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A + I equals more than NVDA
OpenAI released GPT-4, the sophisticated Large Language Model (LLM) behind ChatGPT, one year ago. Over that year, Artificial Intelligence (AI) has never been out of the news and the market cap of US tech stocks has risen by 50%1. That rise has been mostly driven by a few names most of whom are building AI models, including Microsoft, Google and Meta. But the largest rise of all has been in a company which is supplying the hardware.
What about NVIDIA?
NVIDIA designs the Graphical Processing Units (GPUs) that the LLMs need to run their huge models. Over the past year its stock price has more than tripled, sending its market cap above $2trn1, and generating huge market excitement. While this share price move has been supported by strong growth in sales and very high margins, its Price to Earnings (PE) ratio of 771 assumes that this growth will continue into the future. But companies such as Microsoft, Meta, Amazon and Alphabet make up nearly 40% of NVIDIA’s revenue† and they are all developing their own chips. Adding in competition from other chip designers will further act to bring down prices and threaten NVIDIAs margins, leading to lower earnings growth in the future.
We have never owned NVIDIA, mainly due to our concerns about the quality of management and the treatment of stakeholders. They have had SEC charges relating to misleading customers, problems with supplier payments and an unsustainably low tax rate. Up until last year, the GPUs that NVIDIA designed have been mainly targeted at the gaming industry and cryptocurrency mining; we believe neither contributes meaningfully to sustainable development, and both have various negative impacts, including the insatiable energy demand of crypto mining and its use in criminal activity.
Synopsys, TSMC and Arista Networks
Consider Synopsys, an $85.6 bn market capitalisation company1 who sell software for electronic design automation and integrated circuit testing. Their software helps NVIDIA design better chips, make fewer mistakes and get to market faster. Synopsys are integral to the design process of most semiconductor companies, including those supplying chips for networking technologies, building automation, healthcare solutions, distributed and renewals energy grids and electric vehicles. We are much more comfortable with their founder-led culture that seeks to build long-term relationships with their customers and trust that they will deal with investors similarly. The share price of Synopsys has almost doubled over the past year and its now trading on a PE of 62 and a 2.8% yield of next year’s free cash flow1.
By making the internet faster and more efficient they contribute to all the benefits that connectivity brings to sustainable development.
Once the GPUs have been designed, they have to be made; like many other companies, NVIDIA uses Taiwan Semiconductor Manufacturing Company (TSMC) to fabricate its chips. The world’s leading semiconductor foundry offers the most advanced semiconductor process technology in the world and has built and kept their marketplace through the extremely high competence of their management. Their position as the only independent fab has allowed semiconductor innovation to flourish while driving down costs and power consumption; all helping to drive human development forward. The share price of TSMC has almost doubled in the past year, raising its market capitalisation to $641bn. Despite strong growth it looks undervalued compared to its potential, trading on a P/E of 20 and a 9% yield of next year’s free cash flow1.
Once the GPUs have been designed and fabricated and the LLM trained, it needs to be made available to users all over the world. Models as large as GPT-4 have to be housed in enterprise datacentres and accessed through the cloud, services which depend upon the network infrastructure provided by Arista Networks. Meta and Microsoft are Arista’s largest customers2 and much better known than this classic “picks ‘n’ shovels” company, but Arista stands to benefit from all the companies competing in the race to produce the best LLMs. And it’s not all about AI. By making the internet faster and more efficient they contribute to all the benefits that connectivity brings to sustainable development. Arista’s share price has almost doubled over the last year raising its market capitalisation to $87.8bn, still only bringing it to a P/E ratio of 43 and a 2.8% yield of next year’s free cash flow1.
We are as excited about the possibilities of AI as anyone else but choose to harness its potential by investing for the long-term in high quality, well stewarded companies at reasonable valuations.
When faced with the extreme short-term emotion surrounding NVIDIA, we feel confident in our investments in Synopsys, TSMC and Arista Networks. Not just because they stand to benefit from increased AI adoption, but also because of the quality of their management, their contribution to sustainable development and their potential to continue to deliver strong returns for the next decade and beyond. Those returns are growing in a sustainable way as all three companies contribute to all the innovative solutions that we are going to need to keep driving human development while doing more with less. We are as excited about the possibilities of AI as anyone else but choose to harness its potential by investing for the long-term in high quality, well stewarded companies at reasonable valuations.
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