How fast does NVIDIA's earnings need to grow to sustain the current stock price momentum?

Investors need to recognize a reality: the current trading price of NVIDIA's stock already reflects investors' expectations for the company's future growth, and these expectations are even higher than the most optimistic forecasts among Wall Street analysts.

In an article published on Monday, media analyst Mark Hulbert warned that investors are overly optimistic, and it is unlikely that NVIDIA will actually achieve such rapid growth in the near future.

How fast does NVIDIA's earnings need to grow to sustain the current strong momentum of its stock price?

The answer depends on two key assumptions

What will be the return rate of NVIDIA's stock in the next five years?

Hulbert believes that it is almost certain that assuming NVIDIA's stock price can continue to grow at the astonishing rates of the past 1 year (176%) or 5 years (annualized 100%) is unrealistic. As the company develops, the growth rate will inevitably decline.

Being conservative, Hulbert assumes that the annualized growth rate of NVIDIA's stock in the next five years will be 50%, while many optimistic investors expect to maintain triple-digit growth in the coming years.

What will be NVIDIA's price-to-earnings ratio in five years?

Based on the latest fiscal year earnings, NVIDIA's current price-to-earnings ratio is 93. However, a high price-to-earnings ratio will not be sustained indefinitely, so Hulbert expects that NVIDIA's price-to-earnings ratio will almost certainly decrease by mid-2029.

Hulbert assumes that the company's price-to-earnings ratio in five years will be 50. This is also conservative, as the price-to-earnings ratios of semiconductor giants are generally lower than 50, and the lower the assumed target price-to-earnings ratio, the higher the required EPS growth rate.

Based on the above assumptions - NVIDIA's stock price annualized growth rate of 50% in the next 5 years, price-to-earnings ratio of 50, Hulbert calculates that NVIDIA's earnings per share (EPS) need to grow at a rate of 70% per year to maintain its strong growth momentum, more than double the 30% expected by Wall Street analysts.

If NVIDIA's EPS grows at a rate of 30%, its stock price annualized growth rate would only be 15.2%, lower than the expectations of most investors.

Riding on the wave of AI, NVIDIA's stock price surged by 180% in the past year, reaching a market value of $2.8 trillion, just a step away from surpassing Apple. However, if future profit growth falls short of investors' expectations, NVIDIA's stock price could decline.

Qualcomm serves as a cautionary tale

Qualcomm's stock price surged 26 times in 1999, enjoying unparalleled success, but its performance thereafter was disappointing.

Research Affiliates' research calculated that from 1999 to the end of 2022, its annualized return rate was only 2.8% - less than half of the S&P 500 index's return rate

During the twenty-three years, Qualcomm's sales and EPS compound annual growth rates reached 14% and 19% respectively. Moreover, the current profit is 60 times that of the peak in 2000.

How could a stock with "amazing" sales and profit growth lag so far behind the market?

According to Research Affiliates, the answer is: "The good news has already been fully reflected in the stock price!"

Will NVIDIA repeat Qualcomm's mistakes?

A study found that it is very rare for a company's earnings to grow at a rate higher than the median for several consecutive years. Note that the threshold for exceeding the median is much lower than a 30% annual growth rate (based on probability theory, half of the companies can outperform the median).**

This study was published twenty years ago, titled "Level and Persistence of Growth Rates," jointly completed by the University of Illinois and LSV Asset Management. Researchers analyzed all U.S. listed stocks since the 1950s, and found that the number of companies surpassing the median threshold is not large. Twenty years later, a study by Verdad Research reached the same conclusion.

This means that the probability of NVIDIA maintaining its recent growth rate is not higher than flipping a coin. Hulbert wrote that even if NVIDIA can beat the odds, the stock price is unlikely to continue to rise at the recent astonishing pace