NVIDIA (NASDAQ:NVDA) is experiencing the strongest upgrade cycle in company history with its new Ampere graphics processing units (GPUs). Gaming revenue grew 41% year over year in fiscal 2021, and there are three reasons this momentum could stick around long-term. 

1. Gaming is getting social

The flexibility of the PC as a gaming platform puts NVIDIA in a great position to see further growth in gaming. For example, more players are engaging with esports titles while communicating with their gamer buddies through Discord, a popular messaging platform that now has 140 million active users. Discord is not easily accessible for gaming console users.  

There is also a growing number of players that are live-streaming their gameplay, which puts a lot of stress on a PC's processor. These trends are fueling sales of NVIDIA's high-end gaming GPUs. The company's gaming revenue has increased at an 18% compound annual rate over the last four years, reaching $7.7 billion in annual revenue, or nearly half of NVIDIA's total business. 

A young man sitting in front of multiple monitors while playing a video game on a PC.

Image source: Getty Images.

The growth of the company's gaming segment doesn't show signs of slowing. In its recent investor day presentation, NVIDIA management noted that the audience for esports has grown by 75 million over the last two years to reach roughly 436 million viewers. That's an important number because 75% of NVIDIA's installed base of graphics card users play esports titles. A growing esports market just creates more buzz around each new gaming GPU that NVIDIA launches.

2. Most GeForce users are playing on older GPUs

The latest big-budget video games are starting to support high-end graphics features, such as ray tracing and deep learning super sampling (DLSS) -- technologies that NVIDIA introduced with the launch of its Turing RTX GPUs in 2018. Games are getting more immersive and more realistic looking with every new GPU generation, providing a natural incentive for players to upgrade their computing hardware.

NVIDIA has a large installed base of 140 million GeForce users. Many of those are already upgrading to Ampere, as management noted when discussing NVIDIA's recent revenue results for the fiscal fourth quarter. The company reported that sales of its new Ampere RTX 30 series GPUs are outpacing prior generations by two times. But with 85% of users still using older GPUs, NVIDIA still has a deep well of potential sales.

3. Higher selling prices

The strong upgrade cycle underway could be huge for NVIDIA's profits. About half of NVIDIA's growth in gaming revenue stems from higher average selling prices. This means as gamers upgrade, they are fueling a meaningful improvement in NVIDIA's gross margin

Average selling prices for GeForce GPUs have climbed at an 11% annual rate over the last five years, while unit growth has been equally strong. On a non-GAAP basis, NVIDIA saw its earnings per share jump 73% year over year in fiscal 2021, partly reflecting higher gross margin across the data center and gaming segments. 

"We expect this trend to continue over the coming years as gamers upgrade to Ampere," CFO Colette Kress said at NVIDIA's 2021 investor day. Management reported that its revenue is tracking ahead of its previous outlook for the fiscal first quarter. It had forecast $5.3 billion in revenue, representing a year-over-year growth rate of 72%. 

The bigger takeaway is what the increasing selling prices say about the strength of the GeForce brand. NVIDIA commanded an 82% share of the discrete GPU market in the fourth quarter, extending its lead over rival Advanced Micro Devices (NASDAQ:AMD).  

The widening lead over AMD, combined with the trends in streaming, esports, and a wave of new games supporting NVIDIA's feature-rich RTX GPUs explains why investors are paying a high valuation for this growth stock.

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.