The Nvidia blip teaches us an important lesson

Nowadays, no company quite compares to Nvidia. There is its size: despite shedding close to half a trillion dollars of value at one point this week (the highest ever one-day loss in stock market history, a record it can now claim to have broken twice), it remains one of the biggest companies in the world and has the ability to drag a whole index behind it. There’s its share price trajectory – in the past five years its value has risen 10 times more than Apple’s; its multi-billion dollar revenues, making it one of the most profitable companies in the world; and its 70 per cent-plus profit margins. Businesses have been falling over themselves to buy what Nvidia is selling and investors have too.

But this week Nvidia's world was rocked by a small Chinese upstart which sent the equivalent of a three on the Richter scale across the US tech sector. DeepSeek, developed by a company which did not have access to the most advanced computing chips, burst onto the scene offering AI technology similar to that provided by the likes of OpenAI but for a fraction of the cost. It has put the eyewatering capex spending plans of the US technology giants (who are among Nvidia’s biggest customers) into stark relief and put paid to the notion that the US sector has the AI market sewn up.

While the optimism surrounding an AI productivity revolution has driven the incredible boom in Nvidia and the broader Magnificent 7 coterie in the past two years, it is those extraordinary valuations that have kept investors on high alert. Even a small margin decline at the chipmaker has been enough to send investors fleeing. The dotcom boom and bust is well within living memory, and investors know high-flying companies can come crashing down to earth.

It’s true that Nvidia could not be further from a dotcom-style pre-profit or growth-free opportunist, and that it has a compelling story to tell about how its powerful chips are changing the world through AI, driverless cars, robots and data centre upgrades. In the words of Franklin Templeton, “even modest [AI-driven] gains in productivity, spread across the world’s billion knowledge workers, would represent a massive shift in economic output and profitability”. Yet holes can be picked in the bull case for the company. Investor exuberance or nervousness pushing the shares too far in either direction is a constant threat.

As much as the high valuations are a worry, the many billions of dollars being poured into AI capex have also raised eyebrows and led to questions about spending sustainability.

Deutsche Bank notes the idea that “bigger is better” in AI is now being challenged, putting current business plans in question. If the need for and access to compute that others simply cannot match is taken away, “a new breed of competitors may be able to flourish,” it says.

Its figures show that Nvidia’s annualised earnings growth rate over 10 years has been 59 per cent, and 89 per cent over five years, compared to 9 and 11 per cent at Apple. The consensus annualised earnings growth forecast for the next five years is 22 per cent (versus 9 per cent at Apple). 

Even if the current business model is not upended, demand for the company’s powerful chips is likely to fall if the AI revolution fails to deliver the hoped-for productivity gains. Recessions or the return of interest rate hikes to combat inflation could also trigger a severe price correction. Companies could cut back their investment and AI spending. Nvidia could be forbidden from selling any more of its chips to Chinese customers, which (notwithstanding existing restrictions) would deny it a fair whack of revenue. 

Investors are right to be on their guard. One outcome of the Magnificent Seven age has been the distortion of global markets and indices, creating a concentration risk given the weight of these companies in normally well-diversified global indices. Even worse, it has sucked funds from other markets, pumping up the top segment of the US market even more.

DeepSeek has cast the whole US tech sector in a much harsher light. It is a reminder of the real threats that exist to the dominance of these market gods and those high valuations, despite the support of their huge earnings.