Aswath Damodaran

AI’S WINNERS, LOSERS AND

WANNABES: VALUING NVIDIA!
ChatGPT did this!
Investment Confessions: An (Unexpected)
AI Boost!
¨ The first is that my portfolio has held up well this year, in a
market that has been top-heavy and tech-driven, and one big
reason is that it contains both NVIDIA and Microsoft, two
companies that have benefited from the AI story.
¨ The second is that much as I would like to claim credit for
foresight and forward thinking, AI was not even a speck in my
imagination when I bought these stocks (Microsoft in 2014
and NVIDIA in 2018).
¤ I just happened to be in the right place at the right time, a reminder
again that being lucky often beats being smart, at least in markets.
¤ That said, NVIDIA’s soaring stock price has left me facing that question
of whether to cash out, or let my money ride, and thus requires an
assessment of how the promise of AI play’s out in its value.

2
1. The Semiconductor Business – A Growth
Business that is maturing!

3
2. Profitable, with Cycles….

4
3. A Love-Hate Relationship with Markets

5
4a. With a Shifting Cast of Winners

6
4b. And End Users

7
NVIDIA
1. Opportunistic Growth

Aswath Damodaran
8
2. With Large (but Productive) Reinvestment!

9
3. And a Mega Market Payoff

10
AI: Revolutionary or Incremental Change

¨ Revolutionary Changes not only affected wide swathes of

businesses, some positively and some adversely, but that
they also changed the ways that we live, work and interact.
¨ In parallel, we have also seen changes that are more
incremental, and while significant in their capacity to create
new businesses and disruption, don't quite qualify as
revolutionary.
¨ So, where does AI fall on this spectrum from revolutionary to
incremental to minimalist change? A year ago, I would have
put it in the incremental column, but ChatGPT has changed
my perspective. That was not because ChatGPT was at the
cutting edge of AI technology, which it is not, but because it
made AI relatable to everyone.

11
AI: Net Plus or Minus for Markets?

Aswath Damodaran
12
AI: Disruption’s Dark Side

¨ The market is littered with the carcasses of what used to be

successful businesses that have been disrupted by technological
change.
¨ Investors in these disrupted companies not only lose money, as
they get disrupted, but worse, invest even more in them, drawn by
their "cheapness".
¤ This happened, just to provide two examples, with investors in the brick-
and-mortar retail companies that were devastated by online retail, and
with investors in the newspaper/traditional ad companies that were
upended by online advertising.
¨ If AI succeeds in its promise, will there be businesses that are
upended and disrupted? Of course, but we are in the hype phase,
where much more will be promised than can be delivered, but the
biggest targets will come into focus sooner rather than later.

13
AI: Value Effects

• Hardware and Infrastructure: The AI effect on NVIDIA comes from the increased demand
for AI-optimized computer chips, and as that market is expected to grow exponentially, the
companies that can grab a large share of this market will benefit. There are undoubtedly
other investments in infrastructure that will be needed to make the AI promise a reality.
• Software: AI hardware, by itself, has little value unless it is twinned with software that can
take advantage of that computing power. This software can take multiple forms, from AI
platforms, chatbots, deep learning algorithms (including image and voice recognition, as well
as natural language processing) and machine learning.
• Data: Big data, used more as a buzzword than a business proposition, over the last decade
may finally find its place in the value chain, when twinned with AI, but that pathway will not
be linear or predictable.
• Applications: For companies that are more consumers of AI than its purveyors, the promise
of AI is that it will change the way they do business, with positive and negative implications.
The biggest pluses of AI, at least as presented by its promoters, is that it will allow
companies to reduce costs (primarily by replacing manual labor with AI-driven applications)
and make them more efficient, and by extension, more profitable. If every company has AI,
and AI reduces costs and increases efficiency as promised for all of them, it is far more likely
that they will end up with lower prices for their products/services and not higher profits.

14
AI: Social Effects

¨ I know that there are some advocates of AI who paint a picture of goodness,
where AI takes over the menial tasks that presumably cause us boredom and
brings an unbiased eye to data analysis that lead to better decisions. I know that
there are others who see AI as an instrument that big companies will use to
control minds and acquire power. With the experience of the big changes that
have engulfed us in the last few decades still fresh, I would argue that they are
both right.
¨ There are some who believe that AI can be held in check and made to serve its
more noble impulses, by restricting or regulating its development, but I am not as
optimistic for many reasons.
¤ I believe that both regulators and legislators are woefully incapable of understanding the
mechanics of AI, let alone pass sensible restrictions on its usage.
¤ Second, any regulation or law that is aimed at preventing AI's excesses will almost certainly
set in motion unintended consequences, that at least in some cases will be worse than the
problems that the regulation/law was supposed to hold in check.
¨ While this is a pessimistic take, I believe that it a realistic one, and that just as with
social media, it will be up to us, as consumers of AI products and services, to try to
draw lines and separate good from bad. We may not succeed, but what choice do
we have, but to try?

15
The AI Chip Story

¨ The AI story has particular resonance with NVIDIA because unlike most other
companies, where it is mostly hand-waving about potential, it has substance in
place already and a market that is its target. In particular, NVIDIA has spent much
of the last few years investing and developing products for a nascent AI market.
This lead time has given NVIDIA not just market leadership, but revenues and
profits already. Much of the excited reaction to NVIDIA's most recent earnings
report came from the company reporting a surge in its data center revenues, with
much of the increase coming from AI chips.
¨ While the company does not explicitly break out how much of the data center
revenues are from AI chips, it is estimated that the total market for those chips in
2022 was about $15 billion, with NVIDIA holding a dominant market share of
about 80%. If those estimates are right, the bulk of the data center revenues for
NVIDIA in 2022, which amounted to $15 billion in all, comes from AI-optimized
chips.
¨ The ChatGPT jolt to market expectations has played out in increases in expected
growth of the AI chip market over the next decade, with estimates for the overall
AI chip market in 2030 ranging from $200 billion at the low end to close to $300
billion at the high end.

16
NVIDIA: The Lead In to the Story

¨ The driver of NVIDIA's success has been its high-performance GPU cards, but
it is very likely that the businesses that bought these cards and drove NVIDIA's
success in the last decade will be different from the businesses that will make
it successful in the next one.
¨ For much of the last decade, it was gaming and crypto users that allowed the
company to set itself apart from the competition, but the bad news is that
both of these markets are maturing, with lower expected growth in the
future.
¨ The good news, for NVIDIA, is that it has two other businesses that are ready
to step in and contribute to growth.
¤ The first is AI, where NVIDIA commands a hefty market share of what is now a relatively small
market, but one that is almost certain to grow ten-fold or greater over the decade.
¤ The other is in the automobiles business, where more powerful computing is seen as the
ingredient needed to open up automated driving and other enhancements. NVIDIA is only a
small player in this space, and while it does not enjoy the dominance that it does in AI, a
growing market will allow NVIDIA to acquire a significant market share.

17
The NVIDIA Growth Story

¨ Revenue Growth: NVIDIA will remain a high growth company for two
reasons.
¤ The first is that in spite of its scaling up due to growth over the last decade, at
least in terms of revenues, it has a modest market share of the overall
semiconductor market, with revenues that are less than half of the revenues
posted by Intel or TSMC.
¤ The second, and more important reason, is that while its gaming revenue
growth is starting to flag, it is well-positioned in AI and Auto, two markets
poised for rapid growth. In my story, I will assume that these markets will
deliver on their growth promise and that NVIDIA will maintain a dominant,
albeit lower, market share of the AI chip business, while gaining a significant
share (15%) of the Auto chip business

Aswath Damodaran
18
NVIDIA: The Rest of the Story

• Profitability: The semiconductor business has a cost structure that has relatively
little flex to it, but I will assume in my NVIDIA story that the right margin to focus
on is the R&D adjusted version, and that NVIDIA will bounce back quickly from its
2022 margin setback to deliver higher margins than its peer group. While my
target R&D adjusted margin of 40% may look high, it is worth remembering that
the company delivered 42.5% as margin in 2020 and 38.4% as margin in 2021.
• Investment Efficiency: NVIDIA has invested heavily in the last decade, generating
only 65 cents in revenues for every dollar of capital invested (including the
investment in R&D), in 2022. I believe that given the company's larger scale, with
the payoff from past investments augmenting revenues, the company's sales to
invested capital will approach the global industry median, which is $1.15 in
revenues for every dollar of capital invested.
• Risk: I estimated NVIDIA's cost of capital based upon its geographic exposure and
very low debt ratio to be 13.13%, but chose to use the industry average for US
semiconductor companies, which was 12.21%, as the cost of capital in the initial
growth period. Over time, I will assume that this cost of capital will drift down
towards the overall market average cost of capital of 8.85%.

Aswath Damodaran
19
Aswath Damodaran
NVIDA: Value Simulation
¨ Revenue Growth
¤ Base Case: Revenues of $267 billion in 2033
¤ Distribution:

¨ Operating Margin
¤ Base Case: Pre-tax operating margin of 40% (target)
¤ Distribution: Triangular, with 30% (low) and 50% (high)
¨ Reinvestment
¤ Base Case: Sales to Invested Capital of 1.15
¤ Distribution: Lognormal, with range from 0.8-1.94
¨ Cost of Capital
¤ Base Case: Industry average of 12.21%
¤ Distribution: Normal Distribution (with standard dev of 1.5%)

Aswath Damodaran
21
Aswath Damodaran
And a Breakeven Analysis

Aswath Damodaran
23
The Take-Aways from What ifs?

¨ The breakeven table reinforces the findings in the

simulation, insofar as it shows that there are plausible
paths that lead to the current price being a fair value or
under value, but these paths require a daunting
combination of extraordinary revenue growth and super-
normal margins.
¨ In my view, a target margin of 50% is pushing the limits
of possibility, in the semiconductor business, and if
NVIDIA finds a way to deliver value that justifies current
pricing, it has to be through explosive revenue growth.
¨ Put simply, you need another market or two, with
potential similar to the AI market, where NVIDIA can
wield a dominant market share to justify its pricing.

24
Judgment Day: Investing

¨ I love NVIDIA as a company and have nothing but praise for Jensen
Huang's leadership of the company. My valuation story for NVIDIA reflects
all of the positive features in the company will continue into the next
decade, but that upbeat narrative still yields a value well below the
current price.
¨ I would be lying if I said that selling one of my biggest winners is easy,
especially since there is a plausible pathway, albeit a low-probability one,
that the company will be able to deliver solid returns, at current prices.
¤ I chose a path that splits the difference, selling half of my holdings and cashing in
on my profits, and holding on to the other half, more for the optionality (that the
company will find other new markets to enter in the next decade).
¤ The value purists can argue, with justification, that I am acting inconsistently, given
my value philosophy, but I am pragmatist, not a purist, and this works for me.
¨ It does open up an interesting question of whether you should continue
to hold a stock in your portfolio that you would not buy at today's stock
prices, and it is one that I will return to in a future post.

Aswath Damodaran
25
Judgment Day: Trading

26
Trading Follow Through

¨ If you are a trader, even if you believe that NVIDIA's value is well
below its price, you may buy NVIDIA on the expectation that the
stock will continue to rise, borne upwards by momentum or
incremental information.
¤ Given the strength of momentum as a market-driver, you may very well
generate high returns over the next weeks, months or even years, and you
should not let "value scolds" get in the way of your enjoyment of your
winnings.
¤ My only pushback would be against those who argue that momentum can
carry a stock forward forever, since it is the gift that both gives and takes
away.
¨ The strength of momentum in the rise in NVIDIA's stock price will
be played out in the the opposite direction, when (not if)
momentum shifts, and if you are trading NVIDIA, you should be
working on indicators that give you early warning of those shifts,
not worrying about value.

27
AI: Bottom Line

¨ Even if you buy into the argument that AI will change the ways that we
work and play, it does not necessarily follow that investing in AI-related
companies will yield returns. You can get the macro story right, but you
need to also consider how that story plays out across companies to be
able to generate returns.
¨ Refusing to make estimates or judgments about how AI will affect the
fundamentals (cash flows, growth and risk) in a business, just because
you face significant uncertainty, will not make that uncertainty go away,
and instead will create a vacuum that will be filled by arbitrary AI
premiums.
¨ As a society, it is unclear whether adding AI to the mix will make us better
or worse off, since every big technological change seems to bring with it
unintended consequences.
¨ All in all, I am considering asking ChatGPT to write this post for me, using
my own language and history, and I am open to the possibility that it
could do a better job than I can.

Aswath Damodaran
28