Nvidia’s 10-for-1 Stock Split Comes With a Warning. History Says the Artificial Intelligence (AI) Stock Could Do This Next. | The Motley Fool

Nvidia (NVDA 1.75%) completed its 10-for-1 stock split after market close on Friday, June 7. Like most forward stock splits, this one followed significant share price appreciation. The stock surged 225% during the past year and 850% since November 2022, when the launch of ChatGPT sparked the artificial intelligence (AI) gold rush.

Nvidia remains well-positioned to benefit as more businesses invest in AI. Indeed, it is arguably the best pure-play AI stock. However, stock splits have historically been bad news for Nvidia shareholders. The company’s value has declined by an average of 23% during the 12-month period following past splits.

Here’s what investors should know.

Historically, stock splits have been bad news for Nvidia shareholders

Excluding the most recent one, Nvidia has completed five stock splits as a public company, and shares have consistently declined afterwards. The chart below details when each stock split took place, and it shows how the stock performed during the next six months, 12 months, and 24 months.

Data source: YCharts.

As shown above, following the last five stock splits, Nvidia returned by an average of 8% during the next six months. But shares declined by an average of 23% during the 12-month period following the split, and the stock was still down by an average of 3% after 24 months. In short, history says Nvidia could suffer a severe drawdown in the not-so-distant future.

Of course, past performance is never a guarantee of future results, and that saying rings particularly true here. Four of the last five stock splits occurred in close proximity to severe bear markets. Specifically, the S&P 500 declined 49% between March 2000 and October 2002 due to the dot-com bubble, and it declined 57% between October 2007 and March 2009 due to the global financial crisis.

Those market crashes notwithstanding, there has still been a silver lining for patient investors. Nvidia shares ultimately rebounded following all five stock splits and produced phenomenal long-term returns. The chart below shows the magnitude of those returns as of June 12, 2024.

Going forward, whether Nvidia is a good or bad investment depends on two things: (1) how quickly the semiconductor company can grow earnings per share, and (2) how much investors are willing to pay for those earnings.

Nvidia has a durable competitive advantage

Nvidia’s graphics processing units (GPUs) have a near-monopoly in accelerated computing, a discipline that uses specialized hardware and software to speed up complex data center workloads like artificial intelligence (AI) and data analytics.

Nvidia products consistently set performance records in AI training and inference at the MLPerf benchmarks, standardized tests that provide unbiased evaluations of AI systems. Additionally, the company holds more than 90% market share in data center GPUs and more than 80% market share in AI chips.

Nvidia bears brush aside those strengths and cite mounting competition as cause for alarm. Specifically, they point to semiconductor companies like AMD and cloud providers like Amazon, Microsoft, and Alphabet, all of which are building chips to supplant Nvidia GPUs. But that bearish argument ignores the formidable economic moat Nvidia has in its full-stack strategy.

CEO Jensen Huang recently told analysts: “We literally build the entire data center.” He means Nvidia is no mere chipmaker, but rather a full-stack computing company. Nvidia supplements its GPUs with central processing units (CPUs) and networking hardware that’s purpose-built for artificial intelligence. The company also offers subscription software and cloud services that support AI workflows across numerous end markets, from manufacturing and logistics to customer service and healthcare.

The heart of Nvidia’s full-stack computing platform is CUDA, a parallel programming language that allows GPUs (originally engineered for graphics processing) to function as data center accelerators. The CUDA ecosystem is comprised of hundreds of frameworks and software libraries that streamline the development of complex applications. That gives Nvidia an immense advantage, because no other chipmaker has a comparable ecosystem of supporting software.

To quote Morningstar analyst Brian Colello, “CUDA is proprietary to Nvidia and only runs on its GPUs, and we believe this hardware plus software integration has created high customer switching costs in AI, contributing to Nvidia’s wide moat.”

Nvidia stock looks a little pricey at its current valuation

Going forward, Wall Street expects Nvidia to grow earnings per share at 31.7% annually over the next three to five years. If that number is divided into its current price-to-earnings multiple of 75.8, the quotient is a price/earnings-to-growth (PEG) ratio of 2.4. That multiple is a discount to the three-year average of 3.2, but it’s still relatively pricey on an absolute basis.

That said, the consensus earnings forecast leaves room for upside. Spending on AI hardware, software, and services is forecasted to compound at 36.6% annually through 2030, according to Grand View Research. Nvidia could certainly match that pace, and perhaps exceed it. To that end, its current valuation could appear quite reasonable or even cheap in hindsight.

Ultimately, investors have a somewhat difficult decision here, but I think Joseph Moore at Morgan Stanley has the right idea. “[W]e think the backdrop warrants AI exposure even amid extreme enthusiasm — and Nvidia remains the clearest way to get that exposure,” he wrote in a recent note to clients.