Hindsight on Nvidia Provides a Lesson

The Cue for Investors

Now, six months later, the stock price is at more than $28. I congratulate the bold decision by Nvidia's management and the insiders who stood behind their thesis because this proved to be a perfect contrarian call against the Street. The buybacks and insider buys signaled an outright opportunity with a trading window of weeks. That was enough space for any investor wanting to participate to buy in.

The insiders obviously had more insight on how competitive Nvidia's product line was and were more confident in betting on it. But again, it is common knowledge that as a subset of the jittery semiconductors group, the graphics chip market is highly cyclical and volatile. For such stocks, usually the pessimistic situations create the best entry points and should be analyzed with an eye for opportunities.

Demand for all kinds of multimedia gadgets, such as graphics-dependent gaming consoles and 3G video-enabled cell phones, is growing, too. Graphics chip designers can enjoy significant upside for future revenue from a few contracts. For example, Nvidia announced last December that it will help to design customized graphics chips for Sony's (SNE - commentary - Cramer's Take) next-generation PlayStation. Analysts expect this deal to add 10 cents to 20 cents to 2007 earnings, and the stock traded higher after the news.

Apart from all the corporate and insider signals, Nvidia's stock was not too pricey in August 2004 around $10, even with fiscal 2006 estimates slashed by half, to 50 cents. Given the improved outlook with fiscal 2006 consensus estimates back above a dollar, the stock's valuation still does not seem overstretched at the current stock price of $28.

Apart from Nvidia, many semiconductor companies with rich balance sheets have announced their intention to spend sizable cash to buy their own shares. I attribute this to managements being confident in their business outlooks. Major companies that have voiced this intent are:

Intel (INTC - commentary - Cramer's Take)
KLA-Tencor (KLAC - commentary - Cramer's Take)
Texas Instruments (TXN - commentary - Cramer's Take)
Varian (VARI - commentary - Cramer's Take), which recently sold a division to Jabil (JBL - commentary - Cramer's Take) for $195 million and plans to use the proceeds for a $145 million buyback
IDT (IDTI - commentary - Cramer's Take)

The million-dollar question is, are these companies simply trying to buy their growth in a slowing environment, or is this a signal that they believe the semiconductor cycle is bottoming? I will examine the answer to this question in detail in a following article.

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At the time of publication, Alici was long Intel, although holdings can change at any time.

Burak Alici, CFA, FRM, is a founding partner of Alchemy Asset Management, a private investment firm based in Istanbul, Turkey. Alici invests with a global focus, using a broad range of relative value strategies including equity/long, risk arbitrage, capital structure arbitrage, convertible arbitrage and sovereign fixed income. Prior to his work at Alchemy, Alici was an assistant portfolio manager for Ernst Research and Management, where he managed equity portfolios for institutional investors, and head of equity trading at Lindner Asset Management. He holds a master's degree in finance from Boston College and a bachelor's degree in mechanical engineering from Bogazici University, Istanbul. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. Alici appreciates your feedback and invites you to send your comments to [e-mail].