Decoding The NVIDIA Trade — With Michael Batnick

0:00Let's decode the NVIDIA trade, examining why it became the world's most valuable company last week, and what comes next with one of the world's most astute investors. That's coming up right after this.

0:40Welcome to Big Technology Podcast, a show for cool-headed, nuanced conversation of the tech world and beyond. We're joined today by the great Michael Batnick. He's a managing partner in Ritholtz Wealth Management. He's the co-host of The Compound and Friends, which is one of my favorite shows, and also the host of the Animal Spirits podcast. Michael Batnick, welcome to the show. Great to have you here for the first time. What an introduction. World's most astute investors. I've definitely never been called that before, but thank you for having me. I'm excited to talk about it. It's the truth. Yeah, well, you guys were in NVIDIA way, way early.

1:09And so I think it's well-earned. I wasn't. I wasn't. Josh was. Okay. So Josh Brown. I mean, anyway, it's group credit here. We'll give you guys credit. Listen, I followed Josh into enough things. All right. He got lucky on this one. Credit to him. Okay. Sounds good. So let me read you a couple stats about NVIDIA. We're obviously like talking. It's been a kind of an interesting week. They were the world's most valuable company for a minute last week. They've fallen a little bit back to earth this week, but still they are. They've done incredible this year. And they are really the story of this AI boom.

1:39So this is what we can say about NVIDIA today. They are a$2.9 trillion company. They're up 145 % year to date. They've added$1 trillion in market cap since February. And this is from Fortune. If NVIDIA were to lose the gains it has made this year, overnight, the S &P 500 would have to come down approximately 4.5%. So they're really carrying the market. First question for you, is there any precedent here? Like, is this something we've seen before? No, it's a short answer. And I'll just say in fairness to the comment I made about Josh years ago, he was actually dead right on this. I remember he wrote a great blog post saying that semis were the new Dow transports.

2:23The way that information is disseminated, it's no longer on rail. It's on these little tiny chips. And he absolutely nailed that trade. to answer your question, has anything like this ever happened? There have been lots of fabulous growth stocks over the years and decades, but there hasn't been, at least as far as I know, in fact, you know what? No, there hasn't been. There has never been a company of this size growing this quickly. In May, the company reported in the data center alone, 400, and this is obviously their main business, 430 % year-over-year revenue growth. Overall revenue growth was 262%.

3:04You've never seen a company in the trillions of dollars growing with their top line and bottom line this quickly. Right. But the question is like, how do you value the company? Because there were the... Right. So there were two interesting headlines in Bloomberg over the past couple of days, like side by side. One was like... Nvidia is growing so fast Wall Street can't keep up. And then the next one was Nvidia enters a massive correction. So let's go one by one on those. So the first one in terms of being able to value the company. So this is from Bloomberg. In the age of artificial intelligence, no one can figure out what the chip makers revenues are actually going to be, not the Wall Street analysts covering Nvidia or Nvidia executives themselves.

3:47Analysts aren't making up numbers. They take their cues from management like they do with every other company. However, even Nvidia's leadership is struggling to anticipate how much money the chip maker will generate three months into the future. And this is the actual data. Since NVIDIA's sales began exploding in the fiscal quarter that ended in April 2023, revenue has exceeded the midpoint of the company's own forecast by an average of 13%. So basically, NVIDIA is setting this bar for what it expects to earn and just blowing it out by double digits almost every quarter. And then the question is, okay, so how do you value it?

4:20Because it is somewhat expensive if you look at its valuation, according to this story, at least. It is somewhat expensive. I think the easiest historical analog that people are comparing NVIDIA to is understandably the dot-com boom and bust in the late 90s. And Cisco was the poster child for that. Cisco got as expensive as I think it was 130 forward times earnings. Right now, NVIDIA is trading somewhere between 40, let's call it 40 times forward earnings. And the question, Alex, as you astutely asked is like, well, what is the proper valuation? And this is what makes it so fun and so exciting is you don't know.

4:59We'll find, I'll tell you what the proper valuation is three years from now, we'll find out what it was. But what should a company trade at that is growing this quickly, that is defining a new category that can be world-changing, that has margins like this, that has no competitors. I don't know what the right answer is, but it probably shouldn't be traded at a market multiple, call it 20 times or so. So it certainly has earned a premium that it's trading at. The question is, okay, yeah, growth stocks deserve a premium, but how big is too big? And can a company that's in the trillions, now$3 trillion, and it just became the largest company briefly for minutes or passing Apple and Microsoft, It's only the 12th or 13th company over the last 100 years to wear the crown of the number one company in the S &P 500.

5:55There's not been a lot of turnover at top. There's only 12 names, and NVIDIA is one of them. And so I would argue, and I think there's a ton of arguments on the internet about, is this a bubble? Does this make sense? And you've got the market people like myself talking about historical precedent and growth rates and assumptions. And then you've got sort of generalist business people talking about, well, doesn't competition have to come in? Their margins are unsustainably high. But I think what is missing from the conversation is like actual experts that might have more insight on the business and how quick they can grow.

6:33Of course, we're all sort of estimating and guessing the best we can. So I don't know what the proper multiple should be for this company. but it is doing something no company has ever done. It continues to be the loftiest of estimates. And as long as it does that, I should actually, I shouldn't even say that. I was about to say, as long as it does that, it's going to be fine. Who knows? It might, there could be a point in time, one of these quarters where it does beat and the stock drops 20%. You can't predict how the crowd is going to react. You just can't. And I'm going to get into some of the objections that people have on NVIDIA, and we can go through them, including the competition side in a bit.

7:11But let's talk a little bit about what happened this week with this kind of, I call it a massive correction. It's actually a mini correction, but it's just a lot of money. So this is again from Bloomberg, like a day after Wall Street can't keep up. It says NVIDIA enters correction territory as Slump erases$430 billion in market cap. Like, you know, that's a lifetime of work for most companies, but it's a week of losses. There's 14 companies in the S &P 500 that are bigger than the market cap that was raised in three days. That's it. Only 14 companies are more than$430 billion. That's as big as MasterCard.

7:47And it did it in three days. So yeah, the numbers are getting like alarming and startling. Right. And this is from the story. The NVIDIA entered correction territory on Monday as the ongoing sell-off erased a historic amount of value for the AI-focused chip maker. Actually, I'll pick a bone with the chip maker detail, but we'll go through that in a bit. It said the stock fell 6.7 % and the three-day drop raised$430 billion of NVIDIA's market cap, the biggest three-day loss for any company in history. So is it just that with NVIDIA, because it's growing and because there's so much volatility or because there's so much uncertainty, there's going to be volatility?

8:27Is that just something that's going to be baked into it? what happened over the last three days is abnormal in terms of the market cap losses. But for a company that's doubled and doubled again and doubled again, or whatever the performance has been, for it to lose 13 % in three days is completely normal. I mean, there's nothing abnormal about that except for the size and the magnitude of the drop. And matter of fact, So it had a 13 % drop, give or take, over the last three days. It did that back in April. Remember the correction back in April, which actually came and went. So the stock was in a 20 % drawdown.

9:07And I think we sort of forgot about it because since that drawdown, it almost doubled. And again, that drawdown that I'm describing happened from April to May. And then from then to here, the stock almost doubled. That's crazy. Yeah. Yeah. And when you talk a little bit about valuations, talking about it shouldn't have a market valuation, but it could have a growth valuation. So can you explain a little bit about what you mean there in terms of like, all right, so it's making a certain amount of money. We're not going to value it as every other company in the stock market, but there's that, there's another range that it should be in.

9:41Yeah. So NVIDIA has gotten cheaper over the course of the run because the fundamentals have outrun even the incredible share price. So over the last, so last year, NVIDIA earned$1.09. That was her earnings per share. Over the last 12 months, it's done$6.12. So its earnings per share has sextupled over the last year, which is astronomical. So stocks like air quotes are, a discounted cash flow, right? You discount all the future cash flows and you get to a current value, use some sort of discount rate, whatever the appropriate may be, which of course, nobody knows, we're all guessing. And so with a company like this, where it is growing so quickly, it's not what did it earn last year or what did it earn this year?

10:31It's what can it be expected to earn over the next 12 months, over the next 24 months. And you never really know how far out we are going when we discount these things. But the fact is that valuation matters and it doesn't matter. It doesn't matter today because the buyers today are momentum buyers. And that's not disparaging. Momentum is a great strategy and momentum buyers of NVIDIA have been rewarded heavily and momentum buyers of all big tech have been heavily rewarded. But I don't think the marginal buyer today really gives a shit about what NVIDIA might earn in 2026. They just don't. Now, it will matter because these are actually businesses that we're investing in.

11:17And in this respect, Cisco might or might not be a good analog, but there is a potential lesson here to learn. Cisco, the business, compounded its earnings at something like 15 % in the 15 to 20 years after the bubble burst. The stock got destroyed because it wasn't discounting 15 to 20 % earnings per share growth, it ended up discounting like 40 % to 50%. And so valuation matters eventually. But if NVIDIA can continue to do what it's been doing, and that's beyond, I have no idea. But if it can, if it can do, I'm making this up$8 next year,$10 the year after,$14 in 2027, the stock can be$5 trillion.

12:06That's crazy. So yeah, let's talk a little bit about the objections to like, you know, this is sort of the bull case. Here's the bear case, right? Or actually maybe just some general questions about this run and whether it can keep going. First question I have for you is, is this something that is kind of like the next Tesla, right? Like Tesla sort of became something of a meme stock, like it had earnings, but it also became this like place where you put money if you believed in like the EV revolution and just wanted to, you know, park your money somewhere. And it was like worth, you know, multiple times of a Ford, even though it was selling less cars than a Ford.

12:42Is this something that could happen with NVIDIA that like maybe some of the Tesla money has flown into NVIDIA and it becomes something of like a, you know, almost a bigger game, maybe like a GameStop with earnings? Yeah, it's an interesting question. Two things have happened over the last couple of years in businesses that parallel each other that I think are really fascinating. One is Tesla. And you mentioned Ford and GM and everybody else chasing Tesla because they were taking a lot of market share, creating a new category, the electric vehicle, and it was growing rapidly. But then competition came in too heavily.

13:20They overproduced and now there's too many EVs and there's too much supply and these companies are not doing well. The same thing happened with Netflix and all of its competitors. Everybody saw what Netflix was doing with streaming. And of course, the competition didn't want to cannibalize itself. Understandable. They were late to do so. But then during the pandemic, everybody was watching Netflix and the stock price was being rewarded because these SaaS businesses or the recurring revenue businesses were trading at a ridiculous premium. And so all of their competitors jumped into the deep end.

13:56And what they really did was they followed the roadrunner off the cliff. And I think the question is, is a similar trajectory going to happen with NVIDIA? Are its competitors, I don't even know who their competitors are, honestly. I don't even know who does what they do. I know some of the other names. But the question is, are they going to overbuild for an AI world that might not be quite as powerful as everybody is projecting? Another bear case, which I'm sure we're going to get to is, and maybe this is bearish, maybe it's actually bullish. The fact that so many of its revenues is concentrated on five customers, is that a good thing?

14:38Because what happened with Cisco is that all of its customers basically went bust, right? But the flip side is like, okay, well, how much is Amazon going to buy from NVIDIA and the other players? How much is Facebook going to spend? Did they already spend 80 % of what they're going to spend in the next three years? I don't know how financially intensive these businesses are. I mean, obviously, you know a lot better than I do. But I think that's the big question is what does this look like? How much do their customers spend? And when does competition really come in? Right. Right. And like something like 45 % of NVIDIA's data center revenue is coming from the big cloud providers, like those five customers, right?

15:18So I'm curious, while you brought it up, do you think that it is a liability or a strength? I think you can make good points on both sides. Yeah. Talk us through the arguments. Yeah. I think the bull case would be these are the biggest companies in the world. Right. They're not going to go under like the Cisco buyers. Exactly. They have the best balance sheets. They're spending billions, billions on R &D a year. I don't know what the number is for some of these companies, but I think, is Apple spending$25 billion a year on R &D? Whatever the numbers are, they're immense. And so they've got the pockets and they are committed to funding the next big thing, this AI thing, whatever it turns into.

16:02then I guess the flip side would be, okay, but that's like baked into the pie. Like even if you assume that their prior spending is going to continue, where are the incremental buyers for these data centers? I don't know. Well, what's your take? Is that bullish or bearish? Yeah, it's a good question. I mean, the whole thing is predicated on whether this AI quote unquote revolution will continue to go apace because the technology is good enough right now that it's worth investing in for companies who want to build with it. But it's not mature enough to the point where like, it's a definite game changer.

16:38It's like a, it's almost like potential game changer. The good thing and the good news, and I think this is why like there's a floor here is because, and we talked about this a little bit on the compound when we spoke a couple of weeks ago, these companies will continue to use NVIDIA chips, even if generative AI sort of hits a wall, right? Like those chips are very useful to do ranking on reels or to help with the metaverse. So Meta, which said this year it's going to go from 350 to 650 ,000 NVIDIA H100 GPUs or equivalent, which is an incredible increase, right? Like they're going to continue to spend on it because it makes the entire product better and is used in the AI that sort of underpins everything.

17:17But you would need to see more progress in this generative AI move, talking about better chatbots, but also capabilities like agent-like behavior and reasoning that can sort of unpack a command and go through a bunch of different steps. And we're not 100 % there yet. So it seems like they are going to be able to continue to sell, and they are going to be able to sell to these customers. But there is still that big question mark of where does this all end up? And from everything that I hear, it's going to be the next 18 months that will basically decide, like, if they do 18 more months of development of these models within OpenAI, within Anthropic, within Microsoft and Meta, and don't see sort of step change increase in results, then this thing is going to slow down.

18:01But if they continue to see the results they've seen through each generation of the models, then I mean, NVIDIA, you're right, could just keep selling like crazy. because, and this is sort of like the thing I was pointing out when I poked out the chip maker title, is it's just not the chips, it's the chips, it's the software used to train, and it's the networking, even the bands between servers that will allow the companies that are training on NVIDIA models to be able to do more efficient and better training, or sorry, on NVIDIA chips to do more efficient and better training because everything is just so connected where like you look at the competitors and they don't have it.

18:37So like when you asked before, like, what's the competition to NVIDIA? My perspective on this really is that the competition is the AI boom slowing down more than it is any other company that's going to come in and take their lunch. So you mentioned like, we'll know in the next 18 months or so, whether or not businesses are getting an ROI on all the spending. Because right now we know that they're not, I forget what the numbers are, but for every $10 billion spent there, whatever it is, it's moving the revenue by like 3%. but do you think that they're going to get the ROI necessary to continue to spend?

19:10I think that's a great question. So I think within the next 18 months, we're going to know if the models get better. I think the ROI question might be even further pushed out. And so we haven't heard a lot of clamoring about ROI yet. Like there's this one like Sequoia capital number that's been thrown out that like 50 billion for every 50 billion spent, maybe 3 billion has been returned, which is really, really bad. But it's top of the first inning, no? Exactly. Is that number even relevant at this point? No, but it is a preview of what we're going to start to see as these timelines get extended further, right?

19:45Because right now there's this sort of move because the potential improvements are so apparent that people are willing to spend because they think they're coming. But if they don't come, then the ROI question becomes much more clear because you're not looking at like, all right, if we spend this this year, we're going to get this in one or two years, right? It's like, how can companies basically say, stick with us, it's going to be a five-year project or a 10-year project. It's not really done often in software projects. Well, they're able to do, semis have typically been a very cyclical industry.

20:22Right. And there's no real reason to expect this to be different. If the economy were to go into a recession, you would think that these companies would pull back no yeah exactly so and that's sort of another question that i had for you is which is you know there are all these different things that could happen in this in this moment right is it a change in the ai story is it a move to let's say a draw back in the economy and is it possible for the sort of the the money to flow out of the stock as fast as it went in? That's a good question. Yeah, but listen, I mean, we just saw a 20 % drawdown that happened in a couple of weeks.

21:04And like I said, it gained like 90 % after that. So I'm talking about from one to this peak, from March over, I don't know, a five-week period, it lost 20%. But I guess what I would say is, can this thing get cut in half? Absolutely, it can get cut in half. But does that prove that the bears were right? I don't think so. Growth stocks get cut in half all the time. NVIDIA, I mean, this is obviously very different because the business was different. This is pre the gigantic data set of revenue growth, but NVIDIA lost almost 70 % of its market cap a couple of years ago. Right. So can you see a spectacular crash in this thing?

21:45Sure you can. I sort of feel like too many people want that to happen for that to actually happen? Why do they want that to happen? Yeah. There still seems to be, and it's, listen, I'm making this up. It's hard to like, it's hard to like quantify what I'm saying here, but there still seems to be a lot of doubt. But listen, again, for every doubt you could say, hey, asshole, it's$3.3 trillion. What are you talking about doubt? I guess what I would say is if I had to guess, and we're all just guessing here. These things end in bubbles, usually. And as dumb as you think they might be, they always get dumber.

22:19And have we reached the level of sufficiently dumbness? That's like the$3 trillion question. Who knows? Yeah. And we got to go to break. But before we do, I got to ask you one question. What did Cathie Wood see when she decided to sell so much NVIDIA before the whole run up. Yeah, this is what I was talking about this the other day. I don't like to kick people when they're down, but this is a tough one. It was a really tough one. She sold it before the run and listen, she has a difficult job, but to make matters worse, like she never got back on and there was a lot of opportunity for her to do so.

22:55And when you market yourself as the innovation fund and you miss the biggest innovation of the last, I don't know how many decades since the internet potentially that's just yeah that's gotta hurt it must uh you know that that fund has really languished it hit a couple during the pandemic with the zoom and some others tesla but yeah especially now tesla is dragging it down um i don't know how many predictions that tesla is gonna end up being a 15 trillion dollar company by 2030 will help will help that fund okay let's take a break and then talk about what NVIDIA looks like looking ahead, how sustainable this is going to be, and does the stock transform and become basically part of people's portfolio, maybe like an Apple has to this point where it's held by institutions and not as volatile.

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25:21and we're back here on big technology podcast with michael batnick he's a managing partner at ritholtz wealth management the host of the compound and friends podcast and also the host of animal spirits michael great having you here for the first time definitely yeah yeah definitely definitely the right stock to be talking about uh before the break i mentioned like does this thing become a stock in people's portfolios like an Apple, right? Where Apple is like, of course, it's an impressive company, but the stock has become effectively something that institutions hold almost, I don't know, almost like a standard part of their portfolio, no matter what the company does.