Is NVIDIA Corporation Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does NVIDIA Corporation (NASDAQ: NVDA  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell NVIDIA's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at NVIDIA's key statistics:

NVDA Total Return Price Chart

NVDA Total Return Price data. Source: YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

16.6%

Fail

Improving profit margin

49.1%

Pass

Free cash flow growth > Net income growth

0.4% vs. 73.8%

Fail

Improving EPS

79.1%

Pass

Stock growth (+ 15%) < EPS growth

(19.1%) vs. 79.1%

Pass

Source: YCharts. * Period begins at end of Q1 (Jan.) 2011.

NVDA Return on Equity (TTM) Chart

NVDA Return on Equity (TTM) data. Source: YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

10.5%

Pass

Declining debt to equity

0%

Pass

Dividend growth > 25%

Initiated in 2012

Pass

Free cash flow payout ratio < 50%

31.3%

Pass

Source: YCharts. * Period begins at end of Q1 (Jan.) 2011.

How we got here and where we're going
We first looked at NVIDIA last year, and it has slipped a bit in its second assessment to finish with a still-strong seven out of nine possible passing grades. One failing grade -- the same one that kept NVIDIA from a perfect score last year -- was only because NVIDIA's net income growth exceeded the gains in its free cash flow over the past three years. However, NVIDIA's nominal trailing-12-month free cash flow is more than $100 million higher than its net income. On the other hand, the company's long-term revenue growth has been hindered since last year due to a slowdown in PC sales. How might NVIDIA rev up its revenue growth over the next few quarters and come closer to the perfection that's thus far eluded it? Let's dig a little deeper to find out.

NVIDIA posted better-than-expected revenue and earnings per share for its fiscal fourth quarter earlier this year, primarily on the back of increasing demand for GeForce graphics chips for high-end PC gaming. The launch of graphics-heavy games like Call of Duty: Ghosts, Black Flag, Assassin's Creed IV, and Batman Arkham Origins over the holiday season helped swell NVIDIA's GeForce GTX sales in an otherwise-lousy PC market -- PC games are expected to generate around $20 billion in sales this year.

NVIDIA also introduced two desktop graphics processors based on its new Maxwell architecture earlier this year. The Maxwell chips have already outclassed AMD's Radeon R9270 in power consumption and price for performance terms, which are critical considerations for cost-conscious gamers. Foolish writer Timothy Green points out that NVIDIA's Maxwell-based notebook GPUs are expected to capture a big chunk of the growth in gaming notebooks this year. NVIDIA's $1,000 GeForce GTX Titan Black graphics card has also gained momentum in the ultra-high-end PC gaming market. AMD's (NYSE: AMD  ) Radeon 295X2 GPUs are even costlier, and while it's not likely to be a major driver of sales, this monster card is currently the undisputed king of the high-end market, according to recent head-to-head performance tests. This superiority seriously undercuts NVIDIA's long-standing claim to be gamers' greatest ally in the fight for peak graphics performance.

Earlier this year, NVIDIA also announced the launch of its next-generation Tegra K1 mobile processors, which promise to bring console-quality graphics to mobile devices. The company also foresees strong interest in these chips for use in driver-assistance and self-parking systems for the auto market. Volkswagen will use NVIDIA's Tegra Visual Computing Module to power three new in-car systems, and will use Tegra K1 processors to power its future self-driving initiatives.

Fellow Fool shraf Eassa points out that NVIDIA has not yet won a major placement in mobile for the Tegra K1, which has left investors skeptical about the strength of NVIDIA's future revenue growth. Mobile laggard Intel (NASDAQ: INTC  ) already boasts more than 90 tablet placements for its Bay Trail-T processor, but that company's crowing could simply be a bit of braggadocio to cover up the fact that it simply isn't a force in mobile yet. NVIDIA doesn't need to crow quite as much because it already has a much larger slice of the mobile pie with its older chips. Tegra-powered NOTE 7 tablets were unveiled at the PAX East 2014 gaming convention, so there are some design wins to speak of, even if NVIDIA doesn't feel the need to toot its horn quite so loudly.

Putting the pieces together
Today, NVIDIA has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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