Can Nvidia Corporation (NVDA) Stand Tall Amid New Competition?

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Visual computing microchip player Nvidia Corporation (NASDAQ: NVDA ) updated its shareholders in August by reporting a number of financial records and milestones for NVDA stock. Revenue, gross margins and operating income all reached significant all-time levels, and management is rapidly pursuing a business transformation to enter growth markets.

Source: via Nvidia

Just a few years ago, personal computers and stodgy corporate applications represented over 40% of sales.

Today, that is down to 9%. In its place are chips, applications and systems that support gaming, virtual reality and driverless car markets.

It all sounds exciting, but investors could be at risk by moving wholeheartedly into unproven and competitive new markets. NVDA stock is up big so far this year (108%). The key question is whether that will continue, and whether large or upstart competitors stand a chance of squashing it in the future.

What Does Nvidia Do?

NVDA focuses on visual computing, which it thinks is a huge growth area. Advanced Micro Devices, Inc. (NASDAQ: AMD ) is its biggest rival, which also happens to compete with Intel Corporation (NASDAQ: INTC ); this rivalry best illustrates that Nvidia is a microchip company. Its key focus is graphic chips, and its four market segments certainly suggest that the underlying industries it serves do indeed have significant expansion potential.

Its most significant segment is gaming, with Sony Corp (ADR) (NYSE: SNE ) likely a big customer because of its PlayStation gaming franchise. NVDA boasts that its chips help gamers "enjoy immersive fantasy worlds."

Virtual reality, such as Facebook Inc 's (NASDAQ: FB ) Oculus Rift headset, is certainly a newer market, but it could really take off in the gaming space. Nvidia already has existing products in the space, including SHIELD (portable devices for mobile gaming) and GRID (cloud-based applications).

Gaming accounted for $2.8 billion in revenue last year and has grown sales nearly 30% annually over the last three years. Total sales last year were just over $5 billion.

Pro-Visualization is NVDA's next largest market, though at $750 million in sales last year, it is much smaller than gaming. Growth has also been negative over the last few years, though management is hopeful its visual computing solutions for the automotive, media and entertainment industries picks up more.

Datacenter and Auto each represented around $330 million of revenue last year. They are growing like gangbusters. Datacenter solutions are growing 40% annually, while auto is off the charts at 80% a year.

The auto segment has perhaps the most compelling upside potential going forward. The development of self-driving cars is still in its infancy, and Nvidia plans to be a leader in the space for many years to come.

The Big Picture for Nvidia Stock

NVDA's sales have consistently grown at 7% a year for a decade now. Analysts expect a rather large jump this year, with the top line growing as much as 22% to $6.1 billion. For 2017, they project growth returns to 7% and sales reach $6.5 billion.

For the year, the current earnings expectation is $1.85 per share, or 20% growth from last year. Profit growth has averaged an impressive 20% for three years now, though, again, the 10-year average is right around 10%.

The financial picture for NVDA stock looks very healthy. Nvidia has no long-term debt and over $5 billion in cash in the bank. Cash production is great; operating cash flow was $1.2 billion last year to double the reported net income. Capital expenditure is minimal, and annual dividends only require about $200 million to support the quarterly payout.

NVDA Downsides: The Valuation and Competition

For all that NVDA stock has going for it, it is far from cheap. The trailing price-to-earnings ratio is 45X and only a slightly more reasonable 36X on a forward basis. The cash flow multiple is around 20X given the company generates so much cash, but that is hardly bargain-basement level pricing for Nvidia stock.

NVDA is also tiny compared to other chip rivals. Intel is four times larger than the firm and is expected to report close to $60 billion in sales this year. I was surprised to learn that AMD is smaller and only posts sales in the $4 billion range. But Samsung (OTCMKTS: SSNLF ) is a large rival, as are firms such as Broadcom, Texas Instruments Incorporated (NASDAQ: TXN ), and Qualcomm, Inc. (NASDAQ: QCOM ).

Development in the automotive space is also likely to be fierce. Product cycles for microchips are already moving rapidly and auto rivals, including Delphi Automotive PLC (NYSE: DLPH ), which has partnered with rival Mobileye NV (NYSE: MBLY ). There is also speculation that Tesla Motors Inc (NASDAQ: TSLA ) is developing its own chips.

Bottom Line for NVDA Stock

NVDA is a great company that has a lot going for it. It operates in fast-growing markets with huge potential upside. However, the self-driving car industry is so new, it's really difficult to predict if it will be able to compete and generate the returns shareholders need over the long haul. Competition in the traditional chip space is also very intense.

At the currently high valuation (primarily based on P/E), NVDA stock looks risky right now. NVDA stock has doubled in price this year, suggesting that the momentum crowd and hype over driverless cars is at a fever pitch.

Keep an eye on Nvidia stock: If it falls below $40 per share, it is worth a closer look. If it falls back in the $30s, start to get excited and consider picking up some shares.

As of this writing, Ryan Fuhrmann held shares of NVDA.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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