NVIDIA's (NVDA 2.57%) pandemic-era results have been great so far. Through the first half of the 2021 fiscal year (six months ended July 2, 2020), revenue is up 45% to $6.95 billion and adjusted net income is up 90% to $2.49 billion. However, even after reporting booming results, shares trade for a sky-high 22.9 times revenue and 63.5 times adjusted earnings per share -- valuations that assume at least a couple more years of similar double-digit growth.

NVIDIA has already laid the groundwork for years of further advance, though. We are witnessing a massive changing of the guard in the semiconductor industry, and NVIDIA is quickly emerging as the new leader in the space. It's technologically more advanced, has a nimble balance sheet, and generates lots of cash to further strengthen its leadership. The takeover and seamless integration of Mellanox in the second quarter could be just the beginning.

A new hardware upgrade cycle is just starting

Much has been said about how COVID-19 is affecting enterprise-grade hardware purchasing. Faced with the crisis, many companies had to scramble to make sure they had the infrastructure needed to keep their employees productive -- leading to a temporary boost in sales for many semiconductor companies.

But CEO Jensen Huang said his company didn't see any pull-forward of revenue in the quarter due to the pandemic. On the contrary, professional visualization sales dipped 30% from last year to $203 million, with many design and manufacturing professions closed down, and the auto segment fell 47% to $111 million. The data center unit -- which grew 167% year over year to $1.75 billion -- got a big boost from Mellanox. Over 30%, or $526 million, of data center sales were attributable to Mellanox. Backing that out, data center sales grew a more "modest" 87%.

Professional visualization and auto were forecast to be roughly even in the next quarter. Data center growth is also expected to ease, but the upcoming holiday shopping season could be the strongest ever for the video game industry. Huang thus said growth is more closely tied to a new hardware upgrade cycle in gaming, as well as upgrades for cloud computing and artificial intelligence. This upgrade cycle is just getting started, and with widespread adoption. To name just two, Alphabet's (GOOGL 0.83%) (GOOG 0.72%) Google Cloud inked new deals for the A100 data center GPU in the quarter, and on the day of NVIDIA's quarterly release, Microsoft (MSFT 0.74%) Azure said it was also making the A100 available in some of its cloud-based AI services.  

The NVIDIA A100 data center unit, a gray box with NVIDIA logo on the front.

The NVIDIA A100 data center unit. Image source: NVIDIA.

Re-thinking the computing unit

This next hardware cycle underpins NVIDIA's longer-term strategy as it reshapes the broader technology sector. Regarding its chip architecture and focus on building data center units, Huang said on the earnings call that "the computing unit is no longer a microprocessor or even a server or even a cluster, the computing unit is an entire data center now." Put simply, cloud computing has changed the way organizations operate and deliver services, and NVIDIA has positioned itself to capture huge computing market share.  

Huang continued to explain two important technologies for the future of the data center and cloud:

One of them... is acceleration, and our GPU is ideal for it. And then the other one is high-speed networking. And the reason for that is because the server is now disaggregated, the application is fractionalized and broken up into... a bunch of small pieces that are running across the data center. That transition is called east-west traffic. And the most important thing you could possibly do for yourself is to buy really high-speed, low-latency networking. And that's what Mellanox is fantastic at. And so, we find ourselves really in this perfect condition where the future is going to be more virtual, more digital.  

In layman's terms, whether an organization needs to link together large parts of its data center to complete incredibly complex tasks, or simultaneously solve many smaller tasks at different locations within the data center, NVIDIA is the one-stop shop to get it done.

Flexing its muscles with the firepower to back it up

At the end of July, NVIDIA had $11.0 billion in cash and equivalents and $6.96 billion in debt on its balance sheet. It has also generated $4.96 billion in free cash flow (revenue less cash operating and capital expenses, what gets added to cash on the balance sheet) in the last 12 months. Rumors have been swirling that NVIDIA might follow up its Mellanox takeover by purchasing chip design and licensor ARM Holdings -- which Japanese consortium Softbank (SFTB.Y 0.74%) bought for $32 billion in 2016.

There would be plenty of regulatory hurdles for NVIDIA to clear to make a deal work, as many of its smaller competitors license designs from ARM. But a deal could help NVIDIA reenter the smartphone market and introduce some competition to Qualcomm (QCOM 4.26%), not to mention help NVIDIA stay competitive on the power consumption front with its chips (as power efficiency is one of ARM's strengths). Thanks to its rock-solid balance sheet and high profit margins, a tie-up between NVIDIA and ARM isn't far-fetched.

If you own or are thinking about owning NVIDIA shares, I encourage you to think about the company over the next decade. Hardware technology can be a slow-moving and hard-to-change monster, and NVIDIA's momentum is going to be hard to slow down. In powering so much of the leading edge of consumer and enterprise computing innovation, this company has a lot to gain in the next 10 years.

I'm certainly not arguing that shares will continue to increase unabated. On the contrary, a pullback will happen -- either as the company's recent revenue streak starts to ease, or if the current GPU boom takes a sudden turn for the worse. But that's the name of the game with the cyclical semiconductor industry. Nevertheless, NVIDIA is quickly taking over as the chip company to beat. Rather than try to time a pullback, I'm holding on to what I have and will be ready to buy more.