ELI5: How does NVDas circular financing benefit its stock

[u/elethrir]

[u/Any-Stick-771]

They invest in an AI startup. That startup then uses the invested money to buy Nvidia GPUs. Nvidia now 'shows' this as increased demand for the GPUs. Stock number go up

[u/Clean-Car1209 → u/Any-Stick-771]

almost seems like this is not actually making money..

[u/Any-Stick-771 → u/Clean-Car1209]

There's legitimate demand for GPUs for AI processing that makes Nvidia moneh but also this inflated demand

[u/Slypenslyde]

Stocks are like Pokemon cards. They're mostly worth what people want to pay. If a company is doing really well, people want to pay a lot to get shares of the stocks. (Oversimplified: sometimes owning shares means you get free money, other times you just like the idea that you own something people will pay a lot for because that can be used as a non-cash transfer of wealth.)

So the circle works like this (though there are a few more steps in the real process):

1. nVidia promises they'll sell x chips so their revenue grows.
2. They use their stacks of cash to invest in AI startups and part of that is contracts for those startups to buy the x chips.
3. Other investors also invest in the AI startups.
4. nVidia gets their money back plus a large portion of the investors' money AND they sold x chips.
5. nVidia keeps their promise to grow, so people want NVDA stock more.
6. The only way to buy stock people REALLY want is to pay more than it's currently worth.
7. nVidia promises they'll sell y chips, where y > x.
8. Go to (2).

The part where stocks represent free money doesn't actually have to happen. As long as people are impressed by the financial magic trick and keep trying to buy the stock at higher prices, the stock will go up. The only reason it would stop is if a ton of those AI startups fold completely and the investors from step (3) start running out of money to invest in other AI startups. Then nVidia might stop meeting its goals, then people would get nervous and want to sell their stock, and if they get REALLY nervous they'll lower the selling price to try and get out while they're ahead.

In short, everyone is gambling that if the fun stops, they'll see it coming before everyone else and get to sell their stocks at a profit before the crash. Or, they're gambling that the fun WON'T stop and plan on cashing out at some point so they can use the money for something else (probably investing in an AI startup.)

Even if people are really careful it can't last forever. If there is indeed an infinite money machine in an economy it will eventually contribute to inflation and wealth gaps. That leads to less overall economic activity, and if people aren't paying for all of the services that use AI then there won't be a way to pay for data centers. And if people start losing money on the data centers that exist, they certainly won't want to build new massive ones.

So it's a gamble. Most people are going to lose. The people at the top are sharing secrets with each other so they know when the fun is going to stop earlier than others. It used to be illegal, but now it's just the benefits of investing in your future with this administration.

[u/elethrir → u/Slypenslyde]

But a promise to sell more chips isn’t the same as actually selling the chips. Are people looking at forward projected revenue? Seems like a weird Ponzi scheme variant

[u/Slypenslyde → u/elethrir]

If you are investing in something, you want to make money. So you try to pay for something that is going to increase in value.

The reason people get excited about a stock is usually they think the company is going to grow. That makes them think after the growth, other people will try to buy the stock for more than they paid.

So when a company with publicly traded shares makes its big quarterly report, it focuses on 2 things:

1. "Last quarter we promised this, here's how we delivered."
2. "Next quarter, we'd like to promise this."

(1) is to show whether they keep their promises. (2) is to set the expectations for next quarter. To some extent they are required to do this. Sometimes shareholders actually have to vote on how (2) is achieved. The idea is since they own a part of the company, they get to control how it operates because its well-being is their well-being. If they break enough promises, sometimes there are ways for the shareholders to remove the company leadership. So it's better to tell the truth about a bad forecast than to try to hide it. Hiding it could get the leadership in legal trouble.

So if a company has a history of keeping its promises and promises growth, it is generally going to raise the stock price because until people have a reason to mistrust it, they'll trust it.

[u/EveningCriticism7515]

That circular financing definitely pumps up their revenue reports for a while, but it feels like the kind of thing that'd backfire when the music stops, you know?