Authored by Spencer Huang
Nvidia Corporation (NASDAQ: NVDA)
Fall 2021
Overview
Nvidia Corporation is a company that needs no introduction. Founded in 1993 by Jensen Huang, the Santa Clara based technology company has grown dramatically over recent years, reaching a market capitalization of $810 billion (as of November 2021), which makes it the 7th largest US company by market cap. Its shares have more than doubled in the past year and have risen by nearly 1500% over the past five years, reflecting brilliant internal decision making, explosive industry growth, and continued investor optimism for the future.
Nvidia by and large is a multinational company that specializes in the production of graphical processing units (GPUs), which are specialized chips that use parallel processing to accelerate graphics rendering. Since Nvidia’s inception, the use and development of GPUs has established Nvidia as “the leader in visual computing”. Nvidia’s GPUs are most widely known for their use in gaming, but their chips also are used in many professional applications, such as engineering and architecture, as well as in chip systems for vehicles and robots. From its initial focus on 3D graphics and gaming, Nvidia has now branched out into artificial intelligence, data science, and augmented reality.
Company analysis
Nvidia’s revenue streams and operating income can be broken down into three distinct categories: graphics, computing and networking, and all other.
Nvidia’s graphics segment includes its GeForce GPUs , which are used in gaming and PCs, and its GeForce NOW game-streaming service. This is the largest segment of Nvidia’s revenue; for FY 2021, the Graphics segment made up 59% of Nvidia’s revenue for a total of $9.8 billion, representing a 28.7% increase from the previous year. The operating income of this segment also saw tremendous growth: it rose 41.2% in the last year to $4.6 billion.
Following that is the computing and networking segment, which comprises Nvidia’s Data Center platforms and their AI and high performance computing systems. This segment makes up the majority of Nvidia’s remaining revenue; for FY 2021, this segment represented 41% of total revenue. Revenues of $6.8 billion were good for a 108.6% increase from the previous year, while operating income of $2.5 billion represented a 239.3% growth from the year prior.
Lastly, Nvidia has an “all other” category, which includes stock based compensation and other operating expenses. This amounted to an operating expense of $2.6 billion for FY 2021.
Investment catalysts
Nvidia’s continued emphasis on innovation and their position as an industry leader allow the company to take advantage of two recent trends in the tech industry, which will be explored below. The first development allows Nvidia’s graphics segment to push into a nascent industry and establish itself as a leader, while the second development makes use of Nvidia’s computing and network segment to work in tandem with other companies in their vision of a new future.
Beginning with the former, cloud gaming is largely seen as the future of the $175 billion gaming industry. The graphics on existing games are only as good as the processors inside the user’s computer or gaming system. However, with cloud gaming, these processors are stored in datacenters full of servers, with the game streamed to the user in real time. Companies that own data centers can fill them with high-end GPUs and then charge users a membership fee, allowing users to play games that their own devices otherwise couldn’t support. In fact, Nvidia estimates that there are over 1 billion PCs and devices that lack the processing capabilities required to play the latest games. To this end, Nvidia has launched their GeForce NOW service, which allows subscribers to play games over cloud servers equipped with Nvidia’s latest high-end gaming GPUs. Publicly launched less than two years ago, GeForce NOW has a subscriber base of over 12 million users, which compares similarly to Microsoft’s Game Pass (18m) and Electronic Arts’ EA Play (13m), two services that offer downloadable games (but not games to stream). Nvidia’s advantage lies in its potential, considering that it has a base of 140 million users who have a PC equipped with Nvidia graphics and could reasonably be expected to join the service, and in its equipment, considering its graphics cards are some of the most advanced in the industry. Additionally, Nvidia reached a partnership with EA to bring some of EA’s most popular games to GeForce NOW, signalling that Electronic Arts sees Nvidia’s cloud service as one with enormous potential growth.
Secondly, shares in Nvidia rose significantly following Facebook’s earnings release on Oct 25, 2021. In the highly publicized release announcing the creation of Mark Zuckerberg’s “metaverse”, the social media giant conveyed its intention to dedicate “significant resources toward our augmented and virtual reality products and services” — essentially, towards the metaverse. Investors (rightfully) saw this as an opportunity for Nvidia, whose existing Omniverse augmented reality platform may serve as the basis for the Metaverse. It’s believed that most of the Metaverse revenues will be generated by the companies that build the infrastructure. Nvidia’s chips and processing power lends itself well to the construction of the infrastructure, putting it in a good position to capitalize on Meta’s plans for the Metaverse.
Financials
Considering Nvidia’s recent gains since October 2021, it may seem that Nvidia is currently overvalued. Some analysts seem to think so, given that its current price is above consensus price targets.
| Nvidia | AMD | Intel (INTC) | Broadcom (AVGO) | Qualcomm (QCOM) | |
| Forward P/E | 61.7 | 47.2 | 13.6 | 18.2 | 17.5 |
| YOY Revenue growth | +68.1% | ~ +60% | +2% | +15% | +56% |
| Gross margin | 66.2% | ~48% | 54.5% | 55% | 60.7% |
Nvidia’s price to earnings ratio is evidently very high compared to its peers in the semiconductor industry. While this may be concerning for investors, it’s important to realize that Nvidia has the underlying growth to justify such a high ratio. Based on key indicators such as its year over year revenue growth and gross margin, Nvidia is performing much better than its competitors, in particular AMD. In fact, in its recent earnings report (Q3, FY 2021), Nvidia posted record revenue growth in both its gaming and computing segments, blowing away expert predictions.
Risks
For all its innovation and cutting edge technology, Nvidia doesn’t make its own chips. Most of its chips are contracted by Taiwan Semiconductor Manufacturing Company (NYSE: TSM), the world leader in semiconductor wafer production. Thus, if anything were to happen to TSMC, Nvidia’s graphics segment would be severely affected (as would the thousands of other corporate consumers of TSMC chips). TSMC is in an especially precarious geopolitical situation given that China has been eyeing reunification of the Taiwanese island with the mainland for quite some time. Should the conflict escalate and the Chinese invade the island by force, TSMC may be subjected to Chinese rule. Considering the animosity between China and the United States, it may be hard for TSMC to continue to supply Nvidia. However, this scenario remains hypothetical at best; Western powers have it in their best interest to keep Taiwan independent from China for the time being. Additionally, Nvidia has started contracting Samsung for some of their latest chips, reflecting an interest in diversification of suppliers.
Secondly, the global supply chain shortage has hit the chip industry particularly hard. As a result, Nvidia has been unable to produce enough chips to satisfy the burgeoning demands of gamers and professionals alike; its new flagship RTX 3080 Ti Founders Edition chip was sold out in hours and currently fetches a steep resale value. To this end, Nvidia has proposed to acquire British manufacturer Arm for $40 billion to alleviate the shortage. While this move has been subject to antitrust concerns and awaits regulatory approval, it reflects Nvidia’s commitment to find long-term solutions to the supply shortage.
Conclusion
Since its inception, Nvidia has experienced profound growth due primarily to continued innovation, allowing them to take advantage of emerging trends and exciting new opportunities. Nvidia shows no signs of deviating from this mission anytime soon, as evidenced by how their incursions into cloud gaming and augmented reality set them up well for developments in the gaming industry and Meta Platforms’ Metaverse, respectively. I would recommend buying shares of Nvidia and holding.