⚡🤖 Business Overview

🎯Key Metrics

Total: 10.5/17

• +2 ✅✅ Projected Operating Margin: 70.08%
• +1 ✅ Projected 5-Year Revenue CAGR: 10.21%
• +2 ✅✅ Last 5-Year ROIC: 88.23%
• +1 ✅ Estimated Cost of Capital: 10.21% (lower than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -0.84%
• +2 ✅✅ Projected 5-Year EPS CAGR: 23.93% (given the easiness of manipulation of these values, below 10% warrants caution)
• +0 ⚠️ Projected 5-Year Dividend CAGR: 7.72%
• +1.5 ✅ Moody’s Debt Rating: Aa1
• +2 ✅✅ Morningstar Moat: Wide
• -2 ❌❌ Morningstar Uncertainty: Very High

📈Nvidia is currently at the forefront of AI. This shows on its stellar operating margins driven by its wide moat and competitive advantages. Also the fact its returning on its capital around 9 times its cost of capital means that is allocating its capital very well. Its growth projections are also very good, projected to grow revenue above ~10% and EPS above ~20%, given the company size this is astounding.

📉There’s a high level of uncertainty around the whole AI integration and adoption across all the industries, what it may impact or not impact, what effects it will have on our relation to work. All of this mist, clouds and uncertainty always creates many opportunities, for some companies to be created and grow and other ones to shrink and fail. Sometimes the first player is not the one winning at the end, and this may be very well be the case for Nvidia and some of its technological counterparts. All of this is implied in the Very High uncertainty rating by Morningstar.

This is a high value company, very well managed, that will be one of the first to face some pressure on the future if AI does not return on its promises.

Let’s value it to check if there’s a good opportunity at the current prices.

📝Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/S – we assume mean reversion to the historical P/S values;
• Historical EV/EBITDA – we assume mean reversion to the historical EV/EBITDA values;
• Historical P/E – we assume mean reversion to the historical P/E values;
• Historical P/FCF – we assume mean reversion to the historical P/FCF values.

For a company like Nvidia, growing very rapidly, I will apply a higher weight to both DCF and EPS and only then the historical methods. Also for the historical methods I’ll use a shorter timeframe (5 years instead of 10 years) given the expansion and transformation of the company business during the last couple of years.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 10.73%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 50%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital – I’m assuming its Cost of Capital begins at its current estimated value and then gradually converges to the industry average;
• Initial and Terminal Tax Rate – Given the volatility of the effective tax rate of the company during the last couple of years, I’ve decided to use for both the industry average;
• Terminal ROIC – I’ve increased this to 20% given the higher rates the company is providing, the default would be its terminal cost of capital given that normally companies start losing competitive advantages and start returning on their capital around the cost of capital.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 138.11 dollars for Nvidia, below its current price of 177 dollars.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates and assumed that it could have at the higher end a terminal ROIC of ~30% above the value used on the DCF above, and at the lower end it will converge to its terminal cost of capital.

As you can see from the above, Nvidia seems to be overvalued or a little overvalued given that its current price of 177 dollars is between P80 and P90, let’s call it P85. From these simulations we can extrapolate that there’s ~85% probability for the company to be overvalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 30%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 30 PE for the company.

Then again used the Monte Carlo simulations to check what happens when the input values change within a specified range:

Using this valuation method, Nvidia that is currently priced at 177 dollars seems to be undervalued being currently priced well below P10. We can extrapolate from this that there’s more than ~90% probability of the company being undervalued.

This seems to be in contrary to what we’ve seen on the DCF valuation. Let’s check the historical methods to have a clearer picture.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

EPS Scenario Returns

Given the above assumptions, let’s dive in a little bit deeper into the different EPS scenarios for this company. I’ve used the previously assumptions to come up with three different scenarios: a Bear case, a Base case and a Bull case. Each using the lower end, median and higher end of assumptions respectively for PE ratios and EPS growth rates.

From the above assumptions, you can expect above market returns over the next 5 years, when buying Nvidia at the current market price, even on a bearish scenario. Feel free to converge to one or the other scenario using your own projections of EPS growth and PE ratio.

As before, feel free to use this tool yourself: EPS Scenario Returns — The Fair Value Journal

Historical P/S (Weight: 5%)

The current P/S (Price / Sales) ratio is below its 5 year average. This means that the company is a little undervalued by this metric. Assuming a mean reversion to its historical average of 22.50 we can assume a fair value of 188.64 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

Historical EV/EBITDA (Weight: 5%)

The current EV/EBITDA ratio is below its 5 year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 51.10 we can assume a fair value of 237.30 dollars.

Historical P/E (Weight: 5%)

The current P/E ratio is below its 5 year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 63.44 we can assume a fair value of 260 dollars.

Historical P/FCF (Weight: 5%)

The current P/FCF ratio is below its 5 year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 72.50 we can assume a fair value of 239.35 dollars.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, given your confidence in the company, but for me I’ll probably start buying below the 162.99 dollars given the uncertainty and overall volatility of this company. Despite this, I have a high confidence on its fundamentals and the role it will play in AI as a whole.

Overall it seems Nvidia is fairly valued at the current prices.

Fair Value: 195.07 dollars