Is This One Number From Nvidia a Red Flag for Investors?

Nvidia (NVDA 2.63%) has wowed investors over the past few years with its earnings growth and its share performance. This happened as the company shifted focus from the gaming industry to a position central to the development of today’s most talked-about technology: artificial intelligence (AI).

Nvidia makes graphics processing units (GPUs) that power crucial AI tasks like training and inference, as well as a broad array of AI products and services. The company’s expertise has helped it win 80% of the AI chip market and increase revenue and net income by triple digits in recent quarters.

All of this is fantastic, and investors have rewarded the company by piling into the shares, driving them up 2,900% over the past five years. But amid all of this excitement, one particular number could present a risk for the company and its investors. Should it be seen as a red flag and a reason to sell the stock? Let’s find out.

Image source: Getty Images.

From gaming to AI

Years ago, Nvidia’s chips primarily served the gaming industry, but it soon became clear that the GPU’s ability to handle many tasks at once would make it useful in other areas — in particular, AI. The company focused on building out a complete ecosystem of AI products and services, most recently moving into the areas of enterprise software and sovereign AI (which is targeted to particular countries).

So, companies and countries can turn to Nvidia for all of their AI needs. As a result, AI has emerged as Nvidia’s main business in recent years, and this has driven tremendous revenue gains.

Today, in just one quarter, Nvidia brings in more than double the revenue the company generated in an entire year in 2019. In that fiscal year, it reported $11.7 billion in revenue; in the most recent quarter, revenue totaled $26 billion.

Now, let’s talk about the figure that represents a risk for Nvidia: 86%. That’s the percentage of its total revenue linked to AI, meaning the company has become heavily dependent on this business. Of the quarter’s $26 billion in revenue, more than $22 billion came from the data center segment, which includes AI products and services.

Are its revenue prospects in danger?

This suggests that if companies lose interest in AI, and the technology doesn’t take off as expected in the coming years, Nvidia’s revenue prospects could be in danger. So this represents a risk, since it’s impossible to guarantee the long-term success of a newish technology like AI.

But is it really a red flag that should prompt you to sell or avoid Nvidia? Not necessarily. 

Analysts expect AI to grow from a $200 billion market today to more than $1 trillion by the end of the decade. Even if it falls short, there is reason to be optimistic about growth still being strong enough to power revenue gains at Nvidia.

That’s because AI already has proved its usefulness for some companies and organizations by generating results. We can see this in applications for Nvidia’s enterprise software. For example, ControlExpert uses the platform to allow insurance companies to process motor vehicle claims in just one day, a tremendous gain in efficiency.

Monetizing AI

And companies like Amazon, which offers Nvidia products and services through its cloud computing business Amazon Web Services (AWS), already are monetizing AI. Thanks to sales of AI tools, AWS recently reached a $100 billion annual revenue run rate. Amazon itself also uses AI, to help its e-commerce business operate more efficiently.

This bodes well for ongoing investment in AI, and that’s great news for Nvidia. So, yes, the company’s dependence on AI for revenue is a risk — but it’s one you can manage as an investor by diversifying your portfolio.

You can buy and hold shares of Nvidia, while also holding shares of companies that aren’t AI-dependent and operate in other industries. Diversification always is a good idea. All companies and industries come with risk — spreading your investments across a few can dilute that risk.

All of this means I wouldn’t see Nvidia’s dependence on AI revenue as a red flag or a sell sign today. Instead, I would take a positive view, seeing this focus on a hot technology as an opportunity for the company to potentially generate more explosive gains down the road.