NVIDIA Explodes

And so it was that on the day before Independence Day, NVIDIA (Nasdaq: NVDA  ) investors declared their independence from any chance of profiting on their stock this year.

After markets had safely closed for the day (or so we thought) on Wednesday, NVIDIA stunned the market with an earnings warning. Upon waking Thursday morning, investors found their stock down nearly 30% -- and by all the evidence, promptly locked in those losses by selling their shares, which ended the day down more than 30% (and down on Monday).

Happy July 4th!
But was the news really all that bad? Bad enough to justify wiping out more than $3 billion in market cap overnight? Let's find out. NVIDIA's earnings warning consisted of two parts:

  • First, citing "end-market weakness," "delayed ramp of a next generation MCP" (multi-chip package), and a price war on graphics processors, NVIDIA took an ax to sales forecasts for the fiscal second quarter 2009. NVIDIA now expects to book between $875 million and $950 million in sales; about 17% below analyst expectations. NVIDIA did not say how much it would earn on those sales, but lower economies of scale are rarely a boon to profit margins, and price wars never are. (The two main culprits for the supposed price war, Intel (Nasdaq: INTC  ) and AMD (NYSE: AMD  ) , got dragged down by NVIDIA's report, but not nearly as far.)
  • Second, and further threatening profits, NVIDIA confirmed that "warranty, repair, return, replacement and other costs and expenses" for certain defective MCPs and GPUs (graphics processing units) will subtract $150 million to $200 million from this quarter's earnings.

Now let's put that in context. Put on your rose-colored glasses and assume NVIDIA manages to earn last year's Q2 margins on this year's (lower) Q2 sales. Applying a 19.8% operating margin to the midpoint on NVIDIA's sales guidance gives us operating profit of about $180 million. Subtract from that the anticipated charge to earnings, and I think you'll agree that NVIDIA will be lucky to report any profit whatsoever this quarter. I'd lay odds that it will report a loss.

What next?
Peering out a little further, according to Capital IQ, analysts predict that NVIDIA will earn $0.59 per share this year -- meaning the shares trade for about 20 times this year's earnings. If that seems a bit steep considering that earnings are going down rather than up, then consider this: These same analysts expect profits to rebound 60% next year, then tack on another 23% in fiscal 2011.

Call me a Fool, but I can't help but think this is what people mean when they talk about a "buying opportunity."

Related Foolishness:

That's my theory, at least. To learn what the stock N-vestigators at Motley Fool Stock Advisor think about their recommendation's recent performance, grab a free trial to the service and review our analysts' latest updates. Intel is a Motley Fool Inside Value selection.

Fool contributor Rich Smith does not own shares of any company named above. Why do we tell you this? Because The Motley Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 09, 2008, at 2:22 PM, davidkellis wrote:

    Just finished reading an article about the "certain defective MCPs and GPUs (graphics processing units)" that are expected to "subtract $150 million to $200 million from this quarter's earnings."

    The short answer from The Inq.:

    "Don't underestimate how bad this is going to be for NV, we highly doubt $200 million will even begin to cover it." - Charlie Demerjian

  • Report this Comment On July 10, 2008, at 1:10 PM, desdecardo wrote:

    I build PCs as a hobby and my weapon of choice for a processor has always been AMD. The absolute best north/south bridge chipsets for socket 939 and AM2 processors is NVIDIA and that's what I use for motherboards as well as video cards. IMHO, NVIDIA just makes a superior product. While I have run into a number of bad video cards damaged from bad ESD practices, I have yet to pull a bad device from the box (knock wood).

    I think the most telling thing here would be what inventory is doing; If inventory is increasing month over month, there may be some justification for the pull back. If not, this really is a great buying opportunity.

  • Report this Comment On July 14, 2008, at 3:56 PM, jcrash wrote:

    All depends on your time horizon.

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