How long can Nvidia ride the capex boom?

Kevin Cousins

Big technology advancements occasionally catalyse whole industries to embark on massive capital expenditure (capex) programmes.

These events involve powerful narratives that drive strong bull markets as capex spend is often extrapolated years into the future. But they tend to end abruptly, as in reality future capex is highly sensitive to changes in managements’ growth assumptions. Nvidia is currently capturing a huge proportion of AI-related capex spending, which is expected to continue growing for many years.

Why are capex booms so powerful?

Capex booms are rare and dramatic events with huge market implications. Below, we provide more detail on two historic examples of capex booms: US railroads, and the technology, media and telecoms (TMT) bubble. They have the following in common:

• A new transformative technology with the potential to change the world.
• Key companies that benefit from the boom are rerated to enormous valuations.
• Index composition becomes concentrated into the key stocks.

The rapid rerating of affected stocks tends to take the whole market with them to highly elevated levels. Importantly, capex booms result in very rapid reported earnings growth. This is because the companies doing the selling (e.g. Cisco in the TMT boom) record the sales revenue, while the companies doing the spending capitalise the cost and depreciate it over many years. Consequently, the industry profit pool grows dramatically (while the free cash flow pool does not, but few investors seem to focus on this). The technological developments are validated by the rapid profit growth, creating a positive feedback loop and an immensely powerful narrative.

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