1 Red Flag You Shouldn’t Ignore

After almost two years of dizzying comebacks, Nvidia (NASDAQ: NVDA) he seems to finally catch his breath. Shares retreated after hours on Wednesday after a robust earnings report. Nvidia beat estimates, but by a more modest margin than investors are used to.

Revenue rose 122% from the year-ago quarter and 15% sequentially to $30 billion, beating estimates of $28.7 billion. Bottom line, adjusted earnings per share rose 152% year-over-year and 11% quarter-over-quarter to $0.68, ahead of the $0.64 consensus. This was the narrowest earnings gain the company has had since the generative artificial intelligence (AI) boom began.

Nvidia continued to benefit from growing demand from cloud infrastructure companies, which accounted for 45% of its revenue. Moreover, the broader ramp towards accelerated computing and generative AI continued. The company also provided better-than-expected guidance for the third quarter, calling for revenue of about $32.5 billion, up 79% from the year-ago third quarter.

However, an earnings miss likely contributed to the selloff and should not be overlooked by investors.

Nvidia’s gross margin takes a step back

One of the most important metrics in the semiconductor industry is gross margin. Unlike software companies, most of the costs faced by hardware companies tend to come from costs of goods sold or direct costs involved in manufacturing chips and components.

Since the generative AI revolution began, Nvidia’s gross margin has expanded rapidly, a sign that the company is taking advantage of its pricing power and scalability. The chart below shows the company’s gross margin through the first quarter of fiscal 2025, which ended in April.

As you can see, Nvidia’s gross margins have increased since the start of the generative AI boom, going from less than 65% before AI demand kicked in to more than 78% in the first fiscal quarter. However, gross margin declined in the second quarter, falling to 75.1% on a generally accepted accounting principles (GAAP) basis.

The company said this was due to a higher mix of new products in the data center segment and inventory losses related to the launch of Blackwell, but it shows that Nvidia appears to have hit a ceiling with its gross margin expansion. This adds a new risk to the stock as shrinking margins would hurt profitability. This sequential decline in gross margin translated into slower sequential growth on the bottom line than on the top.

The company expects gross margin to fall slightly again in the third quarter to 74.4%-75.0% and is targeting the mid-70% range for the full year, which likely implies more weakness in the fourth quarter.

The story continues

Why gross margin is key

Gross margin is the largest determinant of overall profitability in the semiconductor industry and is a reflection of a company’s pricing power and efficiency.

As you can see from the chart below, Nvidia is now significantly ahead of its peers.

Nvidia’s gross margins are a testament to its strength and competitive advantages in AI, but if competition from AMD and others are starting to impact Nvidia, it’s likely to show up first as lower gross margins.

What it means for investors

With Nvidia’s overall top- and bottom-line growth remaining strong, even on a sequential basis, and the upcoming release of its Blackwell platform in the fourth quarter expected to drive further demand growth, the margin squeeze brute is not an emergency. .

However, investors should watch the number in the coming quarters. If this crucial margin continues to decline, it could herald bigger problems in the business.

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Jeremy Bowman has positions in Broadcom. The Motley Fool has positions in and recommends Advanced Micro Devices, Nvidia and Qualcomm. The Motley Fool recommends Broadcom and Intel and recommends the following options: short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.

Nvidia Stock Investors: 1 Red Flag You Shouldn’t Ignore was originally published by The Motley Fool