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With NVIDIA's 41% Revenue Surge, Some Investors Were Missing the Forest for the Trees

By Nicholas Rossolillo - Feb 18, 2020 at 10:18AM

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NVIDIA is nearly back to peak revenue, and the innovation engine is only getting started.

I say it often, but it's worth repeating: Manufacturing is cyclical, and even innovating semiconductor designers like NVIDIA (NVDA -2.46%) get hit once in a while. After all, when a new end market emerges, the sales surge creates a supply shortage -- but the inevitable slowdown often leads to a period of oversupply and falling prices.

That's just what happened over a year ago now. Here's a quick recap: Booming cryptocurrency values had crypto "miners" scrambling to build rigs, and NVIDIA's graphics processing units (GPUs) were an ideal fit for creating digital tokens. The problem was that NVIDIA's GPUs could be picked up off the shelf at the local electronics store, making it difficult for the company to tell what was being sold for gaming purposes versus cryptocurrency.

Long story short, a steeper-than-anticipated sales decline ensued once the cryptocurrency bubble popped. A rebound was eventually inevitable, so shares have been in strong rally mode since mid-2019. Many investors have nevertheless been steering clear of the stock, citing high valuation using nearly every metric there is -- except for the future potential of the pioneer. That sales rebound is well underway, and the fiscal 2020 fourth-quarter report is proof that underestimating the power of the GPU is a mistake.

A robotic arm holding an NVIDIA chip.

Image source: NVIDIA.

A massive sales rally

What many investors overlooked, and perhaps still overlook, is that NVIDIA is more than just a video game company -- or even a passing fad getting a one-time boost from cryptocurrencies. There is a lot going on under the hood, with GPUs only just beginning to power data centers, artificial intelligence systems, and devices ranging from small robotics to autonomous cars. The industries putting them to use are just as diverse, from retail to healthcare, telecom to industrial manufacturing. NVIDIA has been announcing novel applications, like cloud-based gaming, natural language conversation, healthcare imaging and the study of genomics, manufacturing quality control, even processing of the mail at the U.S. Postal Service, at a steady pace.

And these are just a few of the new GPU applications. Put simply, NVIDIA thinks the GPU is the key to the future of computing as Moore's Law, the observation that transistor density of traditional CPUs was doubling about every two years, no longer applies (or the pace is slowing or changing -- depending on who you ask). Regardless, the power of the GPU is that, rather than solve tasks in a sequential manner like a CPU, it breaks complex tasks into thousands of parts and solves each small section at once (parallel computing, in industry jargon).

Video games and computer graphics were the first applications to make liberal use of the GPU, but NVIDIA always saw that as just the beginning. The numbers are only starting to back that notion up as the company's other reportable segments -- especially data centers and the cloud computing applications they support -- are catching up.

NVIDIA Segment

Q4 2020 Revenue

% of Total Revenue

Segment % of Total Revenue at Crypto Peak in Q2 2019

Segment % of Total Revenue in Q4 2015

Gaming

$1.49 billion

48%

58%

52%

Professional visualization

$331 million

11%

9%

15%

Data center

$968 million

31%

24%

7%

Auto

$163 million

5%

5%

4%

OEM and other

$152 million

5%

4%

22%

Data source: NVIDIA. OEM = original equipment manufacturer. 

And that's the problem with ignoring developing trends, or worse, fretting too much over current valuations. A year ago, at the bottom of the last sales cycle, NVIDIA had a high-single-digit price-to-sales ratio, which some complained was high even then. It's now in the double digits, at 17.1 times fiscal 2020 revenue -- but only 15.9 times sales when factoring for the $3 billion in sales expected in Q1 2021, which equates to another 35% year-over-year increase, following the 41% gain registered in Q4.

An inevitable wave of innovation will lead to booming profits

But hey, NVIDIA is a massive and already-profitable enterprise, so using price-to-sales multiples is a little disingenuous. Besides, as it finishes lapping the steep post-crypto slump of fiscal 2020, its top line is sure to slow down. Measuring profitability is the real way to stick a value on NVIDIA.

And in that department, NVIDIA is also doing just fine. Adjusted earnings per share were 136% higher in Q4, driven by rising gross profit margins (65.4% in Q4), a slower growth in operating expenses, and NVIDIA's share-repurchase program. The stock now trades for 50.1 times 2019 adjusted earnings, but a far lower 31.3 times one-year forward earnings.

If any of NVIDIA's other end markets are worth as much as video games have been -- and I think they are -- then this run is far from over. NVIDIA stock's relentless advance in the last year may be getting a little overheated, but not to a totally unreasonable degree. Those in it for the long haul (at least a few years) should be undeterred.

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