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Tickers in this Article: NVDA, AMD, INTC
Graphics-chip-maker Nvidia Corporation (Nasdaq:NVDA) proved the severity of its recent profit warning by releasing poor results for the fiscal second quarter. Investors had effectively priced NVDA shares for the worst, sending them down 30% on the day of the warning then another 15% before bottoming out at $10.50 in early August.

Stock investors are always forced to divide their time between examining the trees (current earnings results) while not losing sight of the forest (long term thesis, secular trends, competitive advantages). Today we'll review both for the company, named last year's Forbes' Company of the Year, which now may be trading at bargain bin prices.

Into the Trees - Earnings Report Rundown
I highlighted my concerns over Nvidia last November in Tech Sector No Longer A Safe Haven because they represented the nature of many tech stocks at the time - performing well, richly valued and in great danger of a sell-off if the consumer showed weakness. Several quarters later, the consumer is under fire from inflation, and Nvidia shares have been cut by two-thirds.

The highlights - or more to the point, the lowlights - of last week's Q2 earnings report include a charge of $196 million, a large-scale recall based on a manufacturing error, squeezed margins and concerns about a new competitor by the daunting name of Intel Corp. (Nasdaq:INTC).

Revenue was down 23% from the prior quarter and 5% year-over-year at $893 million. While part of the decline is due to normal seasonality, the 25% drop in average selling prices (ASPs) for desktop computer chips was most certainly not. Nvidia made a tactical error by underestimating how good a new product would be from another competitor, perennial #2 chipmaker Advanced Micro Devices (NYSE:AMD).

As a result of ignoring AMD - parent of the former ATI, which it acquired in 2006 - Nvidia's inventory channel quickly swelled and they had to drastically cut prices to get units moving again. As a result of the surprise discounts, slowing global computer growth, and the big non-recurring charge, Nvidia posted a net loss of $121 million versus a $172 million profit a year ago.

Valuable Lessons Here...But Will Management Learn?
I can understand how CEO Jen-Hsun Huang and other top brass would downplay AMD as a competitor. I've been following the company for well over a decade, and rarely did I even consider buying the stock. Not to take anything away from the loyalists out there, but AMD's track record isn't exactly the envy of the industry.

But ATI was a fierce competitor as a stand-alone company, and it was only a matter of time before AMD was able to integrate well enough to put a solid product out. At the moment graphics chips are really a duopoly between Nvidia and AMD, and in my experience it's really not smart to take your eye off the other horse in a two horse race. (For more on competition, in business read Antitrust Defined, and our Economics Basics Tutorial.)

With Intel looming on the horizon, maybe the recall and price-slap was a good thing for Nvidia, because they need to be razor-sharp and ultra aware in the next few quarters.

Forest Level View
Despite all the bad news above, Nvidia is firmly entrenched in the high end graphics processing market and has very strong brand awareness. AMD's surprising entry was a low-end chip, and they have yet to make a real dent in heavy duty processors. Nvidia's business computing segment grew revenues by 38% year-over-year while market share for mobile workstations shot up from less than 50% to over 90% in the past 18 months.

As a fabless chipmaker (production is outsourced), Nvidia isn't straddled with the debt loads of their larger rivals. In fact, they have no debt at all. This allows them to focus on research and development (R&D) and aggressively enter new growth markets.

Nvidia has increased its stock buyback program by a billion dollars, making the program now big enough to retire about 20% of the outstanding shares at current prices. (To learn more, read A Breakdown Of Stock Buybacks, and learn what these company programs achieve and what it means for stockholders like you.)

And despite all the troubles, the company was still operating cash flow positive for the quarter at $90 million.

The best news is that shares appear to be oversold, and have been bid up a healthy 25% since the bottom in early August. The company is still expected to earn 90 cents per share for the current fiscal year, putting the valuation at an attractive 15-times estimates.

More clarity on future growth could come out next week when Nvidia holds an annual love-fest for analysts, developers and clients. A big topic of discussion will be the company's new Tegra product line of mobile "system-on-a-chip" processors that target the exploding smart phone/handheld device market.

Parting Thoughts
At these levels, Nvidia could be a great pickup for longer-term investors. While I'm still not delighted about the state of the U.S. consumer, Nvidia has broad international exposure (over 75% of revenues come from overseas) and is still best-in-breed in its largest market segments. Net income has risen over eight times in just the past four years, while the stock price has barely doubled.

I see graphics capabilities as one the most important drivers of consumer products growth, and high-end chipsets have made their way into cell phones, gaming consoles, computers and TVs - they are a vital part of the "iTubeHD" world we crave more and more.

Will Intel enter the market with a bang or a whimper? Will consumer demand stay strong for visual computing solutions? Be sure to join me (EpiphanyOne) in the FREE Stock Picking Community to share your thoughts and see what other investors are saying.

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