NVIDIA Deep Dive: Riding the AI Wave

Welcome to The Financial Engineer newsletter.

Today, we're diving deep into a company that started AI: NVIDIA. From its humble beginnings as a graphics card manufacturer, NVIDIA has evolved itself into a giga chad of tech titan, powering everything from gaming to self-driving cars. We will explore its journey, business model, strategic decisions, financial performance, and the risks and opportunities it faces.

From Pixels to Possibilities

NVIDIA's story begins in 1993 to bring realistic and immersive graphics to the world of computing. The founders, Jensen Huang, Chris Malachowsky, and Curtis Priem, figured out the potential of graphics processing units (GPUs) and decided to change how we interact with digital content. Initially focusing on gaming, NVIDIA innovations quickly extended to professional graphics, scientific computing, and eventually, the transformative field of artificial intelligence.

The Engine of Modern Computing

NVIDIA's business model is built on a platform-led approach that spans hardware, software, and services. At the core of its offering are its GPUs, the processing powerhouses behind a vast range of applications, including:

• Gaming: GeForce GPUs and RTX technology elevate the gaming experience with stunning visuals and performance.

• Data Centers: NVIDIA's data center platforms power AI, high-performance computing, and data analytics, enabling breakthroughs in scientific research, drug discovery, and business intelligence.

• Professional Visualization: NVIDIA's Quadro and RTX GPUs enable architects, engineers, and designers to create realistic 3D models and simulations, accelerating workflows and pushing creative boundaries.

• Automotive: NVIDIA DRIVE platforms empower autonomous vehicles with the computational muscle needed for safe and reliable self-driving.

A Legacy of Innovation

NVIDIA's journey is marked by continuous process improvement and a pursuit of technological advancements.

Key milestones include:

• The Rise of the GPU: NVIDIA's introduction of the GeForce 256 in 1999 marked the birth of the modern GPU, revolutionizing the gaming industry.

• CUDA: NVIDIA's creation of the CUDA parallel computing platform in 2006 unlocked the potential of GPUs for general-purpose computing, paving the way for AI and other data-intensive applications.

• The AI Revolution: NVIDIA's strategic focus on AI has propelled it to the forefront of this transformative technology, with its GPUs becoming the engine of deep learning and machine learning workloads.

A Growth Story

NVIDIA Corporation reports consistent increases YoY through different channels as can be seen in the excerpt from the Form 10K-Q Quarterly and annual reports presented in their respective reports below:

Revenue Growth:

• Q2 FY2025 (ended 7/28/24): $30,040 million, up 15% QoQ

• Q1 FY2025 (ended 4/28/24): $26,044 million

• Year-over-year growth rate: 101% (comparing Q2 FY2025 to Q2 FY2024)

This revenue growth significantly outpaces the semiconductor industry average, which typically sees high single-digit to low double-digit annual growth rates. NVIDIA's 101% YoY increase is extraordinary, driven by surging demand for AI chips and data center solutions.

Profitability:

• Q2 FY2025 Net Income: $55.2 billion

• Q2 FY2024 Net Income: $45.7 billion

• YoY Net Income growth: 20.8%

While net income growth lags revenue growth, it still represents impressive bottom-line expansion. The discrepancy likely reflects increased R&D spending and potential margin pressure as NVIDIA rapidly scales production.

Margins (TTM as of Q2 FY2025):

• Gross Margin: 64.6%

• Operating Margin: 41.8%

• Net Profit Margin: 42.8%

NVIDIA's margins are outstanding for the semiconductor industry. For comparison:

• Intel's TTM gross margin: 39.5%

• AMD's TTM gross margin: 50.7%

• Industry average gross margin: ~50%

NVIDIA's significantly higher margins reflect its dominant market position and the premium pricing power of its AI-focused products.

Return Metrics (TTM):

• Return on Equity (ROE): 86.2%

• Return on Assets (ROA): 47.3%

• Return on Invested Capital (ROIC): 63.5%

These return metrics are exceptional, far surpassing industry averages:

• Semiconductor industry average ROE: ~15-20%

• Semiconductor industry average ROA: ~5-10%

NVIDIA's outsized returns shows its ability to efficiently deploy capital and generate substantial value for shareholders.

Stock Performance: 5-year cumulative return (1/27/19 to 1/28/24):

• NVIDIA: 1,536.28%

• S&P 500: 99.83%

• NASDAQ: 168.13%

NVIDIA has dramatically outperformed both the broader market and the tech-heavy NASDAQ, showcasing investor confidence in its long-term growth prospects.

Key Financial Trends and Potential Concerns:

1. Revenue growth is accelerating, with the latest quarter showing 101% YoY growth compared to previous quarters' growth rates in the 50-70% range.

2. While margins remain high, there's a slight compression in gross margin (down from 70.1% in Q2 FY2024). This means we need to start paying attention as competition intensifies and NVIDIA potentially offers more competitive pricing to maintain market share.

3. The Computing & Networking segment (which includes data center and AI chips) now accounts for over 70% of revenue. While a strength in AI, it also increases risk if demand in this sector softens.

4. Days Inventory Outstanding has increased to 113 days (up from 92 days a year ago). This could indicate potential oversupply risk if demand were to unexpectedly slow.

5. NVIDIA's forward P/E ratio of 39.5x (as of August 2024) is significantly higher than the semiconductor industry average of ~20x. Justified by growth rates, it leaves little room for mistakes.

6. NVIDIA's exposure to China (approximately 20-25% of revenue) presents a risk given election year, ongoing trade tensions and potential export restrictions on advanced chips.

Risks and Opportunities

NVIDIA operates in an "unstable" tech landscape, presenting both opportunities and challenges:

• Opportunities:

  • The expanding AI market represents a significant growth avenue for NVIDIA, with applications proliferating across various industries.

  • The metaverse and related technologies offer potential for further expansion and diversification of NVIDIA's offerings.

  • Strategic partnerships with OpenAI and acquisitions can strengthen NVIDIA's competitive position and accelerate its growth trajectory.

• Challenges:

  • Intense competition from rivals like Intel and AMD requires continuous innovation to maintain market leadership.

  • Supply chain disruptions and geopolitical tensions can impact NVIDIA's operational stability and profitability.

  • Regulatory scrutiny and ethical concerns surrounding AI development require proactive adaptation to evolving legal and societal landscapes.

Key Takeaways

NVIDIA's early bet on GPUs and AI has given it a significant head start AI. Ability to anticipate and capitalize on market trends has been a great indicator of leadership and product roadmap. NVIDIA's dedication to providing high-performance hardware that meet the needs latest GPU hungry AI companies (some customers had GPU hand delivered by Jensen) has built a loyal customer base.

Note: This analysis is for informational purposes only and does not constitute financial or investment advice. If you observe any errors in numbers, figures, or other information presented here, please email me at [email protected].