Last week Nvidia reported. You will know by now it was good news for the business. I read something last week which said prior to the Q3 update, derivatives trading implied either a 7% up or a 7% down price movement was likely following the news. That’s a scary thought going into Wednesday. It’s even scarier when the company is 8% of the S&P 500 and 6% of the MSCI World.
Nvidia now has a $4.34 trillion market cap. It’s the largest company in the world. It’s also been called a proxy for how well the semiconductor industry and AI story is playing out. Many suspected that this set of results would be the beginning of a market sell-off. But earnings were strong.
Nvidia beat earnings estimate for Q3, with the largest revenue generator for the company being its data-centre business, bringing in $51.2 billion of its $57 billion revenue. Its previous core part of the business, gaming chips, came in slightly below expectations though.
An interesting part of the investor call was the CEO saying the AI bubble, which has been talked about heavily, is “different this time”. Basically hinting they don’t see the bubble. He also referenced the ‘damned if we do, damned if we don’t situation’ the company is now in when saying “If we delivered a bad quarter, it is evidence there’s an AI bubble. If we delivered a great quarter, we are fuelling the AI bubble”.
Now there is not only concentration at the top of the market in terms of the number of companies but now those companies have customer concentration, and it’s suspected to be heavily the same companies at the top also creating the customer concentration. A worrying part of the earnings release was the disclosure to the regulator about its customers. 61% of the $57 billion revenue came from just four unnamed customers. Last quarter it was 56% of revenue which came from four customers.
In addition, a lot of AI projects or businesses are currently not profitable. The stability of earnings is something which the market takes quite seriously. You can see evidence of this as Nvidia reported good earnings yet closed the market out by being down 3%. Their customers still need to prove how they will make money with the products they buy from Nvidia. Another high-profile example of this issue is the $300bn OpenAI-Oracle deal. The boost Oracle shares enjoyed after the announcement of the agreement has now entirely evaporated.
There are two sides of the argument about the AI bubble – which you can’t deny existing. The first is that these companies have transformational potential. However, valuing that appears the problem.
A stock market bubble is when stocks rise out of proportion to the company’s fundamental value. Bubbles often become out of control when it begins to feed on itself. I sort of believe this already happened with lots of investors piling into the Mag-7 stocks. Much of this is to do with behavioural finance biases which essentially cause us as humans to not want to miss out on potential earnings and therefore creates irrational thinking and actions.
However, we’ve experienced this and many in this earnings period suspected it would be a changing of the tide. But Nvidia beat earnings, how did it do this?
Basically, the seemingly relentless demand for its products. It is hard to be too critical of a company that has delivered such astonishing growth, but the circularity of where demand is coming from is an issue. Oracle is spending billions on Nvidia’s chips, Nvidia is investing billions in OpenAI, Open AI has the aforementioned cloud deal with Oracle. Not to mention other circular deals with Intel, Microsoft, and AMD. All worth billions of dollars.
Debates around the potential for off-balance sheet financing, and the ability to change cost recognition (through varying the depreciation charges associated with the deals) have all come to the surface in the tech space recently.
Bullish commentators are calling it the building of the future AI infrastructure, which is likely to ramp up further. Bearish investors call it a house of cards. Either way, if one business has a shake it can impact the entire ecosystem. We all wait with bated breath.
We’ve been underweight the US and generally have tried to be underweight with the Mag-7 in recent years. This has been difficult. It will always be a balancing act to make sure a portfolio is exposed to a number of themes playing out globally whilst not taking unnecessary risk.
Emily Cave – Research Analyst
FPC25588
All charts and data sourced from FactSet
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