A 1,403% share price gain in just five years is the stuff of investor dreams. It is also the stuff of reality, at least when it comes to the performance of Nvidia (NASDAQ: NVDA) stock between May 2021 and today.
Like many investors, though, I am currently standing back from the AI investing frenzy. I am trying to take a long-term view when it comes to finding shares to buy and hold.
But that does not mean I am ignoring Nvidia.
I think the incredible performance of Nvidia’s stock price in recent years (or indeed since its listing back in 1999, with a 563,200% share price gain registered since that time) can teach me important lessons as an investor far beyond the realm of AI.
Addressable market size matters as a company scales
Famously, the chairman of what went on to be a leading computer maker reportedly said in the 1940s that he thought there was a world market for, perhaps, five computers.
Whether he actually said that is unclear. Slop may have exploded with the onset of AI, but it has been around for far longer.
What is interesting, though, is the idea that it might be worth competing in a market with relatively small demand.
Depending on pricing, it can be. UK companies like Rolls-Royce (LSE: RR) compete in markets where demand is fairly small numerically and likely to stay that way.
They can still do well because the price of the products they sell is huge. An aircraft engine can easily set a customer back by millions of pounds, before it is even used. Servicing costs add more.
To be the biggest of the bunch, though – and Nvidia is the world’s largest company based on stock market capitalisation – just being able to command a high price is often not enough. The addressable market volume also needs to be massive.
In the early days of a business that matters less. Being the number one operator in a small market can still be lucrative. Over time, though, market size impacts a company’s ability to keep scaling.
Brilliant businesses have pricing power
Still, the 973% gain in the Rolls-Royce share price over the past five years underlines that the company is attractive to many investors.
A key reason is what is known as pricing power. Rolls-Royce has few rivals, barriers to entry in the complex world of aircraft engineering and nuclear power are high, and its large installed base means Rolls has an inbuilt market for servicing contracts.
Guess what though? Nvidia arguably has even more pricing power than Rolls-Royce. Last year’s operating margin for Rolls was 25%. Good – but still well below half the 60% achieved by Nvidia.
Proprietary chip designs give Nvidia enormous pricing power – hence its massive profitability.
So, should I buy?
Now, much as I like Nvidia’s business model, its stock sells for 46 times earnings. That is too high for my tastes.
Long-term demand for costly AI chips remains unproven. Rivals may try and eat Nvidia’s lunch by producing lower-priced chips that eat into its pricing power.
So, for now, I am not buying any Nvidia stock.
But I am applying lessons from its incredible performance to my hunt for non-AI shares to buy!
Christopher Ruane has no positions in any share mentioned.
