Is Nvidia headed for another wealth-destroying drop? The company lost nearly 2/3rds of its market value as recently as 2021 to 2022!
Now the stock is back up, piggybacking on the AI craze.
At its recent highs, Nvidia was valued at over $1 trillion. But over the past week, the price has fallen by almost 10%; analysts say it’s due to the US government refusing to grant licenses to Nvidia to export chips.
But at a price/earnings ratio of over 100, there could be more than one trigger.
Clients who have a significant portion of their net worth in Nvidia should carefully assess their options.
The question is not, “Will Nvidia fall?” but rather, “Am I compensated for the risk I’m taking in Nvidia?”
200 Companies, or One?
Do you think there’s more risk in owning a portfolio of 200 companies, or of owning a single company, even a “good” company like Nvidia?
Finance theory, and almost all professionals, would agree that it is less risky for individual investors to own a diversified portfolio of 200 companies than to own just one company.
At today’s valuation levels, Nvidia, at $1 trillion, is worth as much as the bottom 200 companies in the S&P 500!
Or, Nvidia alone is worth more all the following companies put together:
Mastercard
+ Home Depot
+ Chevron
+ Merck
+ Coca Cola
+ Costco
+ Walmart
+ McDonalds
+ Bank of America
+ Disney!
There is nothing particularly special about these ten stocks. They are ten of the biggest and most well known (and important) companies in the US.
We all know the expression, “Don’t put all your eggs in one basket.”
If you didn’t already own exposure to the US market, would you invest a large chunk of your wealth in a single company like Nvidia? Or would you rather own ten of the biggest and most important companies?
Nvidia’s Future – Irrational Exuberance?
We have no crystal ball, but we can do math.
Since 2000, Nvidia has returned a compounded annual return of about 30%.
Mathematics assures us that it is virtually impossible that it will do so over the next 23 years.
Here’s the math.
Nvidia is worth $1 trillion today.
If that $1 trillion were to grow by a compounded 30% a year for 23 years, that $1 trillion would have to grow to $417 trillion. Let’s put that in perspective.
According to a recent McKinsey study, total GLOBAL assets today are worth roughly $500 trillion.
Global GDP has grown at about 3% since the 1960s. The total value of global assets can’t grow much faster than the GDP growth rate over the long run.
If we compound $500 trillion at 3% per year for 23 years, we get $986 trillion.
In other words, the entire value of ALL GLOBAL ASSETS in 23 years is likely to be about $986 trillion, or roughly 1 quadrillion.
It is nearly impossible that Nvidia alone will be worth almost half the global assets in 23 years. And given Nvidia’s high price /earnings ratio of over 100, it’s pretty likely that Nvidia is overvalued.
Taxes
Aside from an irrational faith that Nvidia can continue to outperform as it has in the past, the main reason people don’t diversify holdings is taxes.
People who have big gains in Nvidia, and sell, will pay a lot of tax.
Solutions
Many advisors are familiar with several possible solutions, including exchange funds, and various hedging strategies. But not all are aware of a tax-exempt Stock Diversification Trust.
A qualifying stock diversification trust is a tax-exempt entity that allows the client to sell a stock, keep 100% of the proceeds available for reinvestment, and produce income for the client and the client’s family. When we run the numbers, using the trust, instead of selling and paying the tax, the family in most cases can expect to get more than twice as much total net spendable income.
To Learn More
Sterling has published a guide to concentrated stock positions. If you would like a free copy, please request it here. Or if you have a current client situation and would like to discuss it with us, please call 703 437 9720 and ask for Connor or Katherine.
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