Buy Misunderstood Nvidia

| About: NVIDIA Corporation (NVDA)

Summary

Nvidia smashed FQ4 earnings on robust revenue growth.

The market seems to understand the growth drivers, but the earnings story is misunderstood.

The stock is a strong recommendation on any pullback going forward.

After warning investors that upside was limited prior to the drop leading to a bottom in mid-February, Nvidia (NASDAQ:NVDA) is only now trading back at those levels after the rally following solid FQ4 earnings. My previous thesis centered on a stock that had doubled in a little over a year despite limited revenue growth.

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The stock is back over $30 following a huge rally off the lows around $25. The question now is whether the ramped up growth from the automotive sector and other core strategies makes the stock worth chasing now.

Margin Story

The 68% revenue growth in the automotive sector grabs all of the headlines. The sector though only accounted for $93 million in FQ4 revenues out of a total of $1.4 billion.

The big reason for the stock gains is the improving margins. Sure, Nvidia grew revenues ahead of target at a 12% clip in FQ4, but the earnings growth is highly related to keeping operating expenses flat with last year.

The focus on the growth categories of gaming, data center virtualization, and enterprise graphics are helping boost margins. Even in the seasonally weak FQ1, Nvidia forecasts gross margins growing to over 57% after hitting a record 56.8% last fiscal year. Over the last few years, gross margins expanded while revenues slowly grew.

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The 100 basis points gain in gross margins for FY16 combined with revenue growth led to the expansion in operating margins and cash flows. For the last fiscal year, free cash flow surged to nearly $1.1 billion.

Any stock with some appealing sector growth stories mirrored with free cash value growth provides an opportunity for smart investors.

Misunderstood Value

The value story on Nvidia is confusing and mostly misunderstood. The stock trades at nearly $32 now, but the market sees the $17 billion market cap valued at over 22x forward EPS estimates. Oddly though, the market views the stock in the prism of GAAP earnings.

According to sites like Yahoo! Finance and others, NVDA earned $1.08 per share last year and expects to earn $1.44 per share this year. Even YCharts shows the earnings trend for the last and current fiscal years based on GAAP numbers.

NVDA EPS Estimates for Current Fiscal Year Chart

In reality, the company earned $1.67 per share last year when excluding the typical one-time charges and non-cash charges like stock-based compensation. The company grew the EPS figure by roughly 18% over the prior fiscal year. A meager 15% growth rate considering the margin expansion and revenue growth leads to an EPS of $1.92 for this fiscal year.

With around $3.5 billion in net cash, one can quickly see how some value exists even after the recent rally. With an enterprise value of $13.5 billion, the stock trades at a reasonable 14x my forecasted non-GAAP earnings for this fiscal year.

Takeaway

While the growth in the automotive sector and excitement over virtual reality gets the market excited about the stock, the real story is the misunderstood value. The solid execution, expense control, and strong balance sheet are driving the attractive valuation.

The significant catalysts around self-driving cars, deep learning, and eSports make the technology company appealing when trading at a value. After the recent rally, the recommendation is to purchase Nvidia on any dips going forward.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NVDA over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.