How Nvidia (NVDA) Can Justify Its Stock's Sky-High Valuation

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Shares of Nvidia NVDA gained about 1.5% on Friday, extending the red-hot stock's impressive run and lifting its three-month gains to over 25%. The Wall Street darling remains a dominant player in the gaming industry, but its ongoing rise to the top of the technology sector comes on the back of tireless advancements in autonomous driving, machine learning, and artificial intelligence.

Nvidia's investments in these budding industries have also been paying off in the form of rapid earnings and revenue improvement, with the graphics-chip maker notching adjusted EPS expansion of 61% and sales growth of 41% in its most recent fiscal year.

One of the company's main growth drivers has been its Datacenter segment, which includes its AI-powered DGX and Tesla products. In the latest full quarter, Nvidia witnessed Datacenter revenues of $606 million, up about 105% year over year.

But this surge has, at times, allowed Nvidia's valuation to skyrocket into speculative growth stock territory, leading some cautious investors to declare it a bubble that is doomed to burst at the first sign of trouble.

With that said, I want to show one NVDA chart that I think every investor needs to see-regardless of whether you are bullish or bearish on the company's future.

Here's how Nvidia's Forward P/E currently stacks up against its peer group:

Our system places seven other companies into Nvidia's peer group: Texas Instruments TXN , STMicroelectronics STM , Intel INTC , THK Co. THKLY , Sumco SUOPY , Xcerra XCRA , and Amtech Systems ASYS .

This is obviously a diverse group of stocks, with some serving as direct competitors to Nvidia in certain key businesses-and others focusing on different markets entirely. This group is not perfect for direct comparisons, but it does help show how investors value other companies in the evolving semiconductor industry.

There are at least a couple of observations to make here. First, NVDA is trading with its lowest Forward P/E in nearly a year. For Nvidia bulls, this is probably a reason to buy even more. In the several quarters since the stock was previously trading at these levels, the company has done nothing but prove its insane growth and potential.

And of course, we can see that Nvidia is trading at a significant premium to its peer group. This is where investors really need to step back and ask themselves one major question: What exactly is Nvidia doing that warrants this type of valuation?

To many, the answer is pretty clear. Nvidia is on the cutting edge of the artificial intelligence industry, which should put it in a leadership position in a budding market that promises to change the nature of humanity forever (also read: Two "Artificial Intelligence" Stocks You Should Buy Right Now ).

Its products are also the go-to hardware for smart vehicle manufacturers, who need Nvidia's top-of-the-line technology to power advanced in-car systems. Meanwhile, Nvidia GPUs are the top choice among serious PC gamers, which continues to be a strong core business for the company.

Moreover, Nvidia has been identified as a strong option by our proven Zacks Rank system. Our model places an emphasis on earnings estimates and positive estimate revisions, and ever-improving analyst sentiment surrounding NVDA helps the stock earn our top mark.

Over the past 30 days, the Zacks Consensus Estimate for Nvidia's full-year earnings has gained a staggering $1.54, indicating that analysts are struggling to keep up with the company's lightning-fast growth. Thanks to this revision activity, NVDA is sporting a Zacks Rank #1 (Strong).

Nvidia is an expensive stock. But investors simply have to pay a premium for a company of this quality right now. NVDA is poised to outperform the market over the next one to three months, and it is on track to be a dominant tech powerhouse for years to come.

Want more market analysis from this author? Make sure to follow @ Ryan_McQueeneyon Twitter!

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Amtech Systems, Inc. (ASYS): Free Stock Analysis Report

STMicroelectronics N.V. (STM): Free Stock Analysis Report

Intel Corporation (INTC): Free Stock Analysis Report

Texas Instruments Incorporated (TXN): Free Stock Analysis Report

NVIDIA Corporation (NVDA): Free Stock Analysis Report

Xcerra Corporation (XCRA): Free Stock Analysis Report

SUMCO CORP ADR (SUOPY): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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