Despite being down 19% year to date, Nvidia's (NVDA 0.95%) stock has delivered more than 400% returns to investors over the last three years. Investors are optimistic about Nvidia's momentum in selling its graphics processors and systems into various markets, such as cloud servers, self-driving cars, and the metaverse.
However, selling graphics processing units (GPUs) to gamers is still the company's largest business, generating 46% of total revenue last year. It's important that Nvidia maintains strong growth in this business to keep delivering good returns to shareholders, and there are good reasons it will.
Steady growth in gaming
Over the last five years, Nvidia's gaming GPU sales grew from $3.8 billion to $11.8 billion. That's an annualized growth rate of 25%. This growth was balanced across higher average selling prices, which rose at 13% per year and unit sales growth of 11% per year.
The latest hardware survey from Steam, a popular online gaming store, shows that less than 15% of Steam customers are using the latest GeForce 30-series graphics cards, or GPUs. This shows that most gamers don't buy a new GPU every year. To post consistent growth in the gaming segment, Nvidia must sell more units every year to new customers. This hasn't been a problem so far, since there have been an estimated 50 million new gamers entering the market each year.
What's more, Nvidia says that only 29% of its installed base of GeForce users have upgraded to the latest RTX family of gaming GPUs. If Nvidia can grow its gaming segment 25% per year with less than a third of the base upgrading, it's easy to see how the gaming business has legs for more growth as existing GeForce users pull the trigger on a new GPU.
There are over 250 games and software applications that have announced support for Nvidia's ray-tracing technology, which is what the RTX refers to. Ray tracing renders shadow and lighting effects with more realism in games. With so many games supporting ray tracing now, more gamers are likely itching to upgrade to take advantage of this feature. But the shortage of chips impacting the semiconductor industry has kept many gamers from buying a new graphics card. Management expects this situation to remain for some time.
However, when gamers upgrade, they spend an average of $300 more than on their previous GPU. Over the long term, Nvidia estimates that gamers will spend over $100 per year on high-performance GPUs across desktop, laptops, cloud gaming services, or consoles. Adding this up, Nvidia says this represents a $100 billion opportunity.
It won't be easy to capture the entire addressable market. There would have to be at least 750 million GeForce users out of an estimated 3 billion gamers globally. Nvidia's GeForce installed base has hovered below 200 million in recent years, so it's doubtful if it will reach that much revenue in its gaming segment. But with the gaming segment revenue reaching $12 billion in fiscal 2021, Nvidia doesn't have to capture a large portion of its addressable market to show strong growth.
At a large market cap of nearly $600 billion, investors are valuing Nvidia based on the expectation of strong growth across the business, not just gaming. But with most of its GeForce installed base using older GPUs, along with the trends toward higher selling prices, Nvidia has good visibility to growth for a segment that generates nearly half of its revenue.
Because of these opportunities, Nvidia might be able to justify its high price-to-earnings ratio of 62, but it will need to continue firing on all cylinders.