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NVIDIA Improves -- or Does It?

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At first glance, you might not expect the news that NVIDIA (Nasdaq: NVDA  ) released last night to be the stuff of which 15% stock rallies are made.

Earnings for the fiscal third quarter of 2009 amounted to just $0.11 per share -- profits were down 74% from last year. However, if you disregard such sundries as stock-option and restructuring costs, it would have earned $0.20 per share (pro forma), so it actually beat adjusted estimates of $0.12 handily.

There and back again
More important than NVIDIA's performance in the earnings game is ... its performance, period. And as discussed in our pre-earnings Foolish Forecast, NVIDIA is making progress in cleaning up its historical issues and laying the groundwork for future growth. Over the course of the quarter, NVIDIA developed notebook chipsets for Intel (Nasdaq: INTC  ) processors, launched its GeForce 9400M GPU for Apple's (Nasdaq: AAPL  ) Mac notebooks, and developed a new accelerator for use with Adobe's (Nasdaq: ADBE  ) Creative Suite 4.

The new products are nice, yet other issues remain. For example, CEO Jen-Hsun Huang boasted, "Improving gross margin while managing operating expenses enabled us to significantly improve our operating fundamentals."

But that depends highly on your point of view. Yes, these numbers were better than last quarter's disastrous 17% gross and operating loss. But apples to apples -- comparing this year's Q3 to last year's -- gross margins did not improve a whit. To the contrary, they tumbled more than 5 full percentage points to 41%. Meanwhile, "operating expenses" surged more than 15% year over year for the quarter. Currently, the company's operating margin is lower than those of Texas Instruments (NYSE: TXN  ) and Qualcomm (Nasdaq: QCOM  ) but better than that of the anemic Advanced Micro Devices (NYSE: AMD  ) .

Meanwhile, the CEO believes that NVIDIA is "now poised to recapture lost share." Partly as a consequence of lost market share, I cannot help noting that NVIDIA's inventories now tower 71% higher than in Q3 of last year.

Foolish takeaway
To this Fool, the extra inventories that must be moved, coupled with the need to recapture lost market share, foreshadow price drops on NVIDIA chips and further margin deterioration down the road.

Granted, the stock's price -- around a 10 price-to-earnings multiple on a predicted 15% grower -- seems to discount this risk pretty well. But is the margin of safety big enough to make NVIDIA a buy after today's price spike? That, I'm no longer certain of.

For further Foolishness on NVIDIA:

Intel is a Motley Fool Inside Value pick and a Motley Fool PRO recommendation. NVIDIA and Apple are Motley Fool Stock Advisor picks. The Motley Fool also owns a few shares of Intel.

Fool contributor Rich Smith owns no shares of any company named above. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

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 November 07, 2008, at 7:56 PM, Jordan3i4 wrote:

    I respectfully disagree with the valuation technique. Predicted growth rates from analysts are almost always incorrect by a large margin. The company has been growing 50% in the past 5 years, what will make their growth slow to 15% in the next 5? In terms of price to earnings, one would be better off using an estimate of earnings during "normal" times, i.e. not during a recession or boom. Using trailing twelve months may not reflect the company's true earnings potential - in this case not at all, since it would include NVIDIA's disastrous Q2, and bad, but improved Q3.

  • Report this Comment On November 08, 2008, at 12:24 PM, Jordan3i4 wrote:

    What do you mean by the question mark..

  • Report this Comment On November 08, 2008, at 1:42 PM, Jordan3i4 wrote:

    The market share NVIDIA has lost recently will likely be won back with their 9400M chip. Apple, Dell, and many other OEM's will be producing notebooks with this NVIDIA chip in 2009.

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