NVIDIA (NVDA 4.57%) The “it” stock of the year, that’s an understatement: It’s risen 150% this year, crushing the entire market and catapulting it to the top spot as the largest public company by market cap, before dropping to third place behind the leader. Microsoft and appleand the top position is likely to continue to change in the future.
What does this mean for investors?
A stock’s market capitalization is the value of its shares as a whole. It’s calculated by multiplying the stock price by the number of shares outstanding. At the time of writing, Nvidia’s stock is trading at around $123, there are 24.6 billion shares outstanding, and the total market capitalization is $3 trillion.
Market cap doesn’t tell investors much about a stock, but it can still be useful information. Companies with the highest market caps are performing well and have investor confidence. They are winners; they are established leaders and have little risk in their business.
At the same time, they may not grow as quickly as smaller, undiscovered companies. But does that mean they tend to underperform the market?
All five of the current top-five companies by market capitalization have outperformed the market this year, with the exception of Apple. Others include: Amazon and alphabet.
It’s a testament to the concept that winners keep winning. These are all top companies that have a proven track record and are keeping it that way.
Why is Nvidia’s market capitalization increasing?
Nvidia has been getting an incredible amount of attention for its generative artificial intelligence (AI) chips. There’s a huge demand for all kinds of generative AI applications, and Nvidia is a leading manufacturer of chips that can handle the data loads of these types of applications.
Stock price movements are not always logical, but generally speaking, if a company is performing well, its stock price will rise. There are many different metrics to measure performance, including revenue growth, margins, profitability, and return on equity. Nvidia has reported phenomenal growth since the generative AI boom began, driving a significant increase in its stock price.
Why the retreat?
Nvidia’s stock also benefited from the excitement surrounding its recent 10-for-1 stock split, which boosted interest in the stock and drove the price even higher. Shortly after the split, Nvidia briefly rose to the top of the market cap charts, but as this was not driven by any specific company performance metric, it has fallen back to third place.
Part of the reason for the stock price decline was concerns about valuation. The stock price had been quite high, and even after the share price decline, NVIDIA’s stock was trading at a price-to-earnings (P/E) ratio of 72. This is a natural premium valuation, but even the best companies cannot sustain earnings above their value. By comparison, Microsoft’s P/E is around 39.
Does it make sense that Nvidia is the most valuable company in the world? It doesn’t make as much revenue as Amazon, and it doesn’t make as much profit as Apple, but then again, neither do Microsoft. But Nvidia is growing faster than all of the top five companies by market cap, and the market is factoring that into its valuation.
If Nvidia continues to provide infrastructure for the applications that drive global businesses, it will likely remain at the top of the market cap rankings for the time being, but this kind of growth may not be sustainable forever, so investors should prepare for a decline in the stock price.
