Investors focused on backward-looking metrics likely missed out on Nvidia (NVDA), one of the most lucrative investment opportunities in the past decade.
Nvidia has been a top-performing stock over the course of 2023 and into 2024. Shares of the chipmaker have climbed, handily outpacing the S&P 500.
Nvidia’s success underscores the importance of looking at forward expectations as opposed to backward-looking metrics. The price-to-earnings ratio is a popular valuation metric that provides insight framed in a historical context. To better assess the stock’s potential, investors needed to also assess its future profitability.
Price-to-Earnings Only Looks Backward
At the end of 2013, price-to-earnings would have suggested Nvidia’s stock was in a bubble carrying a multiple of 17.39 when it was only a fraction of its current price. As of market close on March 13, it sat above $900 per share.
Michael Mack, associate portfolio manager for VictoryShares and Solutions stated, “People may believe Nvidia was in a bubble back at $200 per share rather than looking at what the expectations were for that business to earn. If you were looking at historical metrics, like price-to-earnings, one would have thought it was overvalued. If you were also referencing forward-looking metrics, such as those analyst estimates provide, you wouldn’t think it was expensive. It could lead one to observe and understand why the company’s price had potential upside.”
At the end of 2013, Nvidia was trading at a P/E ratio of 17.39 compared to the S&P 500’s 17.60. However, the chipmaker’s average expected free cash flow yield¹ was 15.59%. In comparison, the index’s average expected free cash flow yield was 4.47%, according to data from Bloomberg.
Nvidia serves as an excellent case study for why investors should assess both trailing and future free cash flow. By assessing the stock’s future potential, investors might have been able to anticipate its strong growth.
“This case study serves as a prime example of why assessing forward free cash flow is important when considering an investment,” Mack added.
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1/ Expected FCF yield is equal to the expected FCF divided by enterprise value. Expected FCF is the average of the trailing 12-month FCF and the next 12-month forward FCF. Enterprise value measures a company’s total value and is often used as a more comprehensive alternative to equity market capitalization.
Free cash flow (FCF) is a company’s net cash flow from operations minus capital expenditures.
Price-to-earnings (P/E) measures a company’s value. It’s calculated by dividing the stock price by the earnings per share. Earnings per share (EPS) measures a company’s profitability. It’s calculated by subtracting preferred dividends from the company’s net income and then dividing by total shares outstanding.
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Portfolios managed by Victory Capital Management Inc. (VCM), including those managed by VictoryShares and Solutions included shares of Nvidia as of the latest reporting period on 3/31/2024. There can be no assurance that those securities remain in or out of the portfolios managed by VCM.
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