Investors have become increasingly optimistic about NVIDIA's (NASDAQ:NVDA) growth prospects again. Over the last year, the company has seen the gaming and data center businesses experience a dip in sales. But signs of a turnaround for the graphics chipmaker's two largest sources of revenue have helped push the stock up 35% in the last three months.

For the most part, NVIDIA's fiscal third-quarter earnings report on Nov. 14 exceeded expectations. The gaming segment showed a healthy increase in revenue over the previous quarter, further validating that demand is coming back. But a soft outlook for Q4 cast a shadow over what was a stellar earnings report. 

Let's take a look at the gaming segment's performance and what management had to say.

A chart showing a red line bouncing higher, headed by a paper airplane flying through the clouds.

Image source: Getty Images.

The comeback graphics chipmaker

Over the last four quarters, NVIDIA has experienced a dramatic comeback. Some investors might have wondered whether the growth story in gaming was over a year ago when revenue collapsed following the bursting of the cryptocurrency bubble.

However, management has been consistent in emphasizing that gaming demand, especially for NVIDIA's Max-Q gaming notebooks, was still there. The fiscal third quarter showed gaming recovering almost all the lost ground, reaching $1.659 billion in revenue compared to the peak of $1.805 billion in the second quarter of fiscal 2019.

Quarterly revenue trend
 ($ in millions) Q4 FY18 Q1 FY19 Q2 FY19 Q3 FY19 Q4 FY19 Q1 FY20 Q2 FY20 Q3 FY20
Gaming $1,739 $1,723 $1,805 $1,764 $954 $1,055 $1,313 $1,659
Pro Visualization $254 $251 $281 $305 $293 $266 $291 $324
Data Center $606 $701 $760 $792 $679 $634 $655 $726
Auto $132 $145 $161 $172 $163 $166 $209 $162
OEM & Other $180 $387 $116 $148 $116 $99 $111 $143
TOTAL $2,911 $3,207 $3,123 $3,181 $2,205 $2,220 $2,579 $3,014

Source: NVIDIA earnings presentation

Gaming revenue was down 6% year over year but improved 26% sequentially in the last quarter. Management credited the performance to strong demand in both desktop and notebook gaming. 

Gamers have been scooping up NVIDIA's Turing RTX graphics cards. The ray-tracing technology that differentiates these chips from anything else on the market has gained a lot of momentum, with every major game publisher supporting it now. The RTX line of graphics processing units (GPUs) now accounts for more than two-thirds of NVIDIA's desktop gaming revenue. 

Demand for the pricey RTX cards, which can cost as much as a new iPhone, contributed to higher margins. Gross margin improved by 320 basis points year over year. Management expects the mix toward high-value products to push margins higher over the long term. 

NVIDIA's mid-tier offering seems to be selling well, too. The latest Steam hardware survey shows that the RTX 2060 ($350) and the GTX 1660 Ti ($280) have been two popular upgrades lately. The 1660 has been rated by PCWorld as the best GPU for gaming on a 1080p display. 

Advanced Micro Devices (NASDAQ:AMD) has generally been viewed as having the stronger lineup at the mid-tier offering, so this is a really good time to launch NVIDIA's 1660 Ti, which provides improved performance over the original 1660.

The other factor driving demand is notebooks, which CEO Jensen Huang believes is on track to eventually become "the largest gaming platform." There are more than 130 NVIDIA-powered notebooks available this holiday season. Clearly, manufacturers who are making all these models see huge demand in the market.

Huang is excited about the prospect of upgrading the more than 100 million gamers who haven't enjoyed the benefits of ray tracing in a game yet. There are several games available this holiday that support the new graphics technology. That, along with surging demand for notebooks, should keep sales strong for NVIDIA's Turing-based RTX GPUs.

Next quarter won't be as strong

NVIDIA saw total revenue increase by 17% sequentially in Q3, but revenue is expected to fall slightly in the fiscal fourth quarter ending in January. Management's outlook calls for revenue to be about $2.95 billion, down slightly from $3.014 billion in fiscal Q3. This is due to seasonal declines in console builds (NVIDIA makes processors for the Nintendo Switch) and notebooks following the holiday season. 

The soft outlook didn't sit well with some market participants, but it's clear the problems that plagued NVIDIA's gaming business over the last year are behind it now.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.