Is Nvidia a Buy?

Key Points

• Nvidia beats earnings estimates and anticipates trillions in AI infrastructure spending in the coming years.

• The company's dependence on six customers for almost all of its revenue is unnerving, to say the least.

• Despite this very legitimate concern, the stock remains a buy in light of the industry's massive growth.

• 10 stocks we like better than Nvidia ›

What some may consider the peak of earnings season on Wall Street finally arrived after the market closed on Aug. 27. Nvidia (NASDAQ: NVDA), arguably the world's leading artificial intelligence company due to its dominance in GPU chips used in data centers to train and operate AI models, announced its latest quarter.

It seems the pressure only builds from one quarter to the next for a company that has continually delivered increasingly impressive results since the AI boom took off in early 2023. Is Nvidia starting to crack under the pressure? The stock sold off following its earnings release.

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This Fool breaks down the quarter below and explains why Nvidia is still an AI stock investors should consider buying.

Image source: Getty Images.

Here are the good things about Nvidia's latest quarter

From a headline standpoint, Nvidia delivered above and beyond Wall Street's expectations. The company's revenue came in at $46.74 billion versus an estimated $46.06 billion, and earnings per share were $1.05 on an adjusted basis versus an estimated $1.01. The company's sales grew by 6% from the previous quarter and 56% from a year ago.

Nvidia's current flagship AI chip architecture, Blackwell, is building sales momentum with a 17% increase from the prior quarter. Additionally, Nvidia CFO Colette Kress estimated that customers will spend $3 trillion to $4 trillion in AI infrastructure by the end of this decade. That also jives with third-party research. McKinsey & Company estimates that total global data center spending will surpass $6 trillion over the next five years.

The key takeaway is that Nvidia remains dominant in the AI data center chip space, a market that could continue to demand chips for years to come. The company is guiding for $54 billion in sales next quarter. That excludes any potential contributions from H20 chip sales to China, since Nvidia registered zero H20 sales in the second quarter. But if geopolitical tensions ease, management believes that H20 sales could add an incremental $2 billion to $5 billion to that figure.

There is one major red flag investors should consider

While AI's momentum seems likely to continue as the world races to build and adopt such a revolutionary technology, Nvidia does have some causes for concern that investors should note.

The chief concern is Nvidia's dependence on a tiny, deep-pocketed customer base. Much of the money flowing into data centers is coming from a small handful of AI hyperscalers. Just two customers accounted for 39% of Nvidia's revenue in the second quarter, and the top six customers combined for 85% of total revenue!

That's a substantial risk, and it's twofold: not only could any of these companies divert chip funds to a competitor, but they could also scale back their spending if they feel the return on their AI investments isn't sufficient to continue pouring billions of dollars into hardware.

Nvidia could someday have AI opportunities beyond data centers, but that is currently where the money is, and it would be catastrophic if that revenue stream sees any disruption.

Is Nvidia a buy?

That puts investors in a potentially tricky spot when evaluating whether to buy Nvidia stock. Shares currently trade at a price-to-earnings (P/E) ratio of 40 using this year's earnings estimates. At the surface, it's a great valuation for a company analysts currently expect to grow earnings by an average of almost 33% annually over the next three to five years.

But one core customer loss is all it takes to scuttle that outlook altogether, and suddenly, Nvidia may not look nearly so attractive anymore.

For now, it's difficult to envision the AI momentum falling off -- companies have already committed billions of dollars, and there seems to be a recognition that monetization will come over time. These companies have also built on Nvidia's hardware and CUDA programming for the past few years, creating a competitive moat that Nvidia's competitors haven't breached. It doesn't mean that they can't.

Still, I think it says a lot that Nvidia has managed to maintain such a stranglehold, estimated as high as 92% of the market, on arguably the most significant technology opportunity since the Internet's early years. Nvidia is a buy, though investors would be wise to maintain a properly diversified portfolio in case cracks begin to show in Nvidia's AI armor.

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Justin Pope 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.