Gamers, start your engines. Computer graphics specialist NVIDIA (NASDAQ:NVDA) is loaded and ready to report earnings tomorrow after close of trading.
Analysts are already psyched over NVIDIA's predicted numbers. One year ago, the company earned $0.15 per diluted share. Tomorrow, analysts expect that number to more than double to $0.36 -- on just a 12.5% increase in sales. The company seems to owe the disconnect between top- and bottom-line growth rates to its enormous margin growth over the past year.
As reported in last quarter's earnings announcement, NVIDIA widened its gross margins by 710 basis points between Q2 2005 and Q2 2004, through a combination of lower raw materials costs and strengthened pricing power. Between the first half of 2004 and the first half of 2005, the company increased its sales by 25%. But the cost of those sales rose by just 14%, resulting in a 48% increase in gross profits. From the looks of the analyst estimates, Wall Street doesn't expect this trend toward greater profit margins to slow down -- at least, not in the short term.
Through the end of this year, analysts expect NVIDIA to nearly triple the net profits it reported in fiscal 2004. But 2006 looks to be a different matter. In that year, analysts are predicting a dramatic slowdown in earnings growth, to roughly 10% year over year. Investors tomorrow, therefore, should look less at the company's numbers or its performance relative to analyst guidance, and more at the prose portion of the release.
What will NVIDIA have to say about fiscal 2006? Can it give any hope of continuing this year's strong double-digit growth into the next year, or will it be content to just peek above the 10% threshold? In recommending the stock in the May 2005 issue of Motley Fool Stock Advisor, Fool co-founder David Gardner expressed confidence in the company's ability to bury analysts' earnings estimates, terming them "notoriously unreliable" for chip-industry companies like NVIDIA, and citing deals with Sony (NYSE:SNE) for the PlayStation 3, and Motorola (NYSE:MOT) for the increasingly graphics-rich cellphone market, as future earnings drivers.
Tomorrow, we'll want to hear similar assurances from management that these predictions are playing out. If the best NVIDIA can do next year is 10% growth, I don't think the market will continue to value the company at 20 times forward earnings.
Further high-resolution Foolishness:
Fool contributor Rich Smith does not own shares in any company named above.
