Nvidia's golden artificial intelligence (AI) era fuels record-breaking results beyond Wall Street's wildest forecasts

Nvidia shattered expectations with AI-fueled success in Q3. Get the full story here, from regulatory warts to champagne-worthy growth trends.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Semiconductor designer Nvidia (NASDAQ: NVDA) reported earnings on Tuesday evening, covering the third quarter of fiscal year 2024. The company enjoyed massive orders for its market-leading chips for artificial intelligence (AI) systems, focusing on generative AI and large language models. Nvidia's chips power the popular ChatGPT system, and many companies are tapping into that idea in 2023.

The company crushed Wall Street's consensus expectations by a wide margin. The results also exceeded management's guidance targets across the board. Let's take a closer look at Nvidia's financial data and future prospects.

Visual summary of Nvidia's third-quarter earnings, showcasing significant growth in AI-driven revenues and profits.

How profitable is Nvidia?

Nvidia's management expected third-quarter sales to land near $16 billion, with a $300 million margin of safety on both sides. Instead, top-line sales tripled year over year to $18.1 billion. That's a large surprise, and Wall Street's consensus estimates stopped at $16.1 billion.

Adjusted gross margins were targeted at approximately 72.5%. The final tally showed a gross margin of 75%, delivering another significant shock to the upside. For the record, gross margins 2.5% above the stated target added $453 million to Nvidia's operating profit.

As the torrential influx of highly profitable revenues trickled down the income statement, Nvidia collected $10 billion of adjusted net income. Earnings under generally accepted accounting practices (GAAP) rose from $0.27 to $3.71 per diluted share. Adjusted earnings exceeded the average Street view by 20%. Free cash flow worked out to $7 billion, up from a cash burn of $138 million in the year-ago period.

So yes, Nvidia is very profitable right now. The AI fever has triggered a golden age for this provider of essential AI processing hardware.

How is the holiday quarter shaping up?

Nvidia's seasonal business pattern is changing before our eyes. The company used to rely on gaming hardware sales in the fourth quarter and back-to-school systems in the third reporting period of each year, but the ongoing AI revolution flattened those trends like a financial steamroller.

The steamroller is shifting into a lower gear, though. This quarter will probably be remembered as the peak of Nvidia's AI-powered revenue acceleration.

On a year-over-year basis, Nvidia's sales fell 21% in the first quarter, as the ChatGPT-inspired love of AI solutions hadn't translated into product sales yet. The story changed in the second quarter, and Nvidia's revenue doubled. The third quarter's top-line tripling was widely expected; what was an untapped opportunity in the early fiscal year has now evolved into a reliable business engine.

The current quarter's business trends point to a similar revenue acceleration in the next report. Guidance suggest total sales of approximately $20 billion, which would be a 162% gain compared to the fourth quarter of fiscal 2023. At the same time, gross margins are expected to widen a bit more, with a 75.5% target for the adjusted results.

In other words, Nvidia seems to have settled down to a "new normal" range of expected sales, with strong margins suggesting that the company has serious pricing power in this environment.

Is Nvidia a good AI stock?

Nvidia's results were impressive, but some investors still expected more. The stock fell more than 3% on Wednesday morning amid profit-taking and perhaps some disappointment over the slower top-line growth ambition for the fourth quarter.

Furthermore, management pointed out that regulatory limits on chip sales to China will weigh on its future results. The company is seeking workarounds for these rule changes, which may apply to as much as 20% of Nvidia's total sales.

"We expect that our sales to these destinations will decline significantly in the fourth quarter, though we believe it will be more than offset by strong growth in other regions," CFO Colette Kress said on the earnings call.

And there's no denying that the stock is expensive by traditional valuation metrics. After this blowout report, Nvidia's stock trades at 57 times trailing earnings and 27 times sales. These valuations are usually reserved for rapidly growing, asset-light software upstarts, not hardware giants with physical distribution networks.

From a business model standpoint, Nvidia is the firm leader in AI-specific processors at this crucial inflection point. But powerful semiconductor rivals like Advanced Micro Devices (NASDAQ: AMD), Intel (NASDAQ: INTC), and Qualcomm (NASDAQ: QCOM) are also developing high-powered AI chips, to say nothing of potential threats from as-yet unknown upstarts. This is the tech sector, where the sands are always shifting.

So Nvidia may be a long-term winner if it can hold on to its first-mover advantage in the long run. That's a reasonable idea, since the company now can invest tons of AI-driven cash profits into future growth projects. On the other hand, I can't blame investors for cashing in some profits, since Nvidia's stock has more than tripled in 2023.

Ultimately, the answer comes down to how you view Nvidia's prospects developing in the long run, and how comfortable you are with the stock's elevated valuation. Nvidia could be the perfect stock for you or an easy "sell," depending on your tolerance for market risk.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Anders Bylund has positions in Intel and Nvidia. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Advanced Micro Devices, Nvidia, and Qualcomm. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended Intel and has recommended the following options: long January 2023 $57.50 calls on Intel and long January 2025 $45 calls on Intel. The Motley Fool Australia has recommended Nvidia. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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