Nvidia's earnings report this past week had something to offer everyone-the bulls, the bears, and the AI-curious who may still fall somewhere in between.
Chip making is a historically cyclical business, with big shifts in inventories and prices that show up in volatile sales growth and gross margins. During upcycles, like now, investors watch the metrics like hawks for any sign of slippage.
The release showed another outstanding quarter for the AI leader with 106% sales growth, representing an acceleration that's four quarters old now. Gross margin held steady at 75% for the third quarter in a row. In the last downcycle in 2022, gross margin reached a low of 43%.
But, Nvidia's outlook for the current quarter showed an expected gross margin of 74%, down one percentage point. The bears pounced and the stock dropped by as much as 2.9%.
The bulls had a quick counter. Right at the top of the 5 p.m. earnings call, Chief Financial Officer Colette Kress said, "We expect to grow revenue by approximately 70% in fiscal 2028. This is a supply-constrained outlook."
Fiscal 2028 kicks off in five months on Feb. 1, 2027, and Wall Street has been expecting a significant slowdown in growth, to 45%. It was unusual for Nvidia to offer next year's guidance this early in the calendar. But the company knew it had material information to provide: Within minutes, the stock was up 4.8%. The stock closed Thursday up 8.7%.
Later in the call, Kress and CEO Jensen Huang added more color. Gross margin isn't under pressure because Nvidia is losing pricing power. Instead, like everyone else in the manufacturing of electronics, the company is dealing with a severe memory shortage, and prices have risen at an unheard of pace. Nvidia's gross margin could go as low at 71% in the fourth quarter, but the company is planning a price increase next year that will bring the margin back into the range of 72% to 73%. That's below today's 75%, but still historically high for the chip maker.
Huang also suggested the 2028 forecast of 70% sales growth could go higher if the company is able to address supply bottlenecks. In other words, there's no issue with demand.
Analysts have been behind the curve since the AI boom began, badly underestimating Nvidia sales and earnings. We're halfway through Nvidia's fiscal 2027, and since the year began the average revenue forecast is up 23%, while adjusted EPS expectations have risen by 19%.
The new fiscal 2028 guidance set off another round of upgraded financial estimates across Wall Street. Out of 60 analysts tracked by FactSet, 39 came out with new notes within a day of the results. Projected adjusted EPS for the year rose from $12.81 to $14.86, a 16% increase. The revisions mean that the company's price/earnings ratio for fiscal 2028 fell following earnings, from 16 to 15. That P/E could head lower as more estimate revisions trickle in. In fact, it went down while I was writing this column as one more note was posted on FactSet.
Nvidia's P/E is significantly below the S&P 500's, and it has been giving me flashbacks to Apple stock in the 2010s, when the company spent nearly eight years of the decade with a below-market multiple. Apple's forward P/E eventually went from nine to 33, adding trillions in market value.
Apple had to beat back successive negative narratives about its future. How would Apple survive the death of Steve Jobs, its visionary founder and leader, in 2011? How would it innovate?
We heard that the iPhone could only be the market leader for so long. The Apple II and the first Mac showed the world what a personal computer should look like, only to be swamped by cheaper Intel-Microsoft competition. Surely the same would happen in smartphones, the bears said.
Others pointed out that consumer electronics are a cyclical business, deserving lower valuation multiples.
As we now know, CEO Tim Cook built two new segments-services and wearables-from practically nothing, and turned the company into a chipmaking powerhouse.
Apple countered the cyclical hardware skeptics with carrier subsidies, cheap financing, generous trade-ins, and the more steady-growing services segment. In the first half of this year, according to Counterpoint Research, Apple had a 65% share of the premium smartphone market-the high-margin segment. In the second quarter, the top three best selling phones were various versions of the iPhone 17.
All the while, the company has turned hundreds of billions of free cash flow into shareholder returns through dividends and share repurchases, which have now totaled more than $1 trillion.
In the first half of fiscal 2027, Nvidia had $70 billion in free cash flow, $45 billion of which was returned to shareholders. Analysts expect another $93 billion in free cash flow the rest of the year.
Nvidia is already worth $5 trillion-plus, so I'm not predicting a repeat of Apple's long run, but the iPhone maker's performance offers a road map for how an innovative company can eventually break out of a P/E funk. For Nvidia, this past week might have been a turning point.
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