With shares down roughly 15% since the company’s second-quarter earnings report on Aug. 8, Nvidia‘s (NASDAQ: NVDA) legendary bull run might be in trouble. While operational results remain as strong as ever, investors may be growing concerned about the sustainability of Nvidia’s business model and the artificial intelligence (AI) industry as a whole. Let’s discuss two reasons to consider selling the stock and one reason to buy the dip.
Nvidia’s margins look unsustainable
Gross profit margin compares a company’s revenue to the direct production costs of selling its goods or services before overhead expenses like office salaries, advertising, or research. Typically, this metric favors software-as-a-service (SaaS) companies that don’t sell physical products. But with a gross margin of 75%, Nvidia bucks the trend.
For context, Microsoft, the biggest SaaS company in the world, has a gross margin of just under 70%, while Alphabet, the parent company of Google and YouTube, stands at 57%. Nvidia is now selling physical hardware at a greater markup than others can sell digital services. And this dynamic doesn’t look natural or sustainable over the long term.
Generally, free markets tend to compete away excess profitability. And if that doesn’t work, governments tend to get involved.
This month, Bloomberg News reported that the Department of Justice subpoenaed Nvidia in an “escalating antitrust probe” related to its dominant position in the market for AI processors. The report claims that officials suspect the company may be making it harder for clients to use other suppliers and penalizing them if they do.
Nvidia denies the report and claims that its high market share (estimated at 88%) stems from its product’s better speed and quality. Either way, Nvidia’s business practices (legal or not) may be starting to attract the wrong sort of attention. And investors should take notice.
The software side of the industry isn’t carrying its weight
For better or worse, Nvidia has managed to keep competition at bay within the market for AI-capable hardware. That said, the company can’t control the consumer-facing software side of the industry, where cracks are beginning to show in the long-term thesis.
According to The New York Times, the AI boom may be ending, with several high-profile start-ups such as Inflection AI, Stability AI, and Anthropic generating massive losses and/or downsizing their operations. Cloud computing giants like Google or Amazon‘s AWS fare better by targeting the infrastructure side of the opportunity (renting out computing power). But if the start-ups fail, data center demand could also nosedive.
Some of Nvidia’s top customers, such as Meta Platforms, don’t even expect to make money from their AI investment anytime soon.
Meta, which is known for its open-source large language model Llama, is simply trying to stay at the leading edge of the technology. But while this sounds great in theory, it is reminiscent of its failed pivot to the metaverse in 2021 — a money-burning experiment that was eventually shelved amid shareholder backlash.
Shareholders might tolerate companies spending billions on experimental technologies when the economy is buoyant. However, if macroeconomic conditions tighten, managerial teams will be pressured to fall back.
Generative AI might only be the beginning for Nvidia
Despite all these challenges, Nvidia is not a bad company. The chipmaker produces cutting-edge hardware that could quickly find new use cases, even if generative AI demand fades. The most promising opportunity could be self-driving cars, which analysts at McKinsey think could be worth up to $400 billion in revenue by 2035.
Robotics, augmented reality, and even the metaverse could also support demand for Nvidia’s hardware for decades to come.
At the end of the day, long-term investing is the key to sustainable returns in the stock market because it smooths out the market’s volatility and noise — allowing time for a company’s thesis to play out. Nvidia bulls might be willing to overlook some of the chipmaker’s near-term challenges in favor of the bigger picture.
Should you invest $1,000 in Nvidia right now?
Before you buy stock in Nvidia, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Nvidia wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you’d have $652,404!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.
*Stock Advisor returns as of September 9, 2024
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Meta Platforms, Microsoft, and Nvidia. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
2 Reasons to Sell Nvidia Stock (and 1 Reason to Buy) was originally published by The Motley Fool
