDA
• Type: Monopoly
• Stock Price: $117
• Market cap: $2.88 trillion
• Average daily volume: $411 million

Onepager

Here’s a onepager with the essentials of Nvidia:

15-Step Approach

Now let’s use our 15-step approach to analyze the company.

At the end of this article, we’ll give Nvidia a score on each of these 15 metrics.

This results in a Total Quality Score.

1. Do I understand the business model?

Nvidia is an American tech company founded in 1993.

Today, it’s a dominant supplier of Artificial Intelligence (AI) hardware and software.

Nvidia makes money by creating and selling powerful computer chips (GPUs) and software. This helps computers and other devices to show amazing graphics and work really fast.

The company makes money from two main sources:

1. Data Centers (83.3% of revenue): Nvidia’s GPUs are used in data centers for tasks like processing big data and running artificial intelligence programs. Companies pay Nvidia to use their powerful GPUs for these tasks.
2. Gaming (13.7% of revenue): Nvidia’s GPUs are also popular among gamers. Nvidia makes money when gamers buy computers, consoles, or devices that use their GPUs.

Whenever you ask your computer to do something demanding, like using ChatGPT, playing a video game, or running a complex program, chances are Nvidia is speeding up the process.

Here’s what the geographical split looks like:

2. Is management capable?

Jen-Hsun Huang is the CEO, co-founder, and president of Nvidia.

Today, Huang still owns 3.8% (value: $109 billion) of Nvidia, making him one of the richest persons in the world.

It’s great seeing that one of the founders is still leading the company.

Colette Kress has been Nvidia’s CFO since 2013. She previously served for three years as senior vice president and Chief Financial Officer at Cisco.

In total, all directors and executive officers own 104 million shares of the company (value: $121 billion). Total insider ownership at Nvidia is 4.2%.

3. Does the company have a sustainable competitive advantage?

Nvidia has a competitive advantage for sure.

Their chips currently outperform all other chips. That’s why their GPUs have become the go-to choice for powering complex AI workloads. At the end of last year, Nvidia owned 80% (!) of the GPU market share.

There is no good alternative for Nvidia’s GPUs. This allows them to charge higher prices.

The company also enjoys a strong brand name. It has a strong reputation within the gaming industry and AI.

Companies with a sustainable competitive advantage are often characterized by the following:

1. Gross Margin: 75.3% (Gross Margin > 40%? ✅)
2. ROIC: 118.9% (ROIC > 15%? ✅)

 

4. Is the company active in an attractive end market?

Nvidia is active in an attractive end market.

According to Statista, the GPU market is expected to grow from $65.3 billion (2024) to $274.2 billion (2029). This is a CAGR of 33.2% (!).

This means the company is active in a clear secular trend.

When you look at Nvidia’s rivals, you see some competitors like AMD, Intel, IBM, …

However, no one has been able to make GPU chips that are nearly as good as the ones of Nvidia.

5. What are the main risks for the company?

Some of the main risks for Nvidia:

1. Competition: A lot of companies are trying to compete with Nvidia.
2. Dependence: Jen-Hsun Huang(Nvidia’s CEO) is responsible for a large part of the company’s success.
3. Technological disruption: NVDA operates in a changing environment
4. Regulatory risks: Upcoming regulations might affect Nvidia’s revenue
5. Rich valuation level (see later)

6. Does the company have a healthy balance sheet?

We look at 3 ratios to determine the healthiness of Nvidia’s balance sheet:

1. Interest Coverage: 187.2x (Interest Coverage > 15x? ✅)
2. Net Debt/FCF: Net cash position (Net Debt/FCF < 4x? ✅)
3. Goodwill/Assets: 5.8% (Goodwill/assets not too large? < 20% ✅)

Nvidia’s balance sheet looks very healthy.

 

7. Does the company need a lot of capital to operate?

We prefer to invest in companies with a CAPEX/Sales lower than 5% and CAPEX/Operating Cash Flow lower than 25%.
Nvidia:

1. CAPEX/Sales: 1.5% (CAPEX/Sales < 5%? ✅)
2. CAPEX/Operating Cash Flow: 2.9% (CAPEX/Operating CF? < 25% ✅)

The capital intensity of Nvidia is very low. This is something we love to see.

8. Is the company a great capital allocator?

Capital allocation is the most important task of management.
Look for companies that put the money of shareholders to work at attractive rates of return.

Nvidia:

1. Return On Equity: 115.7% (ROE > 20%? ✅)
2. Return On Invested Capital: 118.9% (ROIC > 15%? ✅)

Here’s an evolution of Nvidia’s ROE and ROIC:

 

The company’s capital allocation metrics have been a bit volatile in the past.

Now let’s dive into the most important fundamentals. Is Nvidia an interesting buy?

9. How profitable is the company?

The higher the profitability of the company, the better.
Here’s what things look like for Nvidia:

1. Gross Margin: 75.3% (Gross Margin > 40%? ✅)
2. Net Profit Margin: 53.4% (Net Profit Margin > 10%? ✅)
3. FCF/Net Income: 92.3% (FCF/Net Income > 80%? ✅)

10. Does the company use a lot of Stock-Based Compensation?

Stock-based compensation is a cost for shareholders and should be treated accordingly.

Preferably we want SBCs as a % of Net Income to be lower than 4%.

SBCs as a % of Net Income higher than 10% are seen as a bad thing.

Nvidia:

1. SBCs as a % of Net Income: 8.9% (SBCs/Net Income < 10%? ✅)
2. Avg. SBC as a % of Net Income past 5 years: 27.5% (SBCs/Net Income < 10%? ❌)

Nvidia’s Stock-Based Compensation is on the high side but still acceptable.

I would guess that the SBC as a % of Net Income will be equal to 7-9% per year in the years to come.

11. Did the company grow at attractive rates in the past?

We seek companies that managed to grow their revenue and EPS by at least 5% and 7% per year respectively.
Nvidia:

1. Revenue Growth past 5 years (CAGR): 49.4% (Revenue growth > 5%? ✅)
2. Revenue Growth past 10 years (CAGR): 34.0% (Revenue growth > 5%? ✅)
3. EPS Growth past 5 years (CAGR): 66.8% (EPS growth > 7%? ✅)
4. EPS Growth past 10 years (CAGR): 55.1% (EPS growth > 7%? ✅)

Nvidia has grown at tremendous rates in the past years.

12. Does the future look bright?

You want to invest in companies that manage to grow at attractive rates as stock prices tend to follow FCF per share growth over time.
Nvidia:

1. Exp. Revenue Growth next 2 years (CAGR): 61.9% (Revenue growth > 5%? ✅)
2. Exp. EPS Growth next 2 years (CAGR): 66.8% (EPS growth > 7%? ✅)
3. Long-Term Growth Estimate EPS (CAGR): 33.2% (EPS growth > 7%? ✅)

This outlook looks very attractive.

13. Does the company trade at a fair valuation level?

We always use 3 methods to look at the valuation of a company:

1. A comparison of the forward PE multiple with its historical average
2. Earnings Growth Model
3. Reverse Discounted-Cash Flow

A comparison of the multiple with the historical average

The first thing we do is compare the current forward PE with its historical average over the past 5 and 10 years.

Today, Nvidia trades at a forward PE of 39.9x versus a historical average of 47.5x over the past 5 years.

Earnings Growth Model

This model shows you the yearly return you can expect as an investor.

In theory, it’s easy to calculate your expected return:

Expected return = Earnings growth + Shareholder Yield +/- Multiple Expansion (Contraction)

Wherein Shareholder Yield = Dividend Yield + Buyback Yield

Here are the assumptions I use:

1. Earnings Growth = 15% per year over the next 10 years
2. Shareholder yield = 1%
3. Forward PE to decline from 39.9x to 25.0x over the next 10 years

Expected yearly return = 15% + 1% – 0.1* ((25.0-39.9)/39.9))= 12.3%.

Reverse DCF

Charlie Munger once said that if you want to find the solution to a complex problem, you should invert. Always invert. Turn the problem upside down.

A reverse DCF shows you the expectations implied in the current stock price.

You try to determine for yourself whether these expectations are realistic or not.

You can learn more about a reverse DCF here: Reverse DCF 101.

The consensus states that NVDA’s Free Cash Flow over the next 12 months will be equal to $59.2 billion.

We subtract the Stock-Based Compensation of $3.8 billion to arrive at FCF in year 1 of $55.4 billion in year 1 of our Reverse DCF.

Under these assumptions, our Reverse DCF indicates that Nvidia should grow its Free Cash Flow by 22.9% per year to return 10% per year to shareholders.

This means Nvidia needs to generate $354 billion (!) in Free Cash Flow 10 years from now to justify the current stock prices.

That’s as much free cash flow as what Apple, Alphabet, Amazon, Microsoft, Tesla, Netflix, Meta Platforms, Mastercard, and Visa are generating COMBINED today!

14. How did the Owner’s Earnings of the company evolve in the past?

Over time, stock prices tend to follow the Owner’s Earnings of a company (EPS Growth + Dividend Yield).

That’s why we want to invest in companies that managed to grow their Owner’s Earnings at attractive rates in the past. This is the case for NVDA.

Nvidia:

1. CAGR Owner’s Earnings (5 years): 66.8% (CAGR Owner’s Earnings > 12%? ✅)
2. CAGR Owner’s Earnings (10 years): 55.1% (CAGR Owner’s Earnings > 12%? ✅)

15. Did the company create a lot of shareholder value in the past?

We want to invest in companies that managed to compound at attractive rates in the past.
Ideally, the company returned more than 12% per year to shareholders since its IPO.
Here’s what the performance of Nvidia looks like:

1. YTD: +142.9%
2. 5-year CAGR: +98.0%
3. CAGR since IPO 1999: +37.5% (CAGR since IPO > 12%? ✅)

NVDA is one of the best-performing stocks of the last 20 years.

Quality Score

Finally, let’s bring everything together and give Nvidia a Total Quality Score.

As you can see in the table below, Nvidia gets a Total Quality Score of 8.0/10:

Nvidia is a great business but the valuation looks extreme.

10 years from now, Nvidia needs to generate as much Free Cash Flow as Apple, Alphabet, Amazon, Microsoft, Tesla, Netflix, Meta Platforms, Mastercard, and Visa COMBINED to justify the current stock price.
Furthermore, there is also quite some risk for disruption.

That’s why I am not considering buying the stock.

Happy Compounding

Pieter (Compounding Quality)

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Exclusive Offer from Compounding Quality for Porter & Co.

If you want more about Compounding Quality (and you should because his research, portfolio, and results are absolutely phenomenal), then check out the special offer Pieter has put together exclusively for Porter & Co.

It’s an opportunity that’s only available through this link and it gives you the chance to get a Founding Partner package to Compounding Quality for the price others pay for his basic membership.

To take advantage of it, simply click here, select the “Annual” option, and then Pieter will manually upgrade you to the full Founding Partner level.