What happened
Shares of the largest chipmaker by market cap, Nvidia (NVDA -3.33%), swooned 16.9% in the month of August, according to data from S&P Global Market Intelligence.
Like many other technology stocks, Nvidia had a nice July rally. However, the picture darkened significantly in August. Early in the month, Nvidia warned investors its second-quarter earnings would come in below expectations, especially its graphics segment. When it reported later in August, management guided for an even worse third quarter.
So what
Beginning earlier this year, there has been a big pullback in personal computer sales, as well as a crash in cryptocurrency prices. That has led to a glut of Nvidia graphics chips on the market and at distributors, causing a big decline in Nvidia's graphics segment last quarter.
Reporting second-quarter results on Aug. 24, Nvidia noted that its revenue grew just 3% year over year and was down 19% quarter over quarter. Margins plummeted as well, as Nvidia took a write-down of inventory likely to be sold at lower prices to clear the channel for upcoming releases. Gaming revenue, which made up 44% of revenue in the prior quarter, fell 33% year over year and 44% quarter over quarter, and was the main culprit behind the lackluster headline revenue and profits.
Not only did the second quarter disappoint, but management also guided for a 12% quarterly revenue decline for the current quarter, forecasting revenue of just $5.9 billion, down from $6.7 billion in Q2. While most had expected muted guidance, the outlook for a decline of that magnitude after last quarter's declines was surprising. That's why the stock sold off hard after earnings.
Things got worse just a couple days later, when Federal Reserve Chair Jay Powell's comments at a meeting in Jackson Hole, Wyoming sent virtually all stocks plummeting to close out the month.
Now what
For those looking for a silver lining, while the data center segment "only" grew 61% year over year and 1% quarter over quarter in the second quarter, management chalked that up to supply constraints of networking equipment, with demand outstripping Nvidia's means to supply. That's a much better problem than the demand destruction seen in the gaming segment.
Furthermore, management pointed to an "inflection point" in its small but growing automotive business on the conference call with analysts. Automotive made up just 3.3% of revenue last quarter, but grew 59% quarter over quarter, so it should make more of a contribution immediately and in the years ahead.
Unfortunately, Nvidia investors got another dose of bad news on Aug. 31 after market close. That's when management issued a press release disclosing the U.S. government will now require a special license for Nvidia to sell its best AI chips to Chinese customers, including the A100 and the upcoming H100. Management said that could affect about $400 million of revenue in its fiscal third quarter, or about 7% of total guided revenue, and about 10.5% of last quarter's data center revenue.
Could things get any worse? Nvidia's shares are down a lot this year, but they still don't look "cheap" in the traditional sense, at 36.6 times trailing earnings. Therefore, even though shares have fallen a lot, this new China news has the potential to cause further declines. While it's possible Nvidia will eventually be granted licenses for nonmilitary customers in China, that's far from certain. Therefore, analysts may be taking down their numbers for Nvidia's addressable market for data center chips.
Yet in the long term, the fact that Nvidia makes such amazing semiconductors that it's banned from selling them to adversarial nations says something about the quality of Nvidia's products, management, and technological capabilities. Furthermore, concerns over the A100 and H100's power in artificial intelligence seems to confirm AI is unlocking powerful new capabilities that could help grow this segment more than people realize in the decades ahead.
That's actually a very positive sign for Nvidia's future. Therefore, long-term investors should look hard at adding this top tech stock during this difficult period -- especially if it falls further.
