How to Profit From the "NVIDIA Effect"

It is sometimes said that it is better to get in a stock too early than too late. Once a stock takes off, many investors will wait for it to reverse direction so they can buy it at a lower price.

Of course, that doesn’t always happen. At least, not right away. You need look no further than the hottest stock on Wall Street for proof of that.

Two years ago, NVIDIA (NSDQ: NVDA) could be bought for less than $18 (split-adjusted). Two weeks ago, it crested above $140 before taking a breather.

A year ago, you could have bought NVIDIA for $40. But that price seemed high compared to where it was a year before that.

Six months ago, NVIDIA was up to $50. Once again, many investors chose to wait in the hope that it might pull back.

That didn’t happen. Three months later it was up to $90. Had you bought it then, you’d have racked up a 30% gain in just ninety days.

But had you paid $140 for NVIDIA on June 20, you would have suffered a 15% loss in less than a week. That has some investors wondering if that sudden drop in share price represents a buying opportunity or signals a change in direction for the stock.

That question can only be answered in hindsight.

If NVIDIA is trading for $200 a year from now, then investors will kick themselves for missing out on this opportunity. But if it is going for $50 at that time, then buying it now would be a costly mistake.

Late Bloomer

The huge surge in NVIDIA’s share price has triggered a buying spree on Wall Street. Any company that is perceived to be a beneficiary of the artificial intelligence (AI) revolution is in play.

Case in point is high-speed memory device manufacturer QUALCOMM (NSDQ: QCOM). In April 2022, I recommended QUALCOMM to my PF Pro subscribers while it was trading around $145.

That was shortly after the Fed began raising interest rates to combat inflation. The tech sector tanked as a result, pulling QUALCOMM’s share price below $105 eighteen months later.

By then, I was wondering if I had made a mistake. I still believed in the company, but Wall Street wanted nothing to do with it.

Fortunately, it turned out to be a late bloomer. After trading below $110 seven months ago, QUALCOMM rose above $230 last month. At that price, I was sitting on a gain of 58% in a little over two years despite its poor performance over most of that span.

I don’t know if I would buy QUALCOMM at that price. But I won’t sell it, either. It’s a lot easier to tolerate a high share price when your cost basis is considerably lower than that.

Instead, I would place a limit order beneath its current share price to protect most of my gain. QUALCOMM has technical support around $175, so that strikes me as a good price for my sell order if the stock falls that low.

It’s hard to say how high is too high when it comes to AI stocks. But it’s not as hard to know how low is too low.

Even at a $200 share price, QUALCOMM is valued at 19 times forward 12-month earnings. That is less than the same multiple for the S&P 500 Index.

Binary Proposition

The rapid rise in NVIDIA has investors looking for the next hot AI stock. Last week, I identified Hewlett-Packard Enterprise Company (NYSE: HPE) as “My Favorite AI Growth Stock Under $25.”

There will be many others. Once companies figure out how to apply AI to reduce supply chain costs, improve operating efficiencies, and make their products more competitive, their profit margins should expand.

As that happens, Wall Street will assign higher multiples to those earnings. The compound effect should be a big increase in valuations.

At that point, we are no longer limited to the tech sector for AI beneficiaries. The next wave of AI stocks will come from every sector of the economy.

In effect, NVIDIA has changed the rules for valuing growth stocks. It has become a binary proposition. Companies with an AI aspect to their business will see their earnings multiples rise, while those that don't will see their multiples fall.

It won't last forever, but it won't go away anytime soon, either. For better or worse, the "NVIDIA Effect" is driving the stock market and growth investors need to get on board.