Nvidia (NVDA -0.02%) was added to the Dow Jones Industrial Average (^DJI 0.25%) in November 2024. So, technically, it was only in the index for a small portion of the year. But it was still, by far, the best-performing Dow stock in 2024 with a 171.2% return, walloping second-place Walmart's 71.9% gain and third-place American Express' 58.4%.
Nvidia stock went up a mind-numbing 818.9% between 2023 and 2024, which may lead some investors to question how much further it can run before its valuation gets stretched too thin.
Here's why the rally in Nvidia stock is somewhat justified, why Nvidia could continue outperforming the market and is worth buying, and some reasons to keep Nvidia on a watchlist for now.
Nvidia's momentum knows no bounds
Nvidia followed up a rip-roaring 2023 with another incredible year in 2024 -- briefly becoming the most valuable company in the world before Apple reclaimed the title.
Nvidia has defended its commanding lead in the graphics processing unit (GPU) market despite a slew of competition. In December, Nvidia announced that its Blackwell architecture for generative artificial intelligence (AI) was coming to Amazon Web Services. On Jan. 3, Microsoft said it plans to spend $80 billion in its current fiscal year to "build out AI-enabled datacenters to train AI models and deploy AI and cloud-based applications around the world." On Jan. 7, Amazon said it plans to spend $11 billion in the U.S. state of Georgia alone on AI infrastructure and cloud technologies.
Nvidia could easily beat the market again in 2025 because it continues to innovate, and AI spending is showing no signs of slowing down.
Nvidia rallied to an all-time high on Monday in response to news that Nvidia customer Hon Hai Precision Industry (also known as Foxconn) is seeing massive growth for AI in cloud and networking. The rally could have also been driven by anticipation of Nvidia CEO Jensen Huang giving the keynote address at CES, a major technology conference in Las Vegas. However, Nvidia pulled back 6.2% on Tuesday after Huang's keynote.
Nvidia will report its fourth-quarter and full-year fiscal 2025 results on Feb. 26. Analyst consensus estimates call for $2.95 in fiscal 2025 earnings per share and $4.43 in fiscal 2026 earnings per share -- implying year-over-year growth of 50%. So it's worth understanding that there are lofty expectations already baked into Nvidia's forward price-to-earnings (P/E) ratio of 50.6.
The power of earnings growth
Nvidia is by no means a cheap stock based on near-term expectations. But it could grow into its valuation over time if it continues innovating and sees sustained product demand.
No force is more powerful in the stock market than earnings growth. Earnings growth can justify a premium valuation and make a stock quickly look cheap.
For example, if Nvidia stock returns 20% per year over the next five years but averages 30% earnings growth in that period, its forward P/E will decline from its current level of around 51 to under 30.
This lesson demonstrates why excellent earnings growth can make expensive stocks look like a good value for long-term investors. As long as Nvidia continues on its path, it should have no problem outperforming the S&P 500 (^GSPC 0.16%). However, if there's a major industrywide slowdown or competition heats up, it wouldn't be surprising to see Nvidia sell off.
Image source: Getty Images.
Rapidly growing earnings sets Nvidia apart
Nvidia has been at the forefront of a rapidly growing industry. Earnings are soaring, and so is the stock price. But for earnings to keep going up, Nvidia has to lap its difficult comps. That could become challenging if the investment cycle enters a slowdown or less expensive alternatives, like chips made by Advanced Micro Devices, eat away at some of Nvidia's market share.
The buy case for Nvidia is quite simple. If you believe the company will remain a long-term winner in AI, the stock is worth buying and holding. But it's worth understanding that Nvidia's sky-high operating margins, market share, and growth rate may not be sustainable over the long term.
Even if revenue growth remains strong, Nvidia's earnings growth could fall if its margins come down. Nvidia's trailing 12-month gross margin is 75.9%, and its operating margin is 62.7% -- meaning it's converting the majority of sales into operating income, a truly unbelievable feat.
But earnings growth can slow down
Nvidia's high profitability comes from the ability to set premium prices for its products, which deep-pocketed customers willingly pay to further their AI ambitions. If those customers aren't able to monetize AI as well as they hoped, they could slow their pace of AI spending, which would affect Nvidia even if it continues cranking out great products. Put another way, Nvidia needs to continue making great products, and its customers must be able to afford those products. For example, companies can spend money on Nvidia computing hardware for self-driving vehicles, but those vehicles must sell to justify future order volumes.
Just as the buy case for Nvidia is fairly straightforward, I think the reasons to keep it on a watchlist are also simple. Some investors may prefer to take a wait-and-see approach to how Nvidia handles mounting competition, how it performs in an industry slowdown, and if it can continue to be the undisputed industry leader.
Nvidia has been at the top of its game, uninterrupted, for a couple of years now. If it keeps it up, it's easy to see how Nvidia could become the most valuable company in the world and maintain position. But it's also possible that spending on AI could flatline for a few years, or that some unforeseen challenges will appear that hinder Nvidia's ability to grow.
Approaching an investment in Nvidia
Nvidia is priced for strong and sustained growth, but not for perfection. Despite the run-up, it doesn't have a nose-bleed valuation. Instead of trying to time the market, it's better to do some research and decide where you stand on Nvidia.
If you decide not to buy the stock now and keep it on a watchlist, it's important to have clearly defined reasons for what needs to change to consider buying the stock. That way, you can ensure you are using business performance as a measuring stick, and not the stock price.
