Could Nvidia Reach Another All-Time High? Analysts Are Watching One Key Number

Nvidia (NASDAQ: NVDA) has been one of the stock market's biggest winners over the last five years. The company's share price has rocketed roughly 1,280% higher over the stretch, delivering potentially life-changing returns for patient shareholders.

Thanks to those incredible gains, Nvidia now has a market capitalization of roughly $5.18 trillion and stands as the world's most valuable company by a significant margin. On the other hand, investors had a relatively muted reaction to the company's recent first-quarter report despite the blockbuster sales and earnings growth and management's strong guidance.

Image source: Nvidia.

Nvidia posted adjusted earnings of $1.87 per share on sales of $81.62 billion, a performance that came in significantly ahead of the average Wall Street analyst estimate for per-share earnings of $1.76 on sales of $78.86 billion.

Despite year-over-year sales growth of 85% in the quarter and guiding for a revenue increase of roughly 95% in the current quarter, the company's recent quarterly report and forward targets have yet to power another strong leg of bullish momentum for the stock. With the market seemingly shrugging at what was a blowout quarter in most respects, investors may be wondering whether Nvidia has what it takes to reach a new high.

With that in mind, read on for a look at a key metric that will likely play a huge role in shaping the artificial intelligence (AI) hardware leader's performance over the next three years.

Keep an eye on Nvidia's gross margins

Nvidia posted an incredible adjusted gross margin of 75% last quarter -- up from its already highly impressive gross margin of 71.3% in the prior-year period. The gross margins reflect the AI hardware leader's pricing power, enabling the business to deliver stellar net income margins and strong earnings growth amid dramatic revenue expansion.

While the cyclical nature of semiconductor launches and pricing historically meant that Nvidia was unable to sustain very high gross margins for long, sky-high demand for its advanced AI processors has driven an unprecedented run of prosperity, enabling it to become the world's largest company. For the current quarter, Nvidia once again expects its gross margin to come in at 75%.

As a business that still generates the large majority of its revenue from hardware sales, Nvidia's recent gross margins don't leave much room for expansion. With the AI processor space becoming more competitive and application-specific integrated circuits (ASICs) gaining favor for some artificial intelligence processes, it's reasonable to expect the company could see gross margin compression over the next three years unless software and services become a significantly larger part of overall sales.

On the other hand, management's growth outlook continues to look very promising -- and expansion into new categories including central processing units (CPUs) could open up substantial new sales streams that help drive earnings increases. Nvidia stock stands a good chance of notching new highs over the next three years, but the extent to which the company can sustain its current gross-margin levels will likely remain a central discussion point for its valuation outlook.

Keith Noonan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool has a disclosure policy.