NVIDIA($NVDA) - This grass is always greener.

Table of Contents

1. Summary

2. Why is now the right time to buy NVIDIA?

3. NVIDIA Q3CY24 Highlights:

4. Sales Growth

5. Product Demand & Outstanding Inventory

6. Gross Margin and Pricing Power

7. Operating Margin

8. Earnings Per Share

9. Return on Invested Capital(ROIC)

10. Balance Sheet Assessment

Summary

• Revenue growth was exceptional over the last five years, indicating it’s winning significant market share during this cycle

• EPS growth has massively outpaced its peers, compounding at 86% annually over the last five years

• Best-in-class gross margins reflect its elite pricing power and the mission-critical nature of its business

Why is now the right time to buy NVIDIA?

Nvidia is trading at $138.14 per share, or a 36.5x forward price-to-earnings ratio. While this multiple is higher than most semiconductor companies, we think the valuation is fair given its quality characteristics.

By definition, where you buy a stock impacts returns. But according to our work on the topic, business quality is a much bigger determinant of market outperformance over the long term compared to entry price.

NVIDIA Q3CY24 Highlights:

• Revenue: $35.08 billion vs analyst estimates of $33.13 billion (93.6% year-on-year growth, 5.9% beat)

• Adjusted EPS: $0.81 vs analyst estimates of $0.75 (8.6% beat)

• Adjusted Operating Income: $23.28 billion vs analyst estimates of $21.86 billion (66.3% margin, 6.5% beat)

• Revenue Guidance for Q4 CY2024 is $37.5 billion at the midpoint, above analyst estimates of $37.03 billion

• Gross Margin (non-GAAP) Guidance for Q4 CY2024 is 73.5%, slightly above analyst estimates of 73.4%

• Operating Margin: 62.3%, up from 57.5% in the same quarter last year

• Free Cash Flow Margin: 47.9%, up from 38.9% in the same quarter last year

• Inventory Days Outstanding: 78, down from 81 in the previous quarter

• Market Capitalization: $3.60 trillion

Sales Growth

Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Luckily, Nvidia’s sales grew at an incredible 62.4% compounded annual growth rate over the last five years. Its growth surpassed the average semiconductor company and shows its offerings resonate with customers, a great starting point for our analysis. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

This quarter, Nvidia reported magnificent year-on-year revenue growth of 93.6%, and its $35.08 billion of revenue beat Wall Street’s estimates by 5.9%. Company management is currently guiding for a 69.7% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 49.5% over the next 12 months, a deceleration versus the last two years. We still think its growth trajectory is attractive and implies the market is baking in success for its products and services. Some tapering/deceleration is natural given the magnitude of its revenue base.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business’ capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.

This quarter, Nvidia’s DIO came in at 78, which is 26 days below its five-year average. At the moment, these numbers show no indication of an excessive inventory buildup.

Gross Margin and Pricing Power

In the semiconductor industry, a company’s gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor.

Nvidia’s elite gross margin is one of the best in the semiconductor sector, and its differentiated products give it strong pricing power. As you can see below, it averaged a best-in-class 74.2% gross margin over the last two years. Said differently, roughly $74.16 was left to spend on selling, marketing, R&D, and general administrative overhead for every $100 in revenue.

In Q3, Nvidia produced a 74.6% gross profit margin, which is in line with the same quarter last year. On a wider time horizon, Nvidia’s full-year margin has been trending up over the past 12 months, increasing by 6 percentage points. If this move continues, it could suggest a less competitive environment where the company has better pricing power and leverage from its growing sales on the fixed portion of its cost of goods sold (such as manufacturing expenses).

Operating Margin

Nvidia has been a well-oiled machine over the last two years. It demonstrated elite profitability for a semiconductor business, boasting an average operating margin of 58%. This result isn’t surprising as its high gross margin gives it a favorable starting point.

Analyzing the trend in its profitability, Nvidia’s annual operating margin rose by 35.5 percentage points over the last five years, as its sales growth gave it immense operating leverage.

In Q3, Nvidia generated an operating profit margin of 62.3%, up 4.8 percentage points year on year. The increase was encouraging, and since its operating margin rose more than its gross margin, we can infer it was recently more efficient with expenses such as marketing, R&D, and administrative overhead.

Earnings Per Share

We track the long-term change in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company’s growth is profitable.

Nvidia’s EPS grew at an astounding 86% compounded annual growth rate over the last five years, higher than its 62.4% annualized revenue growth. This tells us the company became more profitable on a per-share basis as it expanded.

Diving into the nuances of Nvidia’s earnings can give us a better understanding of its performance. As we mentioned earlier, Nvidia’s operating margin expanded by 35.5 percentage points over the last five years. This was the most relevant factor (aside from the revenue impact) behind its higher earnings; taxes and interest expenses can also affect EPS but don’t tell us as much about a company’s fundamentals.

In Q3, Nvidia reported EPS at $0.81, up from $0.40 in the same quarter last year. This print beat analysts’ estimates by 8.6%. Over the next 12 months, Wall Street expects Nvidia’s full-year EPS of $2.62 to grow by 44.7%.

Return on Invested Capital(ROIC)

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Nvidia’s five-year average ROIC was 50.9%, placing it among the best semiconductor companies. This illustrates its management team’s ability to invest in highly profitable ventures and produce tangible results for shareholders.

Balance Sheet Assessment

Nvidia has an eye-popping $38.49 billion of cash on its balance sheet (that's no typo) compared to $8.46 billion of debt. This $30.03 billion net cash position is 0.8% of its market cap and shockingly larger than the value of most public companies, giving it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

Before investing in or passing on Nvidia, we urge you to understand the company’s business quality (or lack thereof), valuation, and the latest quarterly results - in that order.

Wall Street analysts have a consensus one-year price target of $161.03 on the company (compared to the current share price of $138.14), implying they see upside in buying Nvidia in the short term.