After a disappointing fiscal second-quarter earnings report for the period ending July 31, shares of Nvidia (NVDA +2.72%) slumped and are now down more than 57% from their all-time highs. The company reported underwhelming results, posting just 3% year-over-year revenue expansion. The semiconductor company also expects fiscal third-quarter revenue to reach just $5.9 billion, a 17% decline versus the year-ago period.
Why is the company decreasing guidance and projecting a challenging end to 2022? More importantly, should investors be concerned about this?
Image source: Getty Images.
Why is the stock down?
The primary driver of the disappointing quarter and the tepid guidance is the declining demand for its gaming graphic processing units (GPUs). Management noted that as macroeconomic challenges affect consumers, the demand for high-quality gaming GPUs started to fall.
As the company's chief financial officer Colette Kress explained, China is also putting a dent in its results. "Sales to North America hyperscale and cloud computing customers increased but were more than offset by lower sales to China hyperscale customers affected by domestic economic conditions," Cress said during the company's recent earnings call.
Outside of the company's earnings report, Nvidia is being impacted by export regulations. On Aug. 26, the U.S. government imposed an additional license requirement for exports to China, Hong Kong, and Russia for two of Nvidia's integrated circuits. Nvidia no longer sells products in Russia, but China and Hong Kong generated $7.1 billion in fiscal 2022 revenue, representing 26% of total revenue. This additional regulation does not completely diminish Nvidia's success in China, but it could cause revenue to remain stagnant.
Executing where it matters most
The primary cause of the weak guidance going into the back half of 2022 is the decline in gaming demand, but other business segments continue to perform well. The company's data center business -- Nvidia's biggest business by revenue -- saw revenue jump 61% compared to the year-ago period. Additionally, Nvidia is one of the top dogs in this space. In Q2, Nvidia powered 72% of the world's top 500 fastest supercomputers.
NASDAQ: NVDA
Key Data Points
Nvidia is also executing in the automotive industry, providing chips for cars and the artificial intelligence systems of self-driving vehicles. Automotive revenue jumped 45% year over year in Q2 to $220 million. This segment is small compared to its gaming and data center markets -- which generated $2.04 billion and $3.8 billion in Q2 revenue, respectively -- but that could change soon. Management believes the auto business could be its next billion-dollar segment.
For many investors, healthy performance in these categories matters more than gaming for two reasons. First, gaming is somewhat cyclical, and demand can fluctuate with economic booms and busts. Investors are seeing that today. Second, Nvidia is targeting an opportunity worth $1 trillion, and gaming only makes up $100 billion of that. The data center systems and automotive industries represent $600 billion of that total potential.
Nvidia has the cash
Another reason to be optimistic about Nvidia's future is its cash flows. While growth might be slowing, the company continues to post robust profitability and cash generation. In Q2, net income under generally accepted accounting principles (GAAP) reached $656 million, representing a 10% margin. The company also had a 12.5% free cash flow margin over the same period.
Compared to Advanced Micro Devices (AMD +3.68%) -- one of Nvidia's primary rivals -- Nvidia has far greater profits on a trailing-12-month basis. This allows it to continue investing heavily to capitalize on its long-term prospects. After all, with more cash, Nvidia can invest at a faster pace, allowing it to gain outsize market share.
Should you buy Nvidia now?
Even after this drop, shares of Nvidia aren't cheap. The company trades at 47 times earnings and 58 times free cash flow, far higher than AMD's multiples. However, Nvidia trades at a premium because it is a premium business. It is the dominant force in the chip sector, and its financials are healthy, even after this top-line slowdown.
All in all, Nvidia still looks like a great company to own for the long term, but investors shouldn't go all in. The coming year looks a bit hairy for Nvidia, and while some of the issues it is currently facing are temporary, they could potentially become long-term problems. Therefore, investors might only want to take a small stake in the business at this time.
