Nvidia has become the combined Taylor Swift and Shohei Ohtani of stocks: glamorous, constantly hitting the ball out of the park, literally and figuratively, attracting millions of frenzied fans who pay to bask in their magic. Like Swift and Ohtani, Nvidia has amassed astonishing statistics: $2.5 trillion in market cap created in just 10 months, with investors frantically trading their shares far more than any other. In just a year, Nvidia has become a real star.
But the entertainment industry analogy falls apart when it comes to what fans pay for. Acolytes of Swift and Ohtani buy expensive tickets for a few hours of galvanizing fun, while Nvidia investors want their money back and then some. A closer look at the data shows that long-term investors who buy the stock at recent prices are unlikely to achieve the expected returns.
The analysis is based on economic profit, also called economic value added (EVA), a fundamental measure that avoids distortions in the accounting that listed companies must use. It’s all about capital, how much it costs and how well a company uses its capital to make profits. Research has shown that this analysis method is more predictive than looking at earnings per share.
An economic profit analysis collected on FortuneThe request from Institutional Shareholder Services’ ISS EVA shows that Nvidia is every bit the superstar it appears to be. You don’t have to be a financial nut to understand these numbers: Nvidia’s return on capital over the last four quarters is 140%, while its cost of capital is 9.3%. “Baffling,” says Bennett Stewart, one of the pioneers of economic profit analysis. “It’s hard to fathom how they could get a much higher return on capital.”
Here’s how amazingly Nvidia makes money. ISS calculates EVA data for 21,000 listed companies worldwide, reporting Nvidia in the 100e percentile for profitability. That doesn’t mean Nvidia is in the top percentile (which is 99e percentile). It means that Nvidia is above all those other 21,000 companies, or may have ties to some of them.
But these remarkable numbers reflect the past, and stock prices are based on the future. So the crucial question for investors is: what are the chances that Nvidia will perform well enough in the coming years to justify its share price, which was recently around $136? EVA can help answer that question.
We asked ISS EVA to calculate how quickly Nvidia would have to increase its economic profits annually over the next twenty years to justify its recent share price. The answer: 21.4%. Nvidia must increase its economic profits by 21.4% every year for 20 years. If it can’t do that, the recent stock price is too high.
