Nvidia's Valuation: What's a Fair Price to Pay Right Now

TL;DR Nvidia trades near $204. Running a conservative 10-year model, a 9% required return (zero margin of safety) puts mid fair value at $250, implying about 11.4% expected annual return. At my personal 15% hurdle, it drops to $154. The business quality is elite; the real question is how sustainable a 63% net margin and a 19.6x price-to-sales ratio really are.

A great company and a good buy price are two different things

There's no debate that Nvidia is a phenomenal business. But the question left for an investor is always the same: can you buy at this price and still earn the return you want? So I look at the numbers before the narrative.

Let's define the company's price first. Price here isn't the share price, it's the market cap, the share price times all shares outstanding, and right now that's a shade under $5 trillion.

Financial strength: start with the balance sheet

The first thing I always check is enterprise value. Nvidia's EV is lower than its market cap, which means it holds more cash than debt. That's the signature of a great balance sheet, and companies with great balance sheets rarely go under.

Look at cash flow too. Free cash flow was $119 billion last year against a five-year average of $49 billion. That's lower than net income, but it's because they're spending heavily on factories and capacity to build more chips. That part doesn't worry me much.

The one number that gives me pause: 19.6x sales

There is one metric that nags at me: the price-to-sales ratio sits near 20.

Why does that matter? Price-to-sales is a clean way to compare companies. Even high-margin businesses like Microsoft and Google usually trade between 8 and 12 times sales. Nvidia's 19.6x is a clear premium. That said, if the bulls are right and we really are in the early innings, sales could jump enough to justify the multiple.

Profitability: sustainability is the real question

Nvidia's net margins are jaw-dropping: a 10-year average of 52%, a 5-year of 54%, and a one-year of 63%, all after every bit of overhead and tax.

The question I ask is whether this is sustainable long term. Ten years ago it wasn't even 50%. In other words, the company is on a historic run of profitability thanks to serious pricing power. Can you assume that runs forever? Even if it holds for a while, if it's not for the indefinite future, it's hard to justify today's valuation on it.

Growth and return on capital: this is the real strength

The growth numbers are overwhelming: 114% annual revenue growth over three years, 67.5% over five, and 47.6% over ten. And it's growth that barely leaned on acquisitions, just $16 billion spent over the last five years.

But the metric I weigh most is return on capital. A high figure means the company deploys its money well, and it's qualitative proof that this is a high-quality business. When I hunt for good companies, I always look for strong returns on capital.

What an eight-point checklist shows

Run it through the eight metrics I use and you get six checks and two X's. The two misses are the 5-year P/E and the 5-year price-to-free-cash-flow.

Those two are a little misleading, though. Free cash flow has surged so much over five years that the multiple looks distorted. It's still expensive, at 41 times free cash flow and 31 times earnings, but those two figures overstate the case. Everything else is a clean check: returns on capital are high, and revenue, net income, and cash flow are all up over five years with very low debt.

Honestly, I like it when the misses are just these. If "a little expensive" is the only problem, all we have to do is sit back and wait for the right price.

What analysts expect

Analyst expectations are wildly aggressive. They see revenue going from $213 billion to a full trillion within the next four or five years, and profit growing more than fivefold. In short, they're saying this thing doesn't stop.

The question is whether that's right. Growth that appears this suddenly is harder to trust. You always have to ask whether it's a permanent new baseline or a temporary overshoot while things settle.

The fair value from my own assumptions

So I ran a 10-year valuation with my own inputs, far more conservative than the analysts:

• Revenue growth: 10%, 15%, and 25% annually for ten years (I know that's absurdly low versus the Street)
• Net margin: 35%, 45%, and 55%
• P/E to assign 10 years out: 20x, 24x, and 28x (the market average is 15-16x, but given the returns on capital, growth, and dominance, this is clearly a good company, so I went higher)
• Required return: 9% with no margin of safety, to isolate pure intrinsic value

The output: against a current price of $204, a low of $115, a high of $738, and a middle of $250. Honestly, that surprised me. It was better than I expected. On the middle assumption, today's price implies an 11.4% annual return.

My personal buy price is different

I love Morgan Housel's line: personal finance is more personal than finance. The 9% above gives the market's intrinsic value. But when I buy an individual stock myself, I demand a much higher return.

It used to be 12%, but as my financial situation and the way I view money changed, I now want a minimum of 15% on individual names. Egregious? Sure. But I only want to swing at the big, fat pitches. I have real estate and businesses, so I only own a single stock when there's a large margin of safety.

Change only the required return to 15% and leave everything else the same, and you get a low of $73, a high of $448, and a middle of $154. The key point: that doesn't mean I think Nvidia is worth less. It just means my personal margin of safety is larger.

The bottom line

Nvidia is a great company with a great balance sheet and enormous potential. But never buy a stock just because my numbers flash green. The point is the process: set your own required return, calculate the price that matches it, and wait for that price to arrive.

If you already hold this stock, are sitting on big gains, and worry about a drop, there's a way to generate income without selling. I cover it in Getting paid to hold Nvidia: understanding the covered call. And the bull and bear cases that feed all of this are in the complete Nvidia bull vs bear case.