Chapter 37: Semiconductors as Secular Growth: Nvidia
Dear Clients,
We are writing with an update of our portfolio positioning within a long-held segment of the portfolio, semiconductors. Long-time readers will know that we have been long-term investors in the secular growth characteristics of this sector – microchips are prevalent in all areas of our lives, from the consumer electronics we use to the data that we consume, to automotive and connectivity applications, to power and sensors. As these microchips become smaller and more advanced, they require greater R&D investment to design and manufacture, leading to increased investment in the overall sector. With the introduction of generative AI which creates more storage and integration of data, the demand for these chips has been accelerated, leading to an additional catalyst for use cases as computing trends continue to scale. In summary, semiconductor trends are less cyclical and more secular. This has been our investment thesis since 2018.
On May 24, 2023, our highest-weighted position, Nvidia, produced quarterly revenue guidance that was over 50% above the median analyst forecast. An earnings beat of this magnitude, especially among large-cap, blue chip companies, rarely occurs. This resulted in Nvidia’s share price appreciating +25% on the day of the report, propelling the company to be valued at $1 trillion in market cap. Demand for Nvidia’s AI graphics processor units (GPUs) was described as “surging” due to the confluence of both accelerated computing trends (as described above) and generative AI. In the span of one short quarter, earnings per share will double, the high-margin data center unit has expanded to 60% of revenue (surpassing Intel’s data center revenues, for the first time), and despite the +25% appreciation in Nvidia shares, the valuation multiple actually shrank as profits will now rise higher than the share price is implying. Moreover, this quarter marked an inflection point in which GPUs will likely overtake their predecessor CPUs, which are not equipped to do this accelerated computing in an era of AI.
Clients are familiar with an example of this accelerated computing – recommender systems, which are the search engines we use such as Google, Amazon, or Bing produced by Microsoft. When a user types in a search query, these recommender systems are quick to make recommendations that will enhance the probability of a user behaviour such as clicking on a link or making a purchase or booking a hotel. With $7 trillion of sales flowing through recommender systems, even a 1% improvement in search effectiveness can improve overall sales by $700 billion. Nvidia’s next-generation GPUs are behind this engine of e-commerce. Even beyond recommender systems, the optimization of workflows and processes within the data center and its networks can produce meaningful economic and productivity gains, as data usage multiplies and its collection is used to optimize decision making. We are still in the early stages of this adoption process across numerous end market verticals including automotive, healthcare, and cloud infrastructure.
At a broader level, clients can see the results of a long-term investment thesis materializing. While there was a minus 63% peak-to-trough downturn in the share price in 2022, we believed that little had changed about the company’s secular growth path, as the building blocks for the industry remained intact, evidenced by healthy R&D growth – even in the year of a recession – a lengthening product roadmap, and earnings that were likely over-recalibrated. As a result, in 2022, we expanded our position in Nvidia and neighbouring semiconductor equipment companies, positioning ourselves for the gains that we are witnessing today. NVDA’s YTD return in 2023 is 164%. We are grateful to clients for their level-headedness during this period of market volatility, where the fundamentals of the company were temporarily out of sync with the share price.
In summary, Nvidia is an example of a cash generative company with a wide economic moat that continues to expand into a growing addressable market where adoption is accelerating. Owner-operator CEO Jensen Huang is a 4% owner in the company, which has no net debt, is capital light, and continues to experience “surging demand” as product adoption continues to pick up. Well-respected growth investor, William O’Neil, founder of Investors Business Daily, passed away at 90 years of age on May 28th, 2023, and once stated, “I never met anyone, or heard of anyone, or read of anyone who was successful who was a pessimist.... You have to be positive, or you’ll never get anywhere.” In paying tribute to this growth mindset, we would like to remind clients that it is the positive, compounding growth characteristics of high quality businesses, held for a long timeframe, that create the most optimal returns because time allows these compounding growth attributes to accumulate. Nvidia would be a case in point.
We hope clients have enjoyed this installment and we are happy to hear your thoughts.
Warmest regards,
Grace Wang, CIM, PFP | Senior Portfolio Manager
Samuel Jang, CFA | Investment Associate | samuel.jang@rbc.com
Leslie Mah | Associate Advisor | leslie.mah@rbc.com | 604-257-7059
Jennifer Hamilton | Associate | jennifer.hamilton@rbc.com | 604-257-2537
RBC Dominion Securities
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