NVIDIA in Perspective:
Overvalued or Fairly Priced?
An analysis by Domenico Soprano
Agenda
What this report covers
01 Assumptions
02 Free Cash Flows
03 Net Present Value and Stock Price
04 Sensitivity Analysis
05 Potential Risks and Uncertainties
06 Risks Related to Assumptions
NVIDIA Corporation, founded in 1993 by Jensen Huang, Chris Malachowsky, and Curtis Priem, is a
leading tech company specializing in GPUs and SoCs for gaming and professional markets.
Huang, a former AMD microprocessor designer, has served as CEO since its founding.
Key acquisitions, such as Mellanox Technologies in 2020, have bolstered NVIDIA's portfolio, especially in
AI and machine learning.
The company continues to drive innovation in AI, deep learning, autonomous vehicles, and high-
performance computing, positioning itself as a crucial player in the future of technology across various
industries.
In this analysis, we will assess the value of NVIDIA by hypothesizing annual growth rates and applying a
Discounted Cash Flow (DCF) analysis, incorporating various assumptions.
The DCF method will enable us to estimate the present value of NVIDIA's projected future cash flows,
accounting for the time value of money.
By integrating these assumptions, we aim to gauge NVIDIA's intrinsic value and provide comprehensive
insights into its potential as an investment.
Assumptions
In our Discounted Cash Flow (DCF) analysis to estimate NVIDIA's intrinsic value, we rely on two key
assumptions: the Annual Growth Rate and the Perpetuity Growth Rate.
These assumptions are pivotal as they directly impact the valuation outcome.
The Perpetuity Growth Rate is the constant rate at which a company's cash flows are expected to
grow indefinitely. This rate is used in the calculation of the terminal value in a discounted cash flow
(DCF) analysis. The perpetuity growth rate reflects a long-term, sustainable growth rate that a
company can maintain in perpetuity, beyond the explicit forecast period.
The Annual Growth Rate is the year-over-year increase in a company's revenue, earnings, or cash
flows. It is a measure of how much a particular financial metric grows on average each year over a
specified period. The annual growth rate is commonly used in financial analysis to project future
performance and to compare a company's growth with its peers or industry standards.
The Perpetuity Growth Rate is set at 2.5%
The perpetuity growth rate is a crucial element in the calculation of a company’s terminal value within a
Discounted Cash Flow (DCF) analysis. This rate signifies the annual increase in the company's cash flows
expected to continue indefinitely, beyond the forecasted period.
Why 2.5%?
A Perpetuity Growth Rate of 2.5% is chosen for its alignment with long-term economic trends, including
inflation and GDP growth rates. This makes it a reasonable and sustainable assumption for projecting
the company’s future cash flows.
Using this conservative rate is essential to prevent the overestimation of the company's terminal value,
thereby ensuring a more cautious and reliable valuation. By anchoring the growth rate to broader
economic indicators, the approach supports a prudent assessment of the company’s long-term prospects.
The Annual Growth Rate between 2024 and 2028
2024 2025 2026 2027 2028
14% 13.5% 13% 12.5% 12%
As markets mature, companies typically undergo a transition toward slower growth rates.
NVIDIA, having experienced a past compound annual growth rate (CAGR) of 23.2%, is now positioned to
shift towards a more sustainable growth trajectory with a projected 13% growth rate.
This adjustment still signifies robust growth, reflecting NVIDIA’s strategic evolution amidst increasing
adoption of AI and machine learning applications driving demand for its GPUs.
Continued heavy investment in research and development is expected to yield new products and
technologies, further supporting future growth.
Lowering the growth rate assumption to 13% is a prudent and realistic adjustment, ensuring that our
projections remain achievable and grounded, avoiding undue optimism in our assessment of NVIDIA’s
future prospects.
Free Cash Flows
After calculating the Free Cash Flow (FCF) for 2023, projections were made using various growth rates to
estimate FCF for 2024 through 2028.
Free Cash Flow, derived from operating income minus capital expenditures, serves as a critical indicator
of a company’s cash generation capabilities over a specific period.
This metric helps assess whether a company can meet its short-term financial obligations internally or if it
requires external financing.
Using different growth rates for the projections allows for a comprehensive evaluation of potential future
scenarios. These projections provide insights into how the company’s financial health may evolve based
on varying assumptions about its growth trajectory and operational efficiency.
2024 2025 2026 2027 2028
$6,560.7 bn $7,446.4 bn $8,414.4 bn $9,466.2 bn $10,602.2 bn
Net Present Value
and Stock Price
The first step in determining the Net Present Value (NPV) and evaluating stock price involves calculating
the Weighted Average Cost of Capital (WACC). This is achieved through the application of the Capital
Asset Pricing Model (CAPM), a financial model used to estimate the expected rate of return for an asset
or investment.
Once all relevant parameters are measured and inputted into the CAPM, such as the risk-free rate (Rf),
market risk premium (Rm), and beta coefficient, the WACC can be computed.
The WACC represents the weighted average of the costs of equity and debt, taking into account their
respective proportions in the company’s capital structure.
Understanding the WACC is crucial as it serves as the discount rate in NPV calculations, which are
essential for determining the present value of future cash flows. This process enables analysts and
investors to assess whether an investment or project is expected to generate returns that exceed the cost
of capital, thereby creating shareholder value.
In the example of NVIDIA, we have:
Rf = risk free rate of interest = 3.5%
E(Rm) = expected return of the market = 8%
ßi = sensitivity = 1.4
E(Ri) = capital asset expected return = 9.8%
Now, we can figure out the WACC:
R (equity) = 9.8%
R (debt) = 3%
D/(E+D) = 0.2
E/(E+D) = 0.8
Tax Rate = 15%
WACC = 8.35%
Finally, we calculate the Terminal Value, Net Present Value and the Stock price:
Terminal Value Calculation
Terminal Value is computed using the Perpetuity Growth Model, representing the present value at a
future point in time of all subsequent cash flows when perpetual stable growth is assumed.
FCF = Free Cash Flow projected for 2028
g = perpetuity growth rate
d = WACC
Terminal Value = $10,602.2 *(1+0.025)/(0.0835-0.025) = $185,764.6 billions
Net Present Value (NPV) calculation
The Net Present Value is the sum of the present values of all cash flows, including the Terminal Value
and the projected Free Cash Flows from 2024 to 2028, discounted back to the present time using the
WACC as the discount rate (i).
Net Present Value = FCF(2023) + FCF(2024)/(1+WACC) + FCF(2025)/(1+WACC)^2 +
FCF(2026)/(1+WACC)^3 + FCF(2027)/(1+WACC)^4 + FCF(2028)/(1+WACC)^5 +
TerminalValue/(1+WACC)^5 = $163,135.9 billions
Stock Price calculation
The Stock Price can be estimated by adding the NPV of all projected cash flows (including the Terminal
Value) to the current value of cash and equivalents, subtracting liabilities, and dividing the result number
of outstanding shares.
Enterprise Value = Net Present Value + Cash and Cash Equivalent - Total Liabilities
Stock Price Estimated = Enterpise Value / Outstanding Shares = $68.95
Comparison with Actual Stock Price
As of July 12th, 2024, the actual stock price of NVIDIA is $127.
This comparison allows analysts and investors to assess whether the stock is overvalued, undervalued, or
fairly valued based on the NPV and financial projections used in the valuation.
This method provides a structured approach to valuing stocks based on expected future cash flows and
the financial health of the company, aiding in investment decision-making processes.
Sensitivity Analysis
To comprehensively evaluate the impact of key financial assumptions on NVIDIA’s valuation, we have
defined specific parameters for sensitivity analysis.
These parameters include the Perpetuity Growth Rate and the Weighted Average Cost of Capital, each
with incremental step-ups.
This approach allows us to assess how variations in growth expectations and cost of capital influence
Enterprise Value and Stock Price projections.
Here are the details of out structured sensitivity analysis:
Perpetuity Growth Rate: set at 2.5%, with step-ups of 0.25% to explore the sensitivity of valuation
metrics to changes in long-term growth analysis.
WACC: established at 8.35%, with step-ups of 0.5% to evaluate the sensitivity of present value
calculations to shifts in the discount rate.
By systematically varying these parameters, we aim to provide a deeper understanding of the potential
range of valuation outcomes and enhance decision-making insights regarding investments in NVIDIA.
This methodological approach ensures a robust assessment of financial projections under varying
economic scenarios.
The sensitivity analysis charts show how variations in the Perpetuity Growth Rate and WACC affect the
Enterprise Value and Stock Price.
Specifically:
The X-Axis represents the Perpetuity Growth Rate with incremental changes;
The Y-Axis represents the WACC with incremental changes.
These representations illustrate how the Enterprise Value and Stock Price changes in response to these
parameter adjustments.
For each combination of WACC and Perpetuity Growth Rate, the charts provide a value for the
Enterprise Value or Stock Price.
These results help understand how different assumptions impact the valuation:
If the Perpetuity Growth Rate increases: The enterprise value and stock price are expected to
increase, as stronger future cash flow growth is anticipated.
If the WACC increases: The enterprise value and stock price are expected to decrease, as future
cash flows are discounted at a higher rate, reducing their present value.
Under all the various assumptions tested in the sensitivity
analysis, the resulting Stock Prices are lower than the
current market price of NVIDIA.
This indicates that the stock is potentially overvalued based
on these valuation metrics.
Specifically, when using a Perpetuity Growth Rate of 2.5%
and a Weighted Average Cost of Capital (WACC) of 8.35%,
the estimated stock price for NVIDIA is $68.95.
This value is significantly lower than the current stock price
of $127 as of July 12, 2024.
This analysis shows that, even under more favorable or
conservative growth and discount rate assumptions, the
intrinsic value derived from our Discounted Cash Flow (DCF)
model suggests a stock price lower than what is observed in
the market. Therefore, investors should consider this
potential overvaluation when making investment decisions.
Potential Risks and
Uncertainties
Market Competition
The semiconductor and GPU markets are highly competitive. Competitors like AMD, Intel, and emerging
players in AI and machine learning could impact NVIDIA’s market share and pricing power, lowering
profit margins and revenue growth.
Technological Disruptions
Rapid advancements in technology could render NVIDIA’s products obsolete or diminish their competitive
edge, having negative impacts on its market position.
Global Economic Conditions
Adverse global economic conditions, such as recessions, and inflation, can affect consumer and business
spending on technology products. Negative economic condition could reduce demand for NVIDIA’s
products, affecting revenue growth and profitability.
Regulatory and Legal Risks
Changes in regulations, particularly regarding data privacy, can impact NVIDIA’s operations.
Regulatory changes or legal issues could result in increased compliance costs, fines, or restrictions on
business practices, affecting profitability.
Supply Chain Disruptions
NVIDIA relies on a complex global supply chain for its manufacturing processes. Disruptions due to
geopolitical tensions, natural disasters, or pandemics can affect production and delivery schedules.
Supply chain issues could lead to production delays, increased costs, and potential loss of revenue.
Risks Related to
Assumptions
Perpetuity Growth Rate
The analysis uses a range of perpetuity growth rates to account for various economic scenarios. This
range reflects different potential long-term growth trajectories for NVIDIA.
If the actual growth rate falls outside of this range, the Terminal Value and overall valuation could be
significantly affected. A higher than expected growth rate would result in a higher valuation, whereas a
lower growth rate would decrease the valuation.
Weighted Average Cost of Capital (WACC)
The analysis incorporates a range of WACC values to reflect varying market conditions and risk
assessments. This range captures potential changes in the cost of capital due to factors such as interest
rate fluctuations and changes in market risk premiums.
Variations in WACC can lead to substantial differences in the Net Present Value (NPV) of future cash
flows. A lower WACC results in a higher valuation, while a higher WACC decreases the valuation.
Cash Flow Projections
The cash flow projections for 2024-2028 are based on declining growth rates and continued adoption of
AI and machine learning applications. These projections are sensitive to market demand and
technological advancements.
If the sector growth or technology adoption does not meet expectations, actual cash flows could be lower
than aticipated, leading to a lower valuation. Conversely, exceeding expectations could result in higher
cash flows and a higher valuation.
Thank you!
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