Stock analysis: As Nvidia(NVDA) becomes the most valuable company by dethroning Microsoft(MSFT), a question worth asking is whether it is overpriced?

Let's look at the important metrics.

PE ratio - It's a ratio of market capitalization to the earnings of the company.

Market capitalization is calculated by multiplying the total number of shares by the present share price. (3.3 trillion USD)

Earnings are what a company gets to retain after it has paid off all of its debts and costs incurred. (40 billion USD)

So PE ratio will be 3335.27/42.6 (amounts in billions of dollars) ≈ 79

Put another way the company is earning 42.6$ for a price of 3335.27, or 1/79, or in terms of percentages 1.2$ per share worth 100$.

Now let's say you go to a bank to deposit your money and it says that it will give you a paltry return of 1.2%. Would you invest your money there? Of course not.

So why are people lining up to buy a stock that offers 1.2% return on your investment?

The reason is the growth potential. While what a bank offers you is a fixed rate of return, a company on the other hand has unlimited potential of growth. What it means is that while it currently earns 1.2$ for every 100$, as you buy and hold the stock, it could earn 2$, 5$, 10$ or even 100$ over time.

But what we must understand is that such a growth in earnings is speculative.

What's driving the current growth of Nvidia are their AI chips. What could undercut such an explosive growth?

• Potential competitors or
• The AI market not growing as fast as anticipated.

In that case the stock price will sharply decrease to adjust for the revised growth estimates. In other words, you will lose a lot of money if the high growth potential isn't achieved.

The metric related to the P/E ratio is the 'forward' P/E ratio, which uses expected earnings instead of the previous year's earnings. It has a somewhat more reasonable value of 37 (still high, by the way) compared to the P/E ratio of 79. However, it is less reliable because it is based on future earnings estimates by analysts, which could be incorrect.

The other ratio that is of concern here is the PB ratio. Price to book value ratio. Book value is calculated by subtracting the liabilities from the assets as they are listed on the balance sheet. In simple words, it is the value of everything the company owns minus everything the company owes.

From the above table, investors are valuing this company at astronomical 67 times its book value.

So I think this stock is priced unreasonably high. However, it is conceivable that investors may continue to drive up the price of this stock amidst the fervor fueled by the prevailing AI hype that has captivated contemporary minds.

Agree? Disagree? Let me know in the comments below.