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Whether it’s speculation over a company’s advancements in artificial intelligence (AI) or a return to growth for formerly high-flying software stocks, odds are you’ve been jumping for joy so far this year if you’re a technology investor. The tech-heavy Nasdaq Composite index is up over 30% year to date, and it could be heading even higher.

One stock in particular comes to my mind when I think of this strong rally: semiconductor and AI specialist Nvidia (NASDAQ: NVDA). In fact, it’s so far ahead of the pack that it could be making history right before our eyes.

After Nvidia joined the trillion-dollar market cap club earlier this year, it was natural for some to believe the hype was more about the narrative of its AI roadmap and less about its underlying fundamentals. However, the company followed up its stellar fiscal Q1 earnings report with an even bigger blowout in Q2.

Up over 200% year to date, Nvidia is indeed expensive, even for a growth stock. Nonetheless, after understanding its latest results, you’ll see now is still a good opportunity to initiate a long-term position.

The poster child of AI

For its fiscal 2024 Q1 (ended April 30), Nvidia reported total revenue of $7.2 billion. While this was good for 19% growth from the prior quarter, it represented a year-over-year decline of 13%. Yet, since the company published those results in late May, Nvidia stock is up almost 50%. Why?

Well, when analyzing the segment operating results, investors learned that Nvidia achieved record revenue in its data center business during the quarter. Although this was encouraging to see, management’s outlook for the next quarter was what really took investors by surprise.

During the earnings call, management guided for fiscal Q2 (ended July 30) revenue to surge 64% year over year to $11.0 billion. Even more impressive, the company ended up blowing past its own expectations and clocked in with $13.5 billion in revenue for the quarter. Nvidia set another record in its data center business, which accounted for roughly three-quarters of the top line.

It’s pretty obvious that Nvidia’s AI product suite is in high demand. But given the staggering results highlighted above, it’s hard to imagine how much better things can get. Right? Not so fast.

Image Source: Getty Images.

What’s next?

If the financial picture above is not enough to raise your eyebrows, consider Nvidia’s fiscal Q3 guidance, which calls for revenue to climb 170% to $16.0 billion. And to make things even better, Nvidia is financing all of this growth profitably. So far this year, the company has generated $8.7 billion of free cash flow, quadrupling its tally from the year-ago period.

But Nvidia faces two challenges. The first is waning demand. Over the last year, many companies, particularly in the tech sector, resorted to layoffs to reduce expenses. Because interest rates remain high (raising the cost of borrowing) and because inflation lingers above the Federal Reserve‘s 2% target, I suspect that companies across all industry sectors will be watching their expenses and cash flow carefully. Nvidia’s premium AI products may have to compete with cheaper alternatives.

Nvidia also faces a challenge from the U.S. government. Because of concerns about national security, the government has become cautious about making advanced semiconductor chips available to some nations, including China and Russia.

These could eventually become serious challenges, but it’s too early to tell what the long-run implications will be for Nvidia. So far, the affected regions have not affected the momentum Nvidia is seeing with its global demand, and management doesn’t seem overly concerned about this threat to the company’s growth, at least in the near term.

Should you buy the stock?

Following Nvidia’s fiscal Q2 results, Wall Street analysts did not hold back with their price targets. Citigroup and Morgan Stanley both have a $630 price target for the stock, which implies roughly 40% upside from current trading levels. Bank of America and Truist are slightly more optimistic with respective price targets of $650 and $668. However, Rosenblatt Securities takes the crown with its $1,100 price target.

Although it’s nice to see broad optimism on the Street, the company’s valuation is raising eyebrows too.

Data by YCharts.

Nvidia’s price-to-sales and price-to-free-cash-flow multiples sit far above those for peer companies like AMD, Qualcomm, and Taiwan Semiconductor. But the graphs also show that these multiples have dropped considerably recently as its data center growth plays catch up.

The best chance for an investor to average down in price is a material miss in earnings or a considerable market pullback. However, neither of these things is guaranteed. For this reason, initiating a small position in Nvidia at its current level is still a good call for long-term investors looking for exposure to a best-in-class AI opportunity.

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Bank of America is an advertising partner of The Ascent, a Motley Fool company. Citigroup is an advertising partner of The Ascent, a Motley Fool company. Adam Spatacco has positions in Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Bank of America, Nvidia, Qualcomm, Taiwan Semiconductor Manufacturing, and Truist Financial. The Motley Fool has a disclosure policy.

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