To The Moon

KEY POINTS

• Nvidia is seeing the impact of slowing consumer demand in gaming.
• But it's still generating profits and sees a major opportunity in the auto business.
• This year’s stock price slump could be a buying opportunity.

In late August, Nvidia reported results for its fiscal second-quarter (ended July 31), and they weren't great. The company's growth slowed dramatically, and its guidance projects that to continue. Like many businesses, the challenging economic environment is taking a toll on this leading chip manufacturer over the short term, causing volatility in the company's financials.

That said, there are many reasons to be bullish on the company. The long-term opportunity for Nvidia looks bright as semiconductors are rising in popularity, and the company is still seeing success in the industries with the highest potential. Shares are down almost 49% year-to-date. Here's why that looks like a deal.

Image source: Getty Images.

Nvidia's rough quarter

Second-quarter earnings results were a significant shift compared to Nvidia's previous quarters. Total revenue increased only 3% year-over-year in Q2 to $6.7 billion. This also represented a 19% decline sequentially. Comparatively, Nvidia has consistently grown its revenue above 40% on a year-over-year basis since the start of 2020.

The company's gaming segment was the primary driver of this disappointing performance. Nvidia's gaming business saw a year-over-year revenue decline of 33% to $2.04 billion in Q2. The bulk of this drop was due to macroeconomic headwinds pressuring consumer demand for its gaming graphics processing units (GPUs).

Third-quarter guidance was bleak as well. The company expects to generate roughly $5.9 billion in revenue during the quarter, which is a drop of 17% compared to the year-ago period. This will likely be driven by sequential declines in its gaming and professional visualization businesses. On the bright side, however, two business segments -- data center and automotive -- are expected to post sequential increases.

Nvidia reported preliminary Q2 guidance earlier in August, so this performance wasn't a surprise. The more prominent concern, however, is that this isn't an industry-wide issue. Advanced Micro Devices, one of Nvidia's rivals, posted 70% year-over-year revenue expansion in its second quarter, highlighted by a 32% rise in gaming revenue over the same period. This might signal that Nvidia is losing market share in the gaming space and even the chip industry.

With this slowing growth, Nvidia's valuation becomes slightly more concerning. The stock is not cheap at 49 times earnings, and while that might be down from its 2020 and 2021 levels, it is higher than the valuation it had for most of 2013 to 2017, plus the majority of 2019.

What metrics truly matter

That said, Nvidia is still the dominant player in the chip space, especially when it comes to gaming GPUs. Nvidia's GeForce gaming GPUs are some of the most popular GPUs on the market, representing all of the top 15 most popular GPUs on the video game platform Steam. In the data center market, 72% of the world's top 500 fastest supercomputers are powered by Nvidia.

It's also important to recognize that Nvidia's gaming business might not be the primary driver of its long-term success. The company targets a $1 trillion opportunity, and gaming only represents 10% of that amount. Comparatively, the data center systems and automotive segments represent 60% of this potential.

On these fronts, Nvidia continued to gain steam in Q2. Data center revenue soared 61% year-over-year to $3.81 billion, while automotive revenue jumped 45% over the same period to $220 million. While still small, management believes its automotive business could become the company's next $1 billion business.

Lastly, Nvidia remained profitable. The company generated $656 million in net income in Q2, and while that was a stark decline from the $1.6 billion profit it posted in the year-ago quarter, it marks a nearly 10% profit margin. Additionally, Nvidia generated $837 million in free cash flow in Q2. It can use this cash to invest in innovation to create the best products, helping it capitalize on its lucrative long-term prospects.

Why Nvidia stock is a buy now

The company is facing some short-term pressure, and that is cause for concern. The fact that rivals aren't seeing the same stress as Nvidia is another reason to be cautious. That said, long-term investors willing to hold, even during short-term turmoil, could still see healthy returns.

Nvidia has a proven track record of dominance and benefiting from its leadership. It will be critical to ensure it persists over the course of multiple years, and investors will be able to see that through top-line expansion. The short-term will be volatile, but long-term investors who can see through the clouds might benefit from buying a small position in Nvidia today.