3 Reasons Buying This Artificial Intelligence (AI) Stock Is a Risk… And How It Could Pay Off

This is the typical market performance of a young, hungry growth stock with big dreams and a small market cap. The company will have to deliver tremendous sales growth and profits for years to come in order to earn this gigantic market value. Any misstep along the way could lead to a sudden price drop — either right away or when investors have taken their time digesting the long-term implications of negative news.

Despite its massive market cap and soaring sales, Nvidia doesn’t run the world.

Economic downturns could take the wind out of the AI boom’s sails. Nvidia’s chosen design priorities might be less popular than some other chipmaker’s AI products in a later (and more lucrative) product generation. Regulators in key markets like China and the U.S. may set up firewalls against international trade, undermining Nvidia’s business prospects. Natural disasters have the power to disrupt Nvidia’s supply chains. International conflicts can have the same effect, while also challenging the global economy.

Nvidia doesn’t have direct control over these issues. There is no such thing as a risk-free investment, no matter how well-positioned the company might be and how flawless the management team’s business plan is. Unexpected events can always throw a spanner in the works, and that’s bad news for high-flying market darlings.

But Nvidia is a market darling for good reason.

The chart above showed you how revenue, earnings, and free cash flow results are soaring in the generative AI boom. The valuation ratios are high, but sharply lower than their peaks in the summer of 2023 — the business results are keeping pace with the investor enthusiasm.

And you should certainly mind the competition risk, but Nvidia is still the silverback gorilla to beat in the AI hardware market. Challengers have a lot of work to do, both in the chip-design labs and the marketing department.

I mean, Nvidia is stealing Intel’s spot in the Dow Jones Industrial Average (DJINDICES: ^DJI) market index, reflecting a sea change in the semiconductor industry. And the incoming cash profits won’t sit idle in some bank account. Nvidia’s product development budgets are suddenly among the world’s most generous, giving the company many new tools for defending its dominant market position.

So I understand why Nvidia is a popular investment idea at today’s rich prices and despite many business risks. The company’s footprint on the AI market is inspiring, and those beefy cash profits should help Nvidia perform in the long run.

And the stock has been very good to my own portfolio. I took some profits in February, but left more than half of my position untouched. I’m not buying Nvidia stock at these prices, which look a bit too generous in the context of the risks noted earlier. But I’m happy to hold the remaining shares and see how the AI market plays out over the next few years. A small Nvidia position is almost mandatory for growth investors in 2024.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Anders Bylund has positions in Alphabet, Amazon, Intel, and Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, and Nvidia. The Motley Fool recommends Broadcom and Intel and recommends the following options: short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.

3 Reasons Buying This Artificial Intelligence (AI) Stock Is a Risk… And How It Could Pay Off was originally published by The Motley Fool