A stock market bubble can look a bit like collective madness, when investors blindly back a particular stock or sector. It’s as if they assume that the stock can only move in one direction, but if it doesn’t live up to expectations then the house of cards can come crashing down. This happened with the tech bubble in 2000, and again with the sub-prime mortgage market in the US and the ensuing financial crisis in 2008.
Now, questions are being asked about some corners of the US tech sector. The two best performing stocks in the S&P 500 in the past 12 months are Super Micro Computers and Nvidia. Both make chips that can perform complex artificial intelligence (AI) tasks like image, facial and speech recognition, as well producing chips that generate the text for chatbots like ChatGPT. Super Micro Computers is higher by 735% in the last 12 months, while Nvidia is up by more than 230%. The next best performer in the US blue chip index is Constellation Energy, a renewable energy provider, that is higher by nearly 150%. The semiconductor sector in the US, of which Nvidia and Super Micro Computers are the main components, is up by more than 114% in the past year, and is higher by nearly 40% so far this year. The next best performing sector in the US so far in 2024 is the oil and gas sector, which is higher by 32.
These are big numbers for a sector that is producing hardware for a technological revolution which is not yet mainstream. This is why there are concerns that another stock market bubble is forming. However, there are some strong arguments that suggest this is not the case. As you can see, there has been some clear divergence in performance within the Magnificent 7, the term used to describe the largest US tech firms.
Chart 1:
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Source: Kathleen Brooks and Bloomberg
Please be aware that information and research based on historical data or performance does not guarantee future performance or results. Past performance is not necessarily indicative of future results, and any person acting on this information does so entirely at their own risk.
This chart has been normalised to show how the Magnificent 7 have moved together over the last 5 years. Nvidia and Microsoft have pulled ahead of the rest of the tech pack, in the last year. This is due to their exposure to the AI theme. Microsoft is the minority owner of OpenAI, the US-based AI research company that was founded in 2015. The other tech stocks in the chart, including Apple, Google, Amazon, Tesla and Meta have mostly traded within a tight range, although Tesla is the biggest underperformer. The exuberance for AI stocks is narrow, and investors are not blindly buying up the entire sector in an effort to get a piece of the pie.
The next question is whether their performance is justified. This is where things get more interesting. We do not think that AI stocks are in a bubble yet. They are certainly richly valued, but, for now, this is backed up by earnings. For example, Nvidia had year-over-year revenue growth in the last 12 months of more than 125%. The gross profit margin for the last 12 months was 73%, the year prior gross profit margin was 73.6%, the year prior it was 58.7%, the year before that it was 58.7%, and before that it was 66%. In Nvidia’s fiscal year 2021 it posted a gross profit margin of 65%. This compares to Apple, another tech giant and currently the second largest company by market capitalization in the world. Apple’s earnings growth has stalled in recent years. In 2020, revenues grew by 5.5%, in 2021 they were 33%, in 2022 they slowed to 7.8%, before contracting in 2023 by 2.8%. Gross profit margin is strong at Apple, but even on this measure it is eclipsed by Nvidia. Apple’s gross profit margin was 38% in 2020, 41% in 2021, 43% in 2022 and 44% in 2023. As you can see, Nvidia has posted fabulous earnings figures in recent years so it is no wonder that investors are interested in the stock.
The question now is, can Nvidia continue to post such good results and could the run of strong earnings end? That will depend on demand for its services. Analysts estimate that Nvidia has a 98% share of the GPU market, this is a graphics processing unit, which is an electronic circuit that is designed to accelerate graphics and image processing. It posted data centre revenue of $18.4bn in the last quarter, up 409% from a year ago. Looking ahead, Nvidia CEO Jensen Huang, said that AI had hit a tipping point, and that ‘demand is surging worldwide, across companies, industries and nations.’ Nvidia also posted a bullish forecast, with revenue expected to rise by $24 billion in the current quarter, while profit margins are expected to be between 76.3% - 77%. While other companies including AMD and Intel are making inroads into the GPU market, none are expected to catch up to Nvidia in the near future.
One way to value a company is to use the price to earnings ratio, is the price of the stock justified by its earnings? The current price to earnings ratio for Nvidia is 73, which is higher than the average P/E ratio for the main US blue chip index, which is 21. However, continued strong earnings growth means that Nvidia’s estimated P/E ratio for the next 12 months is 35, which is a more reasonable figure.
Thus, it is not clear cut if Nvidia is in a bubble, as its valuation seems justified based on its earnings. Due to this, the biggest risk for Nvidia and other AI stocks is if AI doesn’t live up to the hype. We are still in the experimental phase of AI, with tech giants mostly implementing AI into their products and seeing the benefits of generative technology. However, as we move through 2024, firms outside of tech have also adopted AI. Firms are using this technology to write the first draft of documents and to analyse client trends. More AI products are also expected to hit the market in 2024 and beyond, which could also increase the uptake. Data centric firms are already using AI, for example in financial services and healthcare. According to FactSet, the data analytics company, in the Q4 2023 earnings season for the US blue chip index, 179 companies cited AI on their earnings calls, which is higher than the 5 and 10-year average of 73 and 45 citations respectively. This suggests that US companies are adopting this technology, and AI stocks could continue to see interest as generative technology develops and demand increases.
While Nvidia may not be in a typical bubble, and interest in the stock can be justified by the fundamentals, it is extremely volatile. As you can see in the chart below, measures of the 30-day volatility for Nvidia and Super Micro Computers are higher than the Vix, the volatility index for the main US blue chip stock index. Thus, even if Nvidia is not in a bubble, this is still a stock to trade with caution.
Chart 2:
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Source: Kathleen Brooks and Bloomberg
Please be aware that information and research based on historical data or performance does not guarantee future performance or results. Past performance is not necessarily indicative of future results, and any person acting on this information does so entirely at their own risk.
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Source: Kathleen Brooks and Bloomberg 
Source: Kathleen Brooks and Bloomberg 
