Will Nvidia Beat the S&P 500 for the Third Consecutive Year After Gaining 819% in the Prior 2 Years?

Nvidia (NASDAQ: NVDA) has more than recovered from a brutal sell-off in April. At the time of this writing, Nvidia is up 17.5% year to date compared to a 5% gain in the S&P 500 -- putting the chip giant on track to outperform the benchmark index for the third consecutive year after gaining over 819% in 2023-2024. There are plenty of reasons to believe Nvidia can continue being a winning investment for years to come.

If you were to go back in time five or 10 years and ask investors what the most valuable company would be entering the second half of 2025 -- most folks probably would have said Apple, Microsoft, Amazon, or Alphabet. All four of those companies produced excellent returns over that period -- but none compare to Nvidia -- which is now the most valuable company in the world and is within striking distance of becoming the first $4 trillion company.

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Here's why the growth stock is a buy now, but why Nvidia is unlikely to generate explosive gains going forward.

Image source: Getty Images.

Earnings-driven growth for Nvidia

Nvidia gets a lot of attention for its outsize stock performance. At first glance, the surging stock price looks like a bubble full of hot air and euphoria. But what's so unique about Nvidia is that its stock price actually mirrors the company's performance.

In just a few years, Nvidia has gone from inconsistently profitable to a high-margin cash cow. Notice how Nvidia (the pink line) went from having very little net income to becoming one of the most profitable companies in the world.

Data by YCharts.

As you can see in the above chart, Nvidia is fifth behind Alphabet, Apple, Microsoft, and Berkshire Hathaway in terms of trailing-12-month net income. Nvidia's secret sauce isn't sales -- it's high margins. Here's that same list of companies, but ranked in order of profit margins.

Data by YCharts.

Nvidia is converting over half of its sales into net income -- which is incredible for a company that designs a physical product rather than selling software or operating a digital ecosystem.

Full steam ahead on AI spending

Companies with capital-light business models and high margins deserve premium valuations because they don't need to invest a lot of money to make money.

Nvidia outsources its chip manufacturing to partners like Taiwan Semiconductor Manufacturing, similar to how Apple doesn't manufacture most of its products. However, the key difference is that Nvidia mainly sells to businesses, whereas Apple sells to consumers.

Nvidia's key customers are hyperscalers -- the other big tech companies that demand power for cloud computing, to run artificial intelligence (AI) models, and more.

Despite trade tensions and tariff pressures, many of these companies showed no signs of reducing capital expenditures -- a vote of confidence that they are taking a long-term approach to AI.

With sales pouring in for its high-margin chips, Nvidia can fuel its research and development budget for its next generation of products and take risks without straining its cash flow. As long as this virtuous cycle continues, Nvidia will likely be able to continue outperforming the S&P 500.

In addition to having high margins, Nvidia also has an impeccable balance sheet that allows it to aggressively invest in innovation without impacting its financial health. The company exited its most recent quarter with $53.69 billion in cash, cash equivalents, and marketable securities and just $8.46 billion in long-term debt. Having a strong balance sheet and high margins means that Nvidia can afford to take risks without needing every bet to pay off.

Nvidia isn't without risks

Despite these advantages, Nvidia does have some challenges that could impact the stock going forward. Competition is heating up as other companies try to eat into Nvidia's dominant market share. For example, Broadcom is seeing phenomenal demand from hyperscale customers for its AI chips.

Nvidia is also vulnerable to geopolitical risk, both in terms of manufacturing and selling its chips. When trade tensions were heating up in April, Nvidia said that it could take a $5.5 billion charge directly related to tariffs and trade restrictions with China if tariffs persisted.

Another risk is the investment cycle. Nvidia's key customers are spending a lot on chips right now because we are still in the early innings of AI investments. Some customers may take their foot off the gas as the market matures, impacting Nvidia's growth rate.

Finally, there's the law of large numbers. It was much easier for Nvidia to compound when it went from single-digit billions to tens of billions in net income per year. But the larger the company gets, the harder it will be to grow profits at a breakneck rate. Hyperscalers are spending on AI, but they need to see these investments pay off to boost their budgets and, in turn, order volumes from Nvidia.

To be fair, a growth slowdown is already projected in analyst consensus estimates, which call for $4.29 in fiscal 2026 earnings per share (EPS) and $5.76 in fiscal 2027. But even if Nvidia's growth slows to around 30% per year, the stock is arguably still a great value. At $157.75 per share at the time of this writing, Nvidia would have a 36.8 price-to-earnings (P/E) ratio based on fiscal 2026 EPS estimates (and if the stock price remained flat) and a 27.4 P/E based on fiscal 2027 estimates.

Nvidia can continue outperforming the S&P 500 over the long term

Nvidia makes incredibly complicated, cutting-edge products. But its investment thesis is beautifully simple.

Nvidia's earnings growth can justify a higher stock price as long as its customers keep paying top dollar for its chips and other solutions. However, investors should be on the lookout for potential spending pullbacks from key customers or margin erosion from competition.

So far, there have been very few signs that indicate Nvidia's investment thesis is weakening.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Bank of America is an advertising partner of Motley Fool Money. JPMorgan Chase is an advertising partner of Motley Fool Money. Daniel Foelber has positions in Nvidia. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Bank of America, Berkshire Hathaway, JPMorgan Chase, Meta Platforms, Microsoft, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.