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No other company has seen as much of a business transformation as Nvidia (NASDAQ: NVDA) in 2023. Throughout 2022, Nvidia’s sales were falling. However, thanks to unprecedented demand for its GPUs (graphics processing units), Nvidia has come roaring back and is now one of the top stocks to own in 2023.

But Nvidia’s performance hasn’t completely been due to business gains, as there are a lot of lofty expectations built into its stock price. But should this detract investors from Nvidia’s stock? Read on to find out.

Don’t forget, Nvidia is a cyclical company

GPUs play an essential role in artificial intelligence (AI). AI models are built from massive datasets that require powerful computational devices to process them. The most efficient tool for this job is hundreds or thousands of GPUs connected in parallel to pool their resources to interpret and train a model. After that model is created, it still requires the resources to update it continuously.

Because Nvidia has the best GPUs on the market suited for this task, it has seen a ridiculous surge in demand. In Q2 of its fiscal 2024 (ended July 30), revenue skyrocketed 101% year over year to $13.51 billion, a new quarterly record. Management also projects this trend to continue into Q3, giving guidance for $16 billion in revenue, indicating 170% growth.

Those are absolutely incredible growth figures, and the stock has responded in kind by gaining over 200% this year. But the question is, can Nvidia maintain this level of expansion? Nvidia is seeing success, but it’s also a cyclical company, and as such, can have periods of rapid growth followed by periods when demand cools down. The issue with this investing style is understanding when this demand will taper off.

NVDA Revenue (Quarterly YoY Growth) data by YCharts

Data centers meant for AI are the driving force behind Nvidia’s latest boom. But it is unknown how many of these data centers must be built to train AI models for everyone who wants them. Once this build-out is complete, Nvidia will likely see its business come down from its peak.

However, it will still maintain some of its gains as data centers will need to be constantly updated with the latest technology to remain relevant. But if you look at the stock price, it’s clear investors don’t see this happening for some time.

Its valuation has lofty expectations baked in

If you look at Nvidia’s valuation, it has reached unbelievable levels. However, if Nvidia hits its guidance for Q3 and gives guidance for similar growth in Q4 and Q1 of fiscal 2025 ($16 billion), the stock would trade at 18 times salesif the stock price doesn’t change. That doesn’t sound nearly as bad, but it shows that the market has already priced in these astronomical growth levels over the next year.

NVDA PS Ratio data by YCharts

But how long can this growth last? CEO Jensen Huang stated in Nvidia’s Q2 conference call: “We have excellent visibility through the year and into next year. And we’re already planning the next-generation infrastructure with the leading CSPs and data center builders.” Additionally, the language throughout the call indicated that Nvidia doesn’t think this is a one-time boost; it believes it is a functional shift in how companies do business.

If Nvidia is correct in its statement, the AI data center build-out may never be complete, and its business gains will be permanent. Throw in a new generation of data center infrastructure technology, and it will likely mean an upgrade cycle will continue to boost Nvidia.

Still, Nvidia is an expensive stock and must continue to execute on its rosy outlook for the investment thesis to make sense. It won’t be easy to live up to expectations, but that doesn’t mean Nvidia can’t. However, I still think investors should be cautious here as Nvidia has been overexposed to computing trends multiple times and has been burned before.

So, if you want to invest in Nvidia, I’d advise caution and diligence as one poor quarterly result could sink the stock. But if Nvidia can maintain its business gains over the long haul, it should remain a viable long-term investment.

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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool has a disclosure policy.

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