Could Nvidia Make Others Envy Your Wealth?

Semiconductor maker, Nvidia (NASDAQ: NVDA), enjoyed a 5.4% pop in Monday's market action. The reason could be a research report showing a big gain in market share for one of its chips. Is it too late for you to get in on the upward action in this maker of graphics chips for workstations, personal computers, game consoles and mobile devices?

The cause of investor joy was a big jump in market share for Nvidia's standalone graphics processor (GPU) -- a chip that helps display images faster on notebook computers. According to semiconductor researcher, Mercury Research, Nvidia’s GPU share in notebook computers rose 8.9 percentage points in the second quarter. As a result, Nvidia ended June 2011 with the number one market position -- 50.6% of the units shipped -- ahead of Advanced Micro Devices (NASDAQ: AMD) that had 49.4% of GPU shipments.

Is this surprisingly good news enough to prompt an investment in Nvidia? Here are two reasons to consider it:

• Good earnings reports. Nvidia has been able to surpass analysts’ expectations in four of its last five earnings reports. For its first quarter ending in April 2011, Nvidia's earnings were $135.2 million, or 22 cents a share --slightly lower than its previous year profit of $137.6 million, or 23 cents a share. However, Nvidia's adjusted EPS of $0.27 beat by 37% expectations of $0.19. Nvidia predicted a revenue rise in the second quarter between 4% and 6% -- implying revenues of between $1 billion and $1.02 billion and well ahead of analysts' average forecast of $992.5 million according to Thomson Reuters I/B/E/S.
• Low valuation. Nvidia's price to earnings to growth of 0.57 (where a PEG of 1.0 is considered fairly priced) means it is at a pretty cheap price. It currently has a P/E of 34.7 and is expected to grow 61% to $1.05 in fiscal 2011.

Here are two reasons to pause in thinking about a Nvidia investment:

• Under-earned its capital cost. Nvidia is earning less than its cost of capital – but it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2010, Nvidia’s EVA momentum was 8%, based on 2009 revenue of $3.2 billion, and EVA that improved from negative $407 million in 2009 to negative $152 million in 2010, using an 11% weighted average cost of capital.
• Slow growth and shrinking profit -- but strong balance sheet. Nvidia's $3.5 billion in revenues have climbed at an average rate of 3.1% over the last five years and its net income of $253 million has gone down at a 13.3% annual rate over the period -- representing a 7% net margin. It has very little debt ($23 million) while its cash has increased at a 22.8% annual rate from $1.1 billion (2006) to $2.5 billion (2010).

I'd avoid this stock because it is faces too many market headwinds to generate enough profit to exceed its cost of capital. If it comes up with surprisingly high earnings growth due to groundbreaking new products, I'd reconsider. But for now, this does not appear likely.