Here's What I Think Is Going On With Nvidia Stock

By the end of last year, investors had become accustomed to top performance from Nvidia (NASDAQ: NVDA). The stock had delivered quarter after quarter of gains thanks to the company's leadership in the artificial intelligence (AI) chip market. And any surprises had been positive, such as the company becoming the first ever to reach $4 trillion in market value -- that happened last summer -- or the stock closing at a new record high as it did back in October.

But in the first quarter of this year, Nvidia's surprise for investors wasn't a positive one. Instead of reaching an exciting new milestone, the stock declined by more than 6%. The reason for such a move had to do with pressure on AI stocks as well as the general economic and geopolitical environment. Investors worried that AI stocks had climbed too high, too fast -- and future revenue potential may not justify such levels. Meanwhile, the war in Iran made investors more cautious, which meant they hesitated to invest in growth stocks such as Nvidia.

In recent weeks, though, investors have returned to Nvidia stock -- and last week it closed at a record high, bringing the company to a $5 trillion market value. Why such a rapid shift in sentiment? Here's what I think is going on with Nvidia stock...

Image source: Getty Images.

Nvidia's path from $2 to $200

First, a quick note about why Nvidia, a company that's been around for more than 30 years, has attracted such attention over the past few years. After all, during most of the company's history, the stock traded for less than $2 a share. (Today it trades for more than $200.) During that long history, Nvidia primarily served the video gaming industry with its graphics processing units (GPUs) -- an industry that helped the company progressively grow but didn't necessarily represent a game-changing opportunity.

NVDA data by YCharts

When Nvidia entered the AI market, though, -- as the first to offer GPUs to power AI development -- investors recognized the potential and watched as revenue exploded higher.

Importantly, this wasn't just a one-time deal. Nvidia's GPUs are crucial tools driving tasks throughout the AI story, from the training of models to the actual thinking process that happens as models work on a particular problem. And GPUs are set to play the key role in the operation of future AI products, too, such as humanoid robots.

Meanwhile, the fact that Nvidia got in on this market ahead of rivals and made innovation its priority put it on track to stay in the driver's seat.

A peak in valuation

The stock roared higher, reaching a valuation of more than 48x forward earnings estimates early last year .

Now, here are my thoughts about Nvidia's stock today -- after its decline earlier this year and its recent recovery.

First of all, pressures from the first quarter have lifted, at least somewhat. Soaring demand for AI, as noted by many companies, supports the idea of strong long-term revenue prospects. And a ceasefire in Iran spurred optimism about a possible peace agreement.

Beyond this, though, I think investors are excited about two things. First, the very recent comments about AI demand from players, including Taiwan Semiconductor Manufacturing and Intel, suggest that Nvidia will deliver yet another blowout earnings report when it announces figures in May.

Clues from TSMC and Intel

TSMC is the maker of Nvidia chips, and those of other leaders, and the company is in close communication with these customers and their customers. Intel's comments are also bright for Nvidia as the company spoke of high AI demand for Intel's central processing units (CPUs) -- it's important to remember that the two companies struck a deal last year that involves Intel building custom CPUs for Nvidia data center products. So Intel's comments regarding AI demand for CPUs may translate into strength for Nvidia, too.

Second, considering this potential for another fantastic earnings report from Nvidia, investors may see real opportunity in the company's valuation right now. The stock trades at about 24x forward earnings estimates, which looks dirt cheap considering earnings performance so far and the enormous growth potential moving forward.

So here's what's happening with Nvidia stock: Investors are once again confident about Nvidia's AI story, thanks to the clues mentioned above, and with more optimism regarding the general market environment, they're ready to rotate back into growth stocks -- particularly at bargain prices. And now, with Nvidia's earnings report on May 20 as a possible catalyst, growth investors are buying the stock hand over fist. All of this suggests that this isn't just a temporary rebound, and this positive momentum may be set to last.

Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Intel, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.