Can Fed Rate Cut Take Nvidia Stock To $200?

Could Nvidia stock (NASDAQ:NVDA) reach $200 in the next two years? We think there is a possibility. How? Consider this, just about nine months ago, at the end of December 2023, Nvidia stock was trading at around $50 levels. This year the stock has grown over 2x since and trades at close to $116 presently. Looking at valuations, Nvidia stock trades at about 95x trailing earnings. Is this pricey? Not really. Especially if you consider the company’s steadily expanding earnings, the long-growth runway for the artificial intelligence market, and Nvidia’s formidable lead in the accelerated computing market. The Fed’s recent rate cut could also provide a boost as investors seek growth opportunities in a low-rate environment. In the scenario below, we use Nvidia’s revenues, profitability, and valuation multiples to demonstrate a potential path to a $200 stock price.

Rate cuts, a shift toward multimodal models will drive revenue 

Nvidia’s revenues grew by close to 3x over the last 12 months, while notching an average annual growth rate of about 55% over the last three years, and the momentum can hold up. If Nvidia grows its sales at an average annual rate of over 60% for the next two years – its revenues could move from around $61 billion in FY’24 to around $155 billion by FY’26 or over 2.5x.

There are several trends that could drive continued growth. While the initial AI models deployed by the likes of OpenAI in 2022 were largely text-based, models are increasingly multimodal, working with speech, images, video, and 3D calling for higher computing power and a larger number of GPU shipments. Moreover, unlike a decade or so ago when advancements in computing power, particularly with processors, outpaced the development software that could fully utilize these capabilities, in the AI era, the demand for computing power has skyrocketed due to the intense computational requirements of machine learning models. This trend could result in sustained strong demand for Nvidia.

Moreover, last week’s monetary easing by the Federal Reserve could provide an additional boost to Nvidia. The Fed’s 50 basis point rate cut last Wednesday marked the first interest rate cut in close to four years. Check out our analysis of other ways to profit from the Fed’s next move?  With the benchmark federal funds rate standing at 4.75% to 5% post the cut, there remains room for the central bank to lower interest rates further. Lower rates are typically beneficial for growth sectors including technology, which have higher earning potential in outer years, as lower discount rates boost the present value of future earnings. The lower rates are particularly beneficial to Nvidia. Why?  Lower interest rates would reduce financing costs for builders of large data centers, potentially driving up capital spending in the space, and helping players like Nvidia which sells GPUs for servers. Moreover, the economics of the AI revolution remain mixed, given the high costs of model training and inferencing. A drop in interest rates could improve the financial feasibility of these investments.

Now the stock markets are often myopic and tend to extrapolate short-term trends for the long run. In Nvidia’s case, the assumption is that demand growth and pricing power will hold up and profits will remain sizable as the generative AI wave advances. However, there are multiple risks and there remains a real possibility that the stock could see a sizable correction. We detail this possibility in our analysis of Nvidia’s downside to $40. Indeed we believe this broad range of upside and downside potential represents a simple fact: Nvidia is a volatile stock.

Nvidia has already done it in the past

To put things in perspective, NVDA stock swelled over 800% from levels of $13 in early January 2021 to around $130 now, vs. an increase of about 50% for the S&P 500 over this roughly 4-year period. It was a bumpy ride, with returns for the stock being 125% in 2021, -50% in 2022, and 239% in 2023. The underperformance in NVDA’s stock vs. the S&P 500 in 2022 stands out in particular – as the benchmark index had returns of -19% that year. Notably, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

Margins should remain thick driven by higher-end products

Combine this solid revenue growth with the fact that Nvidia’s margins (net income, or profits after all expenses and taxes, calculated as a percent of revenues) are on an improving trajectory – they grew from levels of about 25% in FY’19 to about 49% in FY’24 as the company sees better economies of scale and a more favorable product mix skewed toward complex data center products. Software-related sales are also trending higher. We can assume that margins will remain flat at current levels as Nvidia’s launch of pricier higher-end products such as the Blackwell chips are offset by potential competitive pressures.

Strong results mean a smaller contraction in earnings multiples

Now, if earnings grow 2.5x, the PE multiple will shrink by 2.5x to levels of about 40x, assuming the stock price stays the same. But that’s exactly what Nvidia investors are betting won’t happen. If earnings expand 2.5x over the next few years, instead of the PE shrinking from a figure around 95x now to about 40x, a scenario where the PE metric stays at about 65x looks quite likely. This would make the growth of Nvidia’s stock about $200 within the next two years or so a real possibility. What about the time horizon for this high-return scenario? In practice, it won’t make much difference whether it takes 2 years or 3, as long as Nvidia is on this revenue expansion trajectory, with margins holding up, the stock price could respond similarly. 

[1] Returns as of 9/24/2024
[2] Cumulative total returns since the end of 2016

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