The Best Stocks for 2010: NVIDIA

In recommending NVIDIA (Nasdaq: NVDA  ) as the best stock of 2010, I can't point to any catalysts that make the company a must-own stock next year. Unlike fellow computer-centric best stock candidate Apple (Nasdaq: AAPL  ) , I'm not banking on booming sales leading to another record year. Nor does the company sport a compelling value proposition like another best stock candidate and rival Intel (Nasdaq: INTC  ) .

In the short term, NVIDIA will remain a highly cyclical company roughly tied to the demand of the larger PC industry. That said, tailwinds from Microsoft's (Nasdaq: MSFT  ) Windows 7 launch should benefit the company. After a harrowing 60% year-over-year sales decline in its most recent fourth quarter, the company has rebounded admirably. A series of gut-wrenching quarters followed that Q4, but NVIDIA actually managed to grow year over year when it last announced earnings.

NVIDIA might be an odd choice on the surface. While PC sales are rebounding steadily, the disproportionate growth of netbooks shows that consumers are increasingly willing to sacrifice power, instead seeing computers more as browsing tools. That's hardly the kind of shift that benefits NVIDIA's powerful stand-alone graphics cards.

However, as one hand taketh, an even more powerful hand giveth back. I'm recommending NVIDIA partially because it's an industry leader in a larger trend that could take years to develop -- but which promises to vastly reshape the computing landscape, and which has made so many Intel investors flush with riches.

Talkin' bout a revolution
NVIDIA's long been dependent on its graphics-card business to generate the lion's share of its profits. Consumers would install its cards to create glossy graphics for games on their PC's. If that sounds like a business with shaky long-term prospects, it is. However, the true power of graphics processors was obscured in their former "gaming-centric" incarnation.

In recent years, graphics cards have been shifting to more practical applications. While central processors remain ideally suited as the workhorse in basic computer processes, powerful common visual processes like rendering high-definition video, or editing graphics and photos, can benefit tremendously from the legion of processing cores on a graphics chip. Developers have taken note, and industry standards increasingly support computing languages that allow programs to access the graphics processor for better performance.

However, GPUs might be ready to step beyond performing workaday tasks, and into the realm of dedicated supercomputers. NVIDIA boats that its new Fermi architecture can deliver high-performance computing at "1/10th the cost and 1/20th the power of traditional CPU-only servers." 

Fermi is the next evolution of a trend that's long been benefiting NVIDIA. Its Professional Solutions Business grew at a 22.6% compounded annual growth rate between January 2006 and January 2009. Customers found that high-end graphics cards could do much more than create stunning special effects for movies or games. They could also calculate complex equations for the financial industry, perform geological functions for the energy industry, and perform admirably in scientific research. It appeared that halcyon times had arrived for high-performance graphics computing.

Then the recession hit ... and IT budgets fell off a cliff, taking NVIDIA's Professional Solutions revenue with them.

Look out below!
Researcher Gartner estimated in July that IT spending would decrease at a 6% rate in 2009. That alone is a tough pill to swallow, but it's even worse for NVIDIA. Among IT budgets, computer hardware was hit the hardest, falling a steep 16.3% in 2009. While NVIDIA's high-performance computing solutions can save money and are increasingly used for varying purposes, buying into them is a dicey proposition for risk-averse IT and research departments with tight budgets.

Simply put, once IT spending comes back online, there will be an underappreciated pent-up demand for these neglected areas of spending. Look for NVIDIA's high-end cards to outperform expectations in coming years.

Other avenues for growth
It's also worth noting NVIDIA's attempts to branch into other areas that are complementary to its current expertise.

The company is forging ahead with multiple products that take advantage of the trend toward smaller mobile computing. Its Tegra chip, based on low-power Arm Holdings (Nasdaq: ARMH  ) technology, applies NVIDIA's graphical expertise to a small computer on a chip used in mobile devices like MP3 players and cell phones. The company's Ion graphics processor allows NVIDIA to profit from the trend toward netbook computing. It incorporates Intel's Atom processor with an NVIDIA graphics card platform.

Success isn't guaranteed for these products. Texas Instruments (NYSE: TXN  ) , Qualcomm (Nasdaq: QCOM  ) , Samsung, and other entrenched competitors already have compelling mobile processors, and the netbook market is extremely competitive. However, combine these actions with a chipset business that should benefit from recent FTC actions, and NVIDIA is increasingly broadening its revenue base.

Bottom line
NVIDIA's success isn't assured by any means. It faces major competition directly from Advanced Micro Devices (NYSE: AMD  ) in the graphics arena. AMD is staking its future on its Fusion platform, which combines central and graphics processors into a single package. Intel is testing the waters as well; its new low-cost Pineview processor features an integrated graphics core.

The efficiency and size benefits of integrating central and graphics processors remains to be seen. If it's a sizeable benefit, NVIDIA could find itself scrambling for a solution. Of the three main players in the graphics space, NVIDIA is the only company without a central processor component.

Then again, the production setbacks of Fusion, and Intel's difficulty developing its (now on hiatus) Larrabee chip demonstrate the difficulty in graphics-card development. NVIDIA may have history on its side when it scoffs at the efficiencies of combining central and graphics processors, but an investor would be wise to carefully monitor AMD and Intel's progress in this area.

In the end, I see NVIDIA as a sort of "call option" on the growth of graphics computing. The company has a sizeable lead in a market that has tremendous avenues for growth. If the benefits of GPU computing don't materialize to the extent expected, it's still a solid company with an underappreciated economic moat in the complex graphics space. In addition, its leadership in high-end graphics cards should continue to excel even if the consumer space becomes more challenging. The company wouldn't pay off with tremendous benefits, but it should continue to have a large market for its products.

However, if graphics computing does take off, the addressable market looks huge. Count NVIDIA out of your portfolio at your own risk.

Which is the best stock for 2010? See all 13 candidates here.

Eric Bleeker owns shares of NVIDIA, but no other companies listed above. NVIDIA and Apple are Motley Fool Stock Advisor selections. Intel and Microsoft are Motley Fool Inside Value recommendations. Motley Fool Options has recommended calls on Intel and a diagonal call strategy on Microsoft. The Fool's disclosure policy is super-cooled for maximum power with delicious Tang.


Read/Post Comments (10) | Recommend This Article (29)

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 December 30, 2009, at 2:18 PM, TEBuddy wrote:

    AMD is more likely to be a breakout graphics company. NVDA's main source of revenue has been what?? They have main a lot of money with motherboard chipsets, and that business is going by the way side. Their graphics chips are overpriced and now underperform for their price.

    AMD leads the way in graphics technology, having the standard for OpenCL for workstations and Server platforms. Apple now sides with AMD for the most efficient and powerful discrete graphics. Where is the upside for NVDA? Netbooks, if they win their legal cases with Intel that is. The ION is not a cpu though, it is a chipset with graphics for Intel Atom cpus, so do some research. You were talking about the Nvidia Tegra with an ARMH cpu in it.

    AMD now makes the best chipsets and most efficient cpus and gpus. AMD is positioned to take a large share of NVDAs market.

  • Report this Comment On December 30, 2009, at 2:30 PM, TMFRhino wrote:

    Hi TEBuddy,

    #1- NVIDIA clearly breaks out its revenue streams, you could go back and look at their financial statements to see that graphics cards have always been their key revnue driver.

    #2- I didn't say the Ion was a CPU, here's exactly what I said: "It incorporates Intel's Atom processor with an NVIDIA graphics card platform." Graphics card platform being the NVIDIA's chipset + graphics card.

    Foolish best,

    Eric Bleeker (TMFRhino)

  • Report this Comment On December 30, 2009, at 3:11 PM, halomaster wrote:

    Great article. It's mostly what I have been thinking. However, the idea of combining a cpu and gpu into one processor is a terrible idea. It would make the programing more complex than it already is. I'm not sure why AMD and Intel are pursuing it so passionately. Anyway the fusion idea is doomed to fail.

  • Report this Comment On December 30, 2009, at 6:18 PM, jm7700229 wrote:

    Hello? Military apps?

  • Report this Comment On January 03, 2010, at 3:27 AM, SnapDave wrote:

    NVDA is a fine company. But, "best stock of 2010" based on what they might do outside their core competency? You guys couldn't come up with something better than NVDA or INTC?

  • Report this Comment On January 03, 2010, at 9:12 PM, Fool wrote:

    will intel - or someelse- buy nvda??????

  • Report this Comment On January 04, 2010, at 11:43 AM, TMFEditorsDesk wrote:

    Fool,

    Intel has confirmed interest in buying the company in the past - but antitrust rules would probably prevent any such marriage under current market dynamics.

    Totally conjecture on my part, but if AMD were a stronger competitor (picked up more market share), I think an acquisition would have a stronger chance.

  • Report this Comment On January 06, 2010, at 7:30 PM, SnapDave wrote:

    Funny that a INTC/NVDA combo is an antitrust issue but AMD and ATI wasn't?!

  • Report this Comment On January 06, 2010, at 7:31 PM, SnapDave wrote:

    Frankly I wasn't all that happy about that merger.

  • Report this Comment On January 06, 2010, at 7:32 PM, SnapDave wrote:

    But maybe Intel and nVidia need to merge to make it fair.

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