In the market's recent woes, tech stocks may have suffered the worst. The (semiconductor) chips are certainly down, which makes this a great time to look at some excellent companies.
The graphics card industry seems to offer particularly promising growth potential; these companies make chips that power the latest mind-blowing visuals for computers, gaming consoles, and handheld devices. The two major players are Motley Fool Stock Advisor recommendation NVIDIA (NASDAQ:NVDA) and ATI Technologies (NASDAQ:ATYT). Both companies have taken a hit recently, with NVIDIA getting roughed up the most, down nearly 40% since its high in early May. ATI dropped about 12% in the same time frame. Despite the discounting of these stocks, both companies are positioned to take advantage of a growing market that's big enough for two huge winners.
Who's the champ?
NVIDIA and ATI have been rivals in the PC market for years, battling to have the most powerful graphics card known to man. Market leadership constantly flip-flops between the two. If gamers declare NVIDIA's latest offering the new champion, it's only a matter of months before ATI releases a new product to outdo it, and vice versa. This is a clear two-horse race, with neither company dominating. Witness the last fiscal year's nearly identical revenue streams of $2.4 billion and $2.2 billion dollars for NVIDIA and ATI, respectively. Graphics cards used to be found only in high-end desktops, but both companies are benefiting from expanding of their product lines to low-end desktops, notebooks, handheld devices, and console gaming. Don't expect either company to go anywhere as both increasingly cash in on this growing market.
Now's the time
If you are waiting for a great entry point into this industry, now may be your chance. Both stocks are trading near their recent lows, and the chip market is highly seasonal. The second half of the year generally brings stronger performance due to the holiday and back-to-school seasons, which generally increase demand for new computers and upgrades to run the latest games. Windows Vista is also set to launch in a few months, potentially fueling sales for NVIDIA and ATI, since the features of Microsoft's (NASDAQ:MSFT) new operating system will demand a powerful graphics card.
The next generation of gaming consoles is on its way this fall, joining Microsoft's Xbox 360 (and its ATI video card). The Sony (NYSE:SNE) PlayStation 3 is in NVIDIA's camp, while the Nintendo Wii will use an ATI offering. The increasing prevalence of high-definition video will only further the need for graphics card upgrades, and the world of mobile video and gaming is still in its infancy; it's expected to be a multibillion-dollar market within a few years.
ATI recently acquired Bitboys Oy, a Finnish mobile graphics developer that helped the company land a deal with Nokia to supply chips for the mobile phone maker. NVIDIA has also been on the prowl, acquiring a separate Finnish firm, Hybrid Graphics. Both of these companies seek to solidify their positions as market leaders in the mobile video and graphics industry as it prepares for explosive growth in the next few years.
The numbers
|
Most Recent Quarter |
Revenue* |
Revenue Growth (yoy) |
Gross Margin |
Net Profit Margin |
|---|---|---|---|---|
|
NVIDIA (Q1 07) |
$681,807 |
16.8% |
42.4% |
13.3% |
|
ATI (Q3 06) |
$652,292 |
23% |
30.1% |
4.9% |
|
Most Recent Year | ||||
|
NVIDIA (FYE 1/29/06) |
$2,375,687 |
18.2% |
38.3% |
12.7% |
|
ATI (FYE 8/31/05) |
$2,222,509 |
11.3% |
30.7% |
1.9% |
NVIDIA boasts highly positive margins that reflect the firm's profitability. Its gross margin of 42.4% in the most recent quarter is a 6.4-percentage-point improvement against the year-ago period. The net profit margin has also improved to 12.7% for fiscal year 2006, more than doubling from last year, while quarterly revenue has grown 16.8% in the same period. The revenue boost shows NVIDIA's ability to consistently improve its top line, and its strong first-quarter performance holds promise for its full fiscal year, especially as it heads into the higher-performing later months. Don't be dismayed if second-quarter numbers come in flat; this is traditionally the worst time of the year for semiconductor companies. If Q2 revenues only equal first-quarter numbers, it will still improve on last year's 1.5% dip.
Meanwhile, ATI has generated strong revenue over the years, but has traditionally struggled to manage costs and inventories. Its gross margin this past quarter lagged NVIDIA's by about 12 percentage points, while its profit margin was eight to nine percentage points lower. Because of ATI's weak margins, its stock is priced at just 1.67 times sales and 3.54 times book value. But things now seem to be headed in the right direction; all profitability margins have improved this quarter compared to last year, and though inventory levels are still high, they're lower than they were in the previous quarter of 2006, falling from $427.5 million to $365.6 million. Its new product line has been quite successful, improving third-quarter 2006 revenues by 23% year over year. With a market cap of just $4 billion compared to NVIDIA's nearly $7 billion, this company has a lot of potential to grow -- if it can keep costs under control.
Two chips are better than one
The most recent innovation in the industry has been the introduction of multiple graphics chips in one computer. NVIDIA released its SLI technology, allowing two identical cards to be used together to improve performance in the most demanding games and applications. ATI quickly followed suit with its Crossfire technology; it uses multiple cards from the same product family, but does not require them to be identical. Both companies must be thrilled about the possibilities here, as computer enthusiasts throw as many as four graphics cards into their PCs at $400-$500 apiece. In a brilliant move from the industry's standpoint, instead of having to develop a card twice as fast and sell it for slightly more than the previous generation, NVIDIA and ATI simply let gamers link two cards together to double performance -- and revenue. As long as people are willing to fork over nearly $1,000 for the latest and greatest, this could be a huge victory for both companies. The ability to link the cards also requires a new motherboard equipped with a chipset for either SLI or Crossfire, resulting in additional revenue streams.
Foolish finale
Graphics chip makers have taken a hit, but they aren't down for the count. With their stock prices deflated, this may be a good time to get in on some real growth opportunities. NVIDIA and ATI are both positioned to enjoy long-term success in the PC, gaming console, and handheld markets. Look for strong performances from both companies in the coming months, as they enjoy the launch of Vista and two new gaming consoles.
Feast your eyes on further Foolishness:
- Visions of NVIDIA
- Foolish Forecast: ATI Technologies
- NVIDIA Dials Up Video
- NVIDIA Draws a Rosy Picture
Microsoft is a Motley Fool Inside Value selection, while NVIDIA is a Motley Fool Stock Advisor pick. Try the Foolish newsletter that best fits your investing style free for 30 days.
Fool contributor and Rule Breakers summer intern Glenn Brandys, from the University of North Carolina - Chapel Hill, has no financial stake in any of the companies mentioned in the article. The Fool has a disclosure policy.
