Is Nvidia in Trouble? Or Is This a Buying Opportunity?

Sometimes, companies choose to divulge earnings before their scheduled date. Nobody does this if results are in line -- it's only done if they are either really good or terrible. This decision to report early is a sign of honest management as they want shareholders to know if anything drastic has occurred that could change the investment thesis.

Nvidia (NVDA 1.34%) did precisely that, choosing to release its results three weeks early. Unfortunately for investors, the news was terrible. After the release, the stock traded down around 8% but has since recovered those losses, and then some, due to the broader rally in the market.

That seems like an odd reaction to a terrible announcement, but the market sometimes does strange things. So, was this rally truly deserved, or should buyers beware? Let's find out.

The bad news

Nvidia experienced a tough quarter. While management guided in Q1 for $8.1 billion in revenue during its 2023 fiscal year second quarter (ending July 31), Nvidia only brought in $6.7 billion. That's a 17% miss, a rarity for a reliable company like Nvidia. However, looking at Nvidia's five segments reveals much more.

Source: Nvidia. Chart by author. QOQ = quarter over quarter. YOY = year over year.

The two smaller segments hardly make up any of Nvidia's revenue, so they aren't worth digging deep into. Professional visualization is slightly bigger but dependent on discretionary business spending, which is why it had a challenging quarter.

The most glaring result was gaming's significant year-over-year (YOY) drop. Management pointed to declining sales due to weaker end-demand despite providing its products to distributors. Clearly, this weakness isn't a supply chain problem; it's a demand one.

However, this isn't surprising as its gaming division also supplies the GPUs (graphics processing units) that crypto miners utilize. With the decline in crypto prices and rise in energy costs, it's not as profitable (and in some cases unprofitable) for miners to run their operations, let alone purchase new equipment. The crypto effect and consumers tightening their spending caused Nvidia to miss results drastically.

To make matters worse, Nvidia slashed prices to try to increase demand, causing its gross margin to drop. Of course, businesses can survive if their gross margin falls a few points -- but Nvidia's dropped from 66.7% last year to 43.7% this year. A significant decline demonstrates Nvidia has no pricing power when times are bad -- a terrible sign for investors and Nvidia alike.

On the positive side, Nvidia's data center business had its best quarter ever, though management noted total revenue fell short of expectations. Still, this is a bright spot for Nvidia. While companies may be tightening their expenses, the long-term trend is for a migration to the cloud, which will benefit this division over the long haul.

With all this discussion about revenue, it's easy to forget to check the bottom line of an item that matters: profits. Using Nvidia's preannouncement numbers, Nvidia should post a net income of about $653 million. While down from FY 2022's second-quarter profits of $2.4 billion, it's at least in positive territory.

All eyes and ears will be on the official earnings release (these preliminary numbers can still change) on August 24, when management will field questions and give the all-important Q3 projections.

I'll be looking for a few items. First, I'll want to hear management discuss the crypto effect, as they have often shied away from it. Second, I'd like to learn about the future state of the data center division because it keeps Nvidia's results afloat. Finally, I'll be looking for management to lay out a path forward to regain its gross margin, which will boost profits.

Is there a reason to buy Nvidia stock now?

While I'm a long-term Nvidia bull, there's a lot of uncertainty surrounding the company over the next few months. If the stock was down significantly after the announcement (say 10% or more), I might feel differently. But there's no way you can convince me Nvidia's stock should be higher now than before this announcement. But that's the case.

With the stock trading for a hefty 50 times earnings (this number will go up once official earnings are released due to the denominator in the ratio dropping), it isn't cheap either.

I'm not selling my shares, but I'm not adding either. After I hear what management says, I'll have a better idea of what's going on. After all, they've already dealt with a crypto crash that significantly affected earnings in 2018 and 2019. Nvidia emerged just as strong from that headwind, and I suspect it will do the same this time, too.

But there's a lot of pain and bad news between now and a full recovery, and there will be much better entry points along the way.