Nvidia: Margin Adjustment Is Years Away (Rating Upgrade) (NASDAQ:NVDA)

NVIDIA Corporation (NASDAQ:NVDA) had fallen from an extraordinarily strong quarter, with the market expecting further upside. The AI ​​GPU company provided a remarkably solid outlook despite issues with new chips. This raises the question of whether the decline was actually related to a Justice Department subpoena and not to allegedly disappointing guidance. My investment thesis is more optimistic about the chip company in the near term until the margin problem worsens at Nvidia in the coming years.

Great rhythms

Nvidia just reported a quarter with revenue of $30 billion, beating consensus estimates by $1.3 billion, but the markets sold off its stock. The AI-powered GPU company even reported third-quarter revenue of $32.5 billion, compared to consensus estimates of $31.7 billion.

The stock is down in part due to buy-side sales estimates of between $33 billion and $35 billion, as highlighted by influential sources. Technology analyst Ming-Chi Kuo had this to say:

Either way, the rationale for selling Nvidia doesn't make sense. The stock closed Sept. 3 down 16% in the four trading days since the Aug. 28 earnings report.

Nvidia just reported October quarterly revenue of $3.8 billion above consensus estimates for the July quarter. Once again, analysts and investors are stuck on the company beating its targets and not on relative growth rates. The current consensus target for Q3 amounts to nearly 82% growth, while the chip company consistently beats analyst estimates by more than $1 billion.

The consensus targets below highlight how consensus revenue estimates for Nvidia have increased over time. As of 2023, analysts had been expecting fiscal 2027 revenue of just $50 billion, and current estimates are $207 billion. Estimates for fiscal 2027 have increased by approximately 32% over the past 6 months.

It's clear that Nvidia's revenue numbers remain strong.

No competitive threat

A major reason to be more optimistic about Nvidia in the near term is that Advanced Micro Devices, Inc. (AMD) has been unable to increase AI GPU sales and Intel Corporation (INTC) is talking about investments in artificial intelligence that will still take years to bear fruit. The former chip giant is in the midst of another restructuring that will distract the company from taking on Nvidia.

AMD just reported that GPU sales in the second quarter topped $1 billion. Nvidia just added $3.7 billion in additional data center GPU revenue in the last quarter alone, and forecasts suggest another $1.7 billion in additional revenue, while AMD continues to add millions every quarter.

Analysts now believe AMD will hit $5 billion in GPU sales this year, with New Street Research setting a target of just 20 billion dollars by 2027. Nvidia has already surpassed a $100 billion annual run rate, suggesting AMD is only getting crumbs right now and has no threat of hurting margins for possibly years.

Without any major threats, the Blackwell delay will not affect Nvidia in a major way. At the Q2 2025 earnings press conference, the company made the following statement regarding expectations that new Blackwell GPUs will sell for several billion dollars in the fourth quarter:

Hopper demand is strong and Blackwell is sampling broadly. We have made a shift to Blackwell GPU mass to improve production yields. Blackwell production is planned to begin in Q4 and continue through fiscal 2026.

In the fourth quarter, we expect to ship several billion dollars in Blackwell revenue. Hopper shipments are expected to increase in the second half of fiscal 2025. Hopper supply and availability have improved. Demand for Blackwell rigs is well above supply and we expect this to continue next year.

Nvidia reported that margins actually dipped slightly in the fiscal second quarter, with non-GAAP margins falling 3.2 percentage points from the fiscal first quarter to 75.7%. Operating margins remained at an extremely strong 66.4% with operating income increasing $1.9 billion sequentially due to a limited increase in operating expenses to just $2.8 billion.

Gross margins only declined due to inventory reserves for low-yield Blackwell material. Naturally, Nvidia is not experiencing any pricing pressure as AMD is unable to achieve higher volumes to meet the growing GPU demand.

Nvidia trades at just 30 times its fiscal 2026 earnings per share target. Consensus estimates call for earnings per share to grow at a 40% clip next fiscal year to reach nearly $4 per share.

Nvidia should recover on the back of these figures. The big issue is the transition to more normalized margins in the future, where gross margins will rarely exceed 60% and operating margins may not even reach 40%.

According to updated fiscal 2028 (2027) estimates, Nvidia could see earnings per share decline over the next three years. Consensus estimates are for fiscal 2028 revenue of $227 billion, nearly doubling over the period, but normalized gross margins of 60% with operating margins of 45% result in earnings per share of just $3.46 versus the current fiscal 2026 target of $3.96.

Even the 45% operating margin is extremely high, but Nvidia only operates at an annual operating expense rate of nearly $11 billion. The chip company would have to increase spending to $34 billion to reach this target level.

As the estimates highlight, even if revenues rise to $300 billion in fiscal 2028, earnings per share estimates barely rise at lower margins. The key is how long Nvidia can maintain these seemingly excessive gross margins with little to no operating expense.

Department of Justice case

Considering that the stock fell more than $11 and nearly 10% at the start of trading in September, the after-hours news about a Justice Department subpoena was likely to blame for the significant drop. Regulators are reportedly looking into whether the chip company violated antitrust laws by making it difficult for customers to switch to competitors.

From the outside, it's hard to tell whether the Justice Department has anything to say. The main question is how Nvidia is supposedly preventing its competitors from switching to other competitors that lack chip supply.

Unless AMD and the Justice Department have a case that Nvidia prevented the company from obtaining additional manufacturing supplies, the Justice Department does not appear to have a case. AMD has not openly complained about such a situation.

Nvidia apparently sent by email Bloomberg The following statement suggests that the company wins orders based on merit:

Nvidia wins on merit, as reflected in our benchmark results and the value to customers, who can choose the solution that best fits their needs.

Investors cannot know the actual outcome of any Justice Department case, but they can look at past cases involving tech giants. Alphabet Inc. (GOOG) (GOOGL) was found to be violating antitrust law with its default location on iPhones, but analysts don't foresee a solution for several years. Ironically, Google didn't lose the lawsuit over default search deals until AI became a threat to the search business.

In essence, the Justice Department would still have to file a lawsuit against Nvidia and take the company to trial, which could take years to resolve. Meanwhile, Alphabet recently hit an all-time high of over $190 while the Justice Department trial is ongoing. Since 2020along with cases against other tech giants.

Investors could have a chance to buy Nvidia near $100. The stock would only trade at 25 times fiscal 2026 earnings per share targets, with growth rates still exceeding this multiple.

Carry

The main takeaway for investors is that Nvidia is still firing on all cylinders. The stock's decline, whether due to the DOJ subpoena or concerns about the outlook, is an opportunity to buy back into AI GPU stock. Nvidia will eventually face a margin squeeze, but the company will likely have another 1-2 years of strong margins before the competition catches up.