How does a 2,400% dividend increase sound to you? Many investors would think all their Christmases have come at once if such a thing happened. But that is exactly what US chip giant Nvidia (NASDAQ: NVDA) announced last week – and its stock actually moved down slightly in response.
What is going on?
It’s all about perspective
Do you remember as a child being challenged to fold a piece of paper, then fold it again, and again – more than seven times?
Easy sounding for the uninitiated, but impossible in practice.
What about a 2,400% dividend increase?
Do that for seven years on the trot and the cumulative increase would be… well, never mind. Do the calculation yourself to see what I see on my pocket calculator – and trust me, it is a very big number.
Clearly, this sort of dividend growth is exceptional, even for an exceptional share like Nvidia. I see it as a one-off, not setting a new norm.
Nvidia’s share price growth (the stock is up 1,358% in five years) had left the dividend yield at a paltry 0.02%.
So the massive increase announced last week will simply push the yield up to 0.5%. That is far more attractive than what it was before, but still unremarkable.
Where does Nvidia go from here?
The reason Nvidia can afford to reward its stockholders so handsomely is simple: it is currently producing a gusher of cash.
In its most recent quarter, the company’s net cash flow from operating activities was $50bn. Dividends cost it $0.2bn.
So even the 25-fold increase in dividend the firm announced would still leave close to 90% of operating cash flows untouched by dividend costs.
Even a new $80bn share buyback authorisation may not be enough to suck up the majority of the company’s operating cash flows for the year.
Why is Nvidia suddenly growing its dividend so dramatically?
Does it not have other useful ways to spend its free cash flow, to try and build the business?
A cause for celebration – or alarm?
Maybe not.
The AI chip market is huge and continues to grow at pace. Nvidia is the giant within it.
Even if it was to spend those tens of billions of dollars earmarked for shareholder payouts and share buybacks on growth instead, would it make much difference in the short term? Customers are eating out of its hands and there is a long waiting list for its most popular chips.
The business is in a sweet spot – it is pumping out money and it can probably keep doing so (even more so in fact) without having to spend proportionately more.
That reflects economies of scale and means its already attractive gross profit margin (75%) grows even higher.
Revenues and earnings could keep growing. Earnings growth means Nvidia stock now sells for 33 times earnings – higher than I would like to pay but not outrageously expensive in my view.
Still, I am not yet ready to buy at that price given the risks to the company’s valuation if AI spending slows down, which I feel could well happen in a weakening economy. But I will keep a close eye on this remarkable stock.
Should you invest £5,000 in Nvidia right now?
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Christopher Ruane has no position in any of the shares mentioned.
