NVIDIA's AI Dominance: A Double-Edged Sword for Investors

Nvidia: More AI Waves Are Taking Shape (NASDAQ:NVDA)

CEO Jensen Huang says the AI robot industry could be bigger than the auto and consumer electronics industries combined. Introduction Per my March article, NVIDIA Corporation (NASDAQ:NVDA) has a bright future with accelerated computing, and we need to think about them as an AI factory builder rather than merely a GPU designer. Since the time of that writing, new information has come out, including the March 18th GPU Technology Conference ("GTC"), the 1Q25 10-Q through April 28, the latest annual review with the May 2024 letter to shareholders, and the June 2024 Computex keynote video. My thesis is that Nvidia is just getting started with AI as more waves are taking shape. AI spending will continue with healthcare, government, robotics, and other areas as new waves of development gain strength. Improvements For Future AI Waves Nvidia is making a great deal of money because of the first major AI wave, which is large language models ("LLMs") like ChatGPT. This is merely one wave in the AI journey, and there are shortcomings with this first major wave. Some LLM limitations were discussed in an April Lex Fridman podcast when Meta Platforms, Inc. (META) Chief AI Scientist Yann Lecun said LLMs lack four essential characteristics of intelligent systems (emphasis added): They don't really understand the physical world. They don't really have persistent memory. They can't really reason and they certainly can't plan. Like Meta Chief AI Scientist Lecu, McKinsey also says more breakthroughs are needed: But although gen AI tools such as ChatGPT may seem like a great leap forward, in reality, they are just a step in the direction of an even greater breakthrough: artificial general intelligence, or AGI. McKinsey shows eight capabilities AI needs to achieve: Healthcare And Government The Mastering AI book by Jeremy Kahn says AI is helping medicine regarding challenges such as protein folding. The book says AI will do many things for healthcare beyond drug development: The applications of AI to healthcare extend far beyond new drugs. The technology is already helping radiologists spot tumors and signs of pneumonia in medical imagery. At Johns Hopkins Hospital in Baltimore, an AI algorithm has been used to better predict which patients will develop sepsis, reducing mortality from the condition, which kills 250,000 Americans each year, by 20 percent. [page 176.] The Mastering AI book goes on to say the US military is investing heavily in autonomous capabilities. Former House Speaker Nancy Pelosi has unique insight into future government spending and healthcare spending; she bought 10,000 shares of Nvidia in late June. Robotics During Nvidia's March 2024 GTC keynote video, CEO Jensen Huang discussed the next wave of AI robotics - physical AI. He says we'll need 3 CUDA-compatible computers in the next wave, where the AI machines understand the physical world. The first computer is the same as what we use now - DGX. Rather than consuming text, it will be watching videos. Nvidia has been building the end-to-end systems for robotics for some time. CEO Huang spells out specifics with 2 of the computers, the DGX and the Jetson AGX robot computer: And so if you want to run transformers in a car or you want to run transformers in anything that moves, we have the perfect computer for you. It's called Jetson. And so the DGX on top of training the AI, the Jetson is the autonomous processor. Per CEO Huang, the third computer for robotics is in the middle - reinforcement learning: And so we need a simulation engine that represents the world digitally for the robot so that the robot has a gym to go learn how to be a robot. We call that virtual world Omniverse. And the computer that runs Omniverse is called OVX. The March 2024 GTC keynote pdf puts these 3 computers together in a diagram: Here is another slide from the same keynote showing how Generalist Robot 00 Technology ("GR00T") fits in regarding DGX and AGX with the Jetson stack: Towards the end of the GTC keynote, CEO Huang said there are over 1 million robotics developers in the Nvidia CUDA ecosystem. He said the next generation of robotics will likely be humanoid robotics. Humans are constructed similarly, so we have a great deal of imitation training data which can be provided. Per the May 2024 letter from Jensen Huang in the latest annual review, the future for AI-powered robots is immense. He says it will be bigger than the auto and consumer electronics industries combined (emphasis added): NVIDIA robotics platforms for building and deploying AI-powered robots, such as the Isaac software and Jetson computer, have over 1.2 million developers and 10,000 customers and partners. NVIDIA has dedicated nearly a decade to robotics AI and is excited to see it all come together. In time, humanoid and task-specific robots will be an industry larger than the auto and consumer electronics industries combined. A May 2024 nature article talks about the AI revolution coming to robots, including simulated worlds such as Habitat from Meta Platforms, Inc. (META) and Isaac Sim from Nvidia. It shares thoughts from Nvidia Marketing Manager Gerard Andrews and Meta AI Researcher Akshara Rai (emphasis added): "Simulation is an extremely powerful but underrated tool in robotics, and I am excited to see it gaining momentum," says Rai. Rai is among those pursuing the hypothesis that "true intelligence can only emerge when an agent can interact with its world". That real-world interaction, some say, is what could take AI beyond learning patterns and making predictions, to truly understanding and reasoning about the world. At the June 2024 Computex keynote, Nvidia CEO Huang discussed the way AI limitations are going away. Here is his explanation from the keynote transcript regarding the next wave, which understands the laws of physics. He said all the world's factories will eventually be driven by AI robotics (emphasis added): The next wave of AI is physical AI. AI that understands the laws of physics, AI that can work among us. And so they have to understand the world model so that they understand how to interpret the world, how to perceive the world, they have to, of course, have excellent cognitive capabilities so they can understand us, understand what we asked, and perform the tasks. In the future, robotics is a much more pervasive idea. Of course, when I say robotics, there's a humanoid robotics that's usually the representation of that. But that's not at all true. Everything is going to be robotic. All of the factories will be robotic. A May 2024 blog post from Nvidia talks about the challenges we've seen with robot grasping up to this point. This is improving thanks to simulation efforts from Nvidia and Alphabet Inc.'s (GOOG, GOOGL) Intrinsic (emphasis added): Grasping has been a long sought after robotics skill. So far it's been time-consuming, expensive to program and difficult to scale. As a result, many repetitive pick-and-place conditions haven't been seamlessly handled to date by robots. Simulation is changing that. Enlisting NVIDIA Isaac Sim on the NVIDIA Omniverse platform, Intrinsic generated synthetic data for vacuum grasping using computer-aided design models of sheet metal and suction grippers. The Unlocking the Metaverse book by Paul Doherty talks about the benefits of digital twins, which improve efficiency and lessen the need for physical testing: Digital twins can help facility managers optimize the use of space in a facility. For example, a digital twin of a warehouse could be used to simulate different layouts and determine the most efficient use of space. [Kindle book location: 461.] Self-Driving Today's electric vehicles ("EVs") are robots on wheels, but they warrant their section here. CEO Huang is excited about robotics in general and autonomous driving specifically. During the March 2024 GTC keynote, he mentioned projects with Mercedes, Jaguar Land Rover ("JLR") and BYD: Everything that moves will be robotics. There's no question about that. It's safer. It's more convenient. And one of the largest industries is going to be automotive. We build the robotic stack from top to bottom as I mentioned, from the computer system, but in the case of self-driving cars, including the self-driving application. At the end of this year, or I guess, the beginning of next year, we will be shipping in Mercedes and then, shortly after that JLR. A January post by former Tesla AI Director Andrej Karpathy talks about the potential for Waymo and Tesla. He implies it is now a question of when and a question of who regarding robotaxis rather than a question of if. He highlights the different strategies used by Waymo and Tesla: Waymo has taken the strategy of first going for autonomy and then scaling globally, while Tesla has taken the strategy of first going globally and then scaling autonomy. Unlike Tesla, Waymo trains their neural networks using TPUs. Given Tesla's use of Nvidia GPUs, it wasn't surprising when Nvidia CEO Huang said Tesla is ahead of the competition regarding autonomy. Regardless of which companies end up making the bulk of the world's self-driving vehicles, I think it is a good bet they will be powered by Nvidia. Valuation I expect Nvidia's earning power to remain strong in the years ahead, as competitors will have a difficult time taking share. I believe customers will have no choice but to spend prodigious sums in the years ahead on Nvidia AI factories to satiate their needs. In a June 2024 Goldman Sachs report, Head of Global Equity Research Jim Covello said it is a big leap to expect competitors to dethrone Nvidia from its dominant position: Today, Nvidia is the only company currently capable of producing the GPUs that power AI. Some people believe that competitors to Nvidia from within the semiconductor industry or from the hyperscalers - Google, Amazon, and Microsoft - themselves will emerge, which is possible. But that's a big leap from where we are today given that chip companies have tried and failed to dethrone Nvidia from its dominant GPU position for the last 10 years. Technology can be so difficult to replicate that no competitors are able to do so, allowing companies to maintain their monopoly and pricing power. It is a mistake to merely value Nvidia as a GPU chip company. I like to think of the company holistically, starting with five of the main points of focus from the March 2024 GTC keynote: AI factories are the modern types of data centers in this new industry, and the vertically integrated Blackwell platform will play an essential role. NVIDIA Inference Microservices ("NIMs") are pre-trained models which have been packaged and optimized. Neural Modules ("NeMo") microservice is an end-to-end platform of composable building blocks for developing custom generative AI. Providing NIMs, NeMo microservice, and DGX Cloud, Nvidia sees themselves as a 3 pillar AI foundry, doing for the AI industry what Taiwan Semiconductor Manufacturing Company Limited (TSM) does for the chip industry. As we said above, the AI robotics business could grow to be bigger than the auto and consumer electronics industries combined. Valuation comes down to the amount of cash we can pull out of a company from now until judgment day. These considerations from the March 2024 GTC keynote make me think it's a good bet Nvidia will have significant earning power in the future. This should mean substantial amounts of cash will be pulled out eventually as the company matures years down the road. Here are operating income and sales figures for Nvidia, AWS, and Google Cloud by calendar quarter. Note that Nvidia's quarters are a month late. Nvidia has an unbelievable operating margin, so they passed AWS in operating income back in the calendar period ending June/July 2023. They also passed AWS in sales for the period ending March/April 2024: Nvidia's revenue, cost of revenue, and gross profit have gone up prodigiously over the last 4 quarters as AI demand has skyrocketed. Q/Q revenue growth from the last 4 periods was 18.9%, 87.8%, 34.2% and 22%. The cost of revenue increases were 14.7%, 59.0%, 16.7%, and 12.5% such that gross profit growth percentages were 21.3%, 103.6%, 41.6%, and 25.3%. The quarter through July 2023 was an inflection point, but increases in the 2 quarters since then have been incredible as well: I like to keep track of the Q/Q and Y/Y growth rates for operating income, gross profit, and revenue in a table: Q/Q Op Inc. Q/Q G. P. Q/Q Rev. Y/Y Op Inc. Y/Y G. P. Y/Y Rev. Y/Y CoR Apr '21 Jul '21 25% 16% 15% Oct '21 9% 10% 9% Jan '22 11% 8% 8% Apr '22 -37% 9% 8% -4% 50% 46% Jul '22 -73% -46% -19% -80% -31% 3% 65% Oct '22 20% 9% -12% -77% -31% -17% 11% Jan '23 109% 21% 2% -58% -23% -21% -16% Apr '23 70% 21% 19% 15% -14% -13% -11% Jul '23 218% 104% 88% 1263% 225% 101% 7% Oct '23 53% 42% 34% 1633% 322% 206% 71% Jan '24 31% 25% 22% 983% 338% 265% 139% Apr '24 24% 22% 18% 690% 339% 262% 122% Click to enlarge On an annual level, revenue increased 126% from $27 billion in FY23 to $60.9 billion in FY24. Cost of revenue went up 43% from $11.6 billion to $16.6 billion, such that gross profit grew 188% from $15.4 billion to $44.3 billion. A large portion of Nvidia's cost of revenue is what TSMC sees as AI-related revenue. In the 1Q24 TSMC call, CEO C. C. Wei said the following regarding AI-related demand for energy-efficient computing power (emphasis added): For the next 5 years, we forecast it to grow at 50% CAGR and increase to higher than 20% of our revenue by 2028. If TSMC has a 50% revenue CAGR for AI-related compute for 5 years, then the implications for Nvidia are enormous. Again, much of Nvidia's cost of revenue goes to TSMC, and they should lose some share such that their cost of revenue may have a 5-year CAGR of less than 50% - perhaps 45%. Looking at Y/Y percentages for the last quarter ending in April 2024, Nvidia's cost of revenue went up 122%. The increase in revenue was higher than this at 262% while the increase in gross profit was higher still at 339% and the lift in operating income was the highest of all at 690%. This shows the operating income CAGR can be much higher than the cost of revenue CAGR. If the 5-year cost of revenue CAGR is 45%, then it's not out of the question for the 5-year operating income CAGR to be 60%. If this happens, then every dollar of yearly operating income from today will be more than $10 in 5 years. Forward-looking investors need to be patient and remember the way the math works. If everything is consistent, then a 60% CAGR means Q/Q increases of about 12.5%. I recently wrote about the way economic benefits from AI have more of an impact on designers like Nvidia than fabricators like TSMC. I expect this to continue, and it is one of the reasons why Nvidia has a bright future ahead. Nvidia's 1Q25 operating income was $16.9 billion on revenue of $26 billion, for an operating income run rate of $67.6 billion. Given expected long-term growth, I think a multiple of 45 to 50x is not unreasonable for a valuation range of $3 to $3.4 trillion. Per the 1Q25 10-Q, there were 2.46 billion shares outstanding as of May 24, 2024, and there has been a 10:1 split since then. The July 18 share price was $121.09, so the market cap is just under $3 trillion. The market cap is close to an explainable valuation range, and I think Nvidia Corporation stock is between a buy and a hold for long-term investors. Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research. I'm an individual investor heavily influenced by Warren Buffett and Charlie Munger. Munger's 1994 USC Business School Speech is something I think about a lot: ### Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return -- even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result. ... Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you're going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% -- or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work. ### Feel free to follow me on twitter: https://twitter.com/ftreric Analyst's Disclosure: I/we have a beneficial long position in the shares of NVDA, AMZN, GOOG, GOOGL, META, MSFT, TSLA, VOO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Nvidia Is Still Historically Overvalued With Negative Catalysts Developing (NASDAQ:NVDA)

This idea was discussed in more depth with members of my private investing community, The Contrarian. Learn More " "If everybody indexed, the only word you could use is chaos, catastrophe... The markets would fail." - John Bogle, May 2017. "The AI hype is a classic example of a big market delusion. It's just like the dot com era when everyone was laying huge bets the internet would change everything. The narrative was correct. But the market bet that narrative would play out a lot faster than it ultimately did." - Rob Arnott As Told To The FT. The momentum trade is faltering, as the Russell 2000 (RTY) has surged the most relative to the S&P 500 Index (SP500) in history the past five days ending Tuesday, July 16th (this was true for the chart ending on Tuesday, July 16th's close, however it stayed true for Wednesday's close as well). Additionally, momentum favorites are starting to fall like dominoes, one by one. This was evident from price action on Wednesday, July 17th, 2024, and Thursday, July 18th, thus far, with momentum favorites like Eli Lilly (LLY), which is down over 7% today as I edit this note, and Nvidia Corporation (NASDAQ:NVDA, NEOE:NVDA:CA) retreating from their recent highs in the same aggressive fashion that they visited these highs. Adding to the cloud overhanging semiconductor stocks, which had their worst single day performance since 2022 on Wednesday, there is pertinent negative news developing on the semiconductor sector and Nvidia itself. The Biden administration seeks to enforce a broader mandate on semiconductor exports to China, and the prospective Trump administration says that Taiwan has taken chip manufacturing jobs from the United States, specifically naming Taiwan Semiconductor aka TSMC (TSM) as a beneficiary. Additionally, ASML Holding N.V.(ASML), the chip equipment maker, just reported earnings, and they received 49% of their revenue from China, so the more comprehensive export ban will impact Nvidia and its cohorts directly and indirectly. Suffice it to say, I have been spectacularly wrong, at least thus far, with my previous public February 8th, 2024, Seeking Alpha article on Nvidia. There, I hypothesized that we were living in 2000 all over again and NVDA shares were set to peak. Again, I emphasize temporarily wrong, as epic bubbles have a way of overshooting even previously unbelievable levels. However, this is the risk, and it is still the risk today in NVDA shares, that irrationally can go on a lot longer than you think is possible. For now, I have to own this incorrect call. However, any good analyst, trader, or investor, will continually try to take advantage of the market opportunities that are the reality facing us, even when they make mistakes. As the saying goes, when there is blood in the streets, even if it is your own, take advantage of the resulting opportunity. Ultimately, the speculative blow-off top in Nvidia shares went much further than I ever imagined, something I will discuss in the next section, to give perspective. I have chronicled this along the way, yet each time, Nvidia shares have kept galloping higher and higher, ignoring any traditional valuation bounds like price-to-sales ratio. Critics point out that it seems like I am a Perm-bear on technology stocks. However, that is not true, as evidenced by my May 13th, 2016 bullish take on Apple (AAPL), published right here on Seeking Alpha. For reference, when I published that Seeking Alpha article on Apple in May 2016, Apple's price-to-earnings ratio was 10.3, compared to the S&P 500's price-to-earnings ratio of 18.8 at that time, and Apple's price-to-sales ratio was 3.9. For comparison, Nvidia's price-to-earnings ratio for the trailing twelve months today is 69.0, and its price-to-sales ratio for the trailing twelve months is 36.9. Ultimately, starting valuation is incredibly important, and Nvidia's starting valuation today is historically high, especially compared to something like Apple in May 2016. While it has been a bumpy start to my prediction, I still think Nvidia is going to play out like Cisco Systems (CSCO) in 2000. In fact, there is a cogent argument that NVDA shares are far more overvalued than Cisco was comparatively in 2000. Building on this narrative, looking at enterprise value as a percentage of GDP, Nvidia has skyrocketed past Cisco at its June 18th, 2024 peak. Shorter-term price action for Nvidia looks like a top is indeed forming in NVDA shares, with momentum now starting to break to the downside. Citigroup (C) made the observation that the volume weighted average share price of Nvidia is now lower than where it was on May 24th, which was Nvidia's last earnings date. Said another way, volume weighted purchasers of NVDA shares on average are down since May 24th, when the stock price was actually much lower back then. The next demarcation line of interest is NVDA's 50-day moving average at $115.02. Breaking this moving average would open a door to a test of the 200-day moving average, which is much lower. Scratch your head, take a snapshot in time, and remember this insanity that we are mired in right now, and take advantage of the historic opportunity. Seemingly each day, something mesmerizing happens in the markets. Said another way, it is unbelievable price action on top of unbelievable price action that makes everything not normal feel somewhat normal, in an environment where asset prices are anything but normal. Those that lived through the markets in 1998-2003, this feeling now is precisely how the markets felt back then. What I mean is, with unbelievable price action, and the recent volatility in the Invesco QQQ Trust (QQQ), which had its worst day relative to the iShares Russell 2000 ETF (IWN) in 22 years on Thursday, July 11th. It then had its worst absolute day since 2022, yesterday, on Wednesday, July 17th. This is bringing back shades of price action from January 2000. As many remember, the Nasdaq Composite (COMP:IND) famously cracked in March 2000, before an almost double-top in the SPDR S&P 500 Index ETF (SPY) in October 2000. Could Nvidia be leading the markets lower after it led the markets higher? On the short-term chart shown earlier, it certainly looks like it. On the longer-term chart, however, the recent decline is just a blip, at least for right now, in Nvidia shares. What a beautiful stock chart and a beautiful American company. How could I not buy this on the long side somewhere along the way? Just looking at the stock price chart, I feel like a dunce, and my 30 plus years of market participation and education has all been for naught. The silver lining, though, is there is now opportunity on the other side. Clearly, Nvidia is a wonderful company, and the founder and CEO of Nvidia, Jensen Huang, has a backstory that is an amazing story, too. In fact, I admire Jensen Huang, particularly his viewpoint about needing pain and suffering to foster resilience. Here is one of his direct quotes on the topic. Greatness is not intelligence. Greatness comes from character. And character isn't formed out of smart people, it's formed out of people who suffered. Jensen Huang. The next quote is particularly near and dear to my heart, as I believe in it immensely, so in a way, I feel a bond with Jensen Huang on this topic. Unfortunately, resilience matters in success, (and) I don't know how to teach it to you except for I hope suffering happens to you. Jensen Huang. Read that last quote again that Jensen gave in his March 2024 address at Stanford, which is music to my heart because Jensen Huang is saying you need to go through pain and suffering to have resilience to ultimately have success. And, oh boy, you are in luck, dear reader, because Mr. Market can surely dish out his share of pain and suffering. In fact, I wrote about the importance of resilience all the way back in October 2018, the article I wrote about resilience is linked here, with a snapshot of that post shown below. At the time I wrote that blog post, we were in the middle of a tremendous amount of pain and suffering. However, that character that this pain and suffering built, that resilience, ultimately paid off remarkably. Let me tie everything together now. So let's recap and get to the concluding thoughts and takeaways. On July 9th, 2024, Keybank (KEY) raised its price target on Nvidia from a $130 to $180, which would be an $1800 share price for Nvidia pre-split, and on July 12th, Benchmark raised their price target for Nvidia shares to $170. This is the same Nvidia that has the following characteristics. The cherry on top of the sundae here is that Goldman Sachs (GS) came out in the last few days reiterating something that Julian Garran, a partner at MacroStrategy, has been saying. Specifically, that AI, 18 months after its heralded introduction to the world, and roughly 14 months after the Nvidia May 2023 kick-off, has yet to produce one transformative application. Think about that for a minute. Here is an excerpt below and the link to the report. Wrapping up, if you have time, read the report, and if you don't, read the excerpt above. I'll translate for you, too, as follows. TL:DR - Price action in the broader stock market is a replay of 2000 and price action in AI stocks is a historic bubble. Could it keep going? Yes, that is the risk. However, there are building signs in the past week that the air is starting to be let out of the balloon.

Here Is Why Nvidia Still Has More Upside (NASDAQ:NVDA)

Nvidia's data center opportunity is significant and could be underestimated by the market. When I wrote my first article on Nvidia Corporation (NASDAQ:NVDA) more than a year ago, the stock had a hold rating among Seeking Alpha analysts with valuation being the major driver of that rating. More than 200% later, the stock is still a hold among analysts, with 11 rating it at least a buy and 24 rating a hold or less as of the time of writing. Again, the bear case seems to revolve around the lofty growth prospects for the company. While the tripling of the stock in just over the past year should mean the hold rating is more accurate now than it was then, this article will discuss why Nvidia might still have more upside. In my first article on Nvidia written more than a year ago, I focused on remarks made by Nvidia CEO Jensen Huang stating that data centers present today were not ready for AI and that will spur capex spending of $250 billion a year (that grow) for multiple years for products and services Nvidia was essentially the only game in town in. From the article: So not only should Nvidia be a $1 trillion market cap, but it should also topple Apple as the world's most valuable company if what Huang said turns out to be true. The question becomes, why is Nvidia trading at just below $1 trillion, rather than at almost $3 trillion like Apple? Well now that Nvidia did reach that $3 trillion valuation, its natural that questions arise about the sustainability of that valuation. In the risks section of that article, I mentioned that Nvidia might lack that iOS factor that Apple had and kept consumers in this article. In today's article, I'll discuss how CUDA could be just that. In 2007, Nvidia developed Compute Unified Device Architecture (CUDA for short) to help use its GPUs in parallel computing for non-graphics workload. To simplify this in extremely basic terms, the main way computing is done is by solving problems one at a time (sequential computing), Nvidia didn't just design GPUs, it built the architecture necessary to try and solve really large computing problems by breaking them down into smaller problems and solving them all simultaneously (or in parallel). CUDA, again in very basic terms, is the piece of software that helps developers tell machines that they want to use the hardware for parallel computing (which is necessary for AI workloads). That piece of software was built with Nvidia's GPUs in mind and vice versa. And because Nvidia was really early, CUDA became the go-to programming platform for training AI models. As a result, those who preferred working with CUDA had to use NVIDIA GPUs, and those who were using the company's GPUs were better off using CUDA, creating a virtuous cycle for Nvidia. In my opinion, this is a crucial part of Nvidia's bull case and where the similarities are with Apple's iPhone. For years, Apple traded at 10x earnings on the premise that this is just a hardware company and eventually someone will make a more compelling or cheaper piece of hardware and win all the market share. That threat never materialized precisely because of iOS. Similarly, in Nvidia's case, it is no longer about making a better chip or a cheaper one for that matter, competitors must also solve the software part of the equation. This is arguably the more difficult part of competing with Nvidia as the longer this takes the more entrenched Nvidia will become. If you think about Apple's business, it's a two-headed dragon. You buy an iPhone, a quality piece of hardware, the Apple upsells you with the services enabled by its iOS and software. Powering the iOS also means that consumers who buy an iPhone are unlikely to switch and will buy other Apple hardware products, creating a consumer lock-in. Similarly, with Nvidia, consumers buy the GPUs today because they are perceived to be the best on the market. But there is also a software component required to activate the capabilities of those GPUs. It is Nvidia's leadership in CUDA that maintains its competitive advantage. Like with Apple, when it's time for consumers to upgrade their GPU, they will stick to Nvidia because CUDA only works with Nvidia. And if they want AMD they will have to learn its computing software and switch the training models they created which creates a significant switching cost that is similar to that faced by Apple consumers. One simple way to understand just how large Nvidia's opportunity could be is to look at AI startup CoreWeave. The company jumped to a $19 billion valuation just a few weeks ago, thanks to being one of the main providers of Nvidia GPUs. Here is an interesting bit from the company's blog: With over 45,000 GPUs in our fleet, we are the largest private operator of GPUs in North America. Our GPU infrastructure is delivered from 5 data centers in Chicago, North Carolina, New Jersey and New York, and rivals the assets operated by the large cloud computing companies. This works out to about 9,000 GPUs for the type of data center required to run AI workloads. The US International Trade Commission estimated that there were roughly 8,000 data centers worldwide in 2021. Now if you believe AI is the new internet, those 8,000 data centers are going to be refined for AI workloads (revisit the recap on Nvidia's initial bull thesis). That means 72 million GPUs, and that's without any growth in the number of data centers, something that looks destined to happen. At a cost of at least $30,000 per GPU, that is approximately $2.2 trillion in GPU sales. Sure that, as GPUs keep improving, less of them will be needed. But that will be more than offset by the growth in data centers and the rise in unit prices of GPUs. CNBC recently reported that Nvidia holds 80% share of AI chips. So that is potentially $1.8 trillion in sales going to Nvidia with sky high-margins. And that's just data center revenue, so excluding gaming for example and other verticals. So even if you assume that capex cycle takes 10 years (and it will likely take less) Nvidia's average sales per quarter in that case ($44 billion in this case) would be almost double what it generated for the whole of 2023. Let's focus on the Compute & Networking segment given its the relevant one for my thesis. As discussed in the paragraph above, even if the AI transition takes a decade to optimize the data centers present today and assuming there is no growth in the number of data centers worldwide, Nvidia would generate an average revenue over the next 10 years of $176 billion excluding graphics. And because of CUDA, Nvidia actually can lock in customers for now. The faster the transition to AI data centers, the more Nvidia sells given its dominant competitive position, which entrenches CUDA's position as the platform for parallel processing, and in turn leads to more GPU sales in the future. There is also the DGX cloud business which offers AI-training-as-a-service platform and customizable AI models for the enterprise, which can help cement Nvidia's competitive position even more. As a result, it is highly likely the company can maintain its current margins of 67% and generate operating income of $118 billion on average over the next 10 years just from compute & networking. let's assume its net interest income is $0 instead of the current $820 million. Slap the current corporate tax rate on those earnings and Nvidia's income would be $93 billion. That means Nvidia is selling at 31x forward earnings assuming: 1) Transition to AI takes 10 years, 2) There is no growth in the number of data centers worldwide. 3) Gaming and other high-growth avenues like automotive make no money for 10 years. Given how unlikely those 3 factors are, I feel that valuation has a lot of margin of safety and propels my reiterating of the buy rating There are signs of competition coming for Nvidia's dominant position. The first one is probably Apple Intelligence. There are two main reasons why Apple Intelligence is a threat to Nvidia. The first is that Apple Inc. (AAPL) will use its own chips, meaning Nvidia won't make its way to Apple devices even if AI is the new internet. The second issue is that Apple will do some if not most of the AI workloads on the device. This implies that the use of Nvidia GPUs could be less than forecast if companies embrace what is in essence a type of edge AI, given Nvidia's GPUs will mostly be in data centers. Another issue to be wary of is the concentration of sales. There is one mystery customer that makes up a significant number of Nvidia's sales: Sales to one customer, Customer A, represented 13% of total revenue for fiscal year 2024, which was attributable to the Compute & Networking segment. One indirect customer which primarily purchases our products through system integrators and distributors, including through Customer A, is estimated to have represented approximately 19% of total revenue for fiscal year 2024, attributable to the Compute & Networking segment. Our estimated Compute & Networking demand is expected to remain concentrated. There were no customers with 10% or more of total revenue for fiscal years 2023 and 2022. In a way, this is an important indication on validity of the thesis that AI is the new internet. If the thesis is valid, sales concentration should decline over time as everyone embraces AI. If it is not, then the concentration should persist and Nvidia will be at the whims of this customer. Investors must pay attention to this metric. The growth in AMD Inc. (AMD) and Intel Corporation (INTC) GPUs is also a threat, given they use their own competing programming platform, which would undermine CUDA in the long-term if it takes off. OpenAI for example launched its own CUDA alternative. Meta meanwhile launched software that enhanced interoperability between Nvidia and AMD GPUs, a move designed to undermine CUDA. From Reuters: Software has become a key battleground for chipmakers seeking to build up an ecosystem of developers to use their chips. Nvidia's CUDA platform has been the most popular so far for artificial intelligence work. However, once developers tailor their code for Nvidia chips, it is difficult to run it on graphics processing units, or GPUs, from Nvidia competitors like AMD. Meta said the software is designed to easily swap between chips without being locked in. These efforts have yet to change the competitive dynamics in my opinion, but it is the key battle investors need to keep their eye on as they assess Nvidia. Despite the stock's impressive run up over the past 12 months or so, Nvidia still has room to run thanks to the huge opportunity in GPU sales for the data center. Nvidia's CUDA also provides high conviction that the company can continue to maintain its 80% share in GPUs. The biggest risk however is that big tech players are trying their hardest to dislodge Nvidia's leadership in the computing platform part of the supply chain. Having said that, this risk is yet to materialize and so the stock remains a buy, especially on any dips. The market is not a zero-sum game by any means however, and these attempts to dislodge CUDA could help AMD and Intel as well.

Photronics: Extremely Undervalued, And A Cash Rich Photomask Leader (NASDAQ:PLAB)

Photronics, Inc. appears to trade at close to 4.4x FWD EBITDA, and the sector median is close to 15x FWD EBITDA. Photronics, Inc. (NASDAQ:PLAB) is a leading manufacturer of photomasks, which are necessary for manufacturing semiconductors. The company can see significant demand thanks to the ongoing demand for semiconductors due to new AI and IoT applications. I would also expect FCF growth thanks to the planned investments in IC capacity and efficiency announced for 2024. Assuming a conservative growth rate comparable with previous headcount growth, FCF growth, and net PP&E growth, my DCF model indicated that the fair price could be close to $54.85. There are many other indicators about the undervaluation of PLAB, including the total amount of cash in hand of close to $493.9 million and the tangible book value per share of $16.75. Business Growth, And Headcount Growth Photronics, Inc. is, according to the last annual report, the world's leading manufacturer of photomasks, which are necessary for manufacturing certain semiconductors. The company reported eleven manufacturing fabs in Taiwan, China, Korea, the United States, and Europe. Photomasks are a key element in the manufacture of ICs and FPDs and are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates during the fabrication of ICs, a variety of FPDs and, to a lesser extent, other types of electrical and optical components. Source: 10-k The company sells its photomasks to FPD designers and manufacturers. The number of customers does not seem small. During 2023, the company reported a total of 696 customers. Hence, I see certain diversification in the geographic operations and the number of clients. In my view, the headcount growth experienced from 2014 to 2023 is one of the most remarkable indicators of long-term growth. From 2014 to 2023, the headcount increased from 1500 to 1885. I think that headcount growth is linked to net sales growth. Under my financial models, I assumed that headcount growth would continue, which may accelerate net sales growth. It is also worth noting that EPS expectations include growth in 2024, and 2025. Forward 2025 PE is expected to be around 11x. The following information was obtained from Seeking Alpha. Increase In The Total Amount Of Cash, Total Equity I think that one of the most relevant indicators of business successes is net property, plant & equipment growth and total assets growth. It means that directors are investing in new capacity, which indicates, in my view, beneficial expectations about the future. Besides, in my opinion, net property, plant & equipment growth indicates that Photronics is reinvesting its cash flow and other sources of financing in new properties and assets. Net PP&E increased from $550 million in 2014 to $729 million in 2023. Total assets also increased from $1 billion in 2014 to about $1.5 billion in 2023. Other relevant indicators of long-term growth include total equity growth and cash growth from $192 million in 2014 to $499 million in 2023. Given the current amount of cash in hand, I think that we could expect a new acquisition of shares in the coming years. With an enterprise value of close to $1.2 billion, I do not know for how long directors may be able to explain why they hold that amount of cash. If we divide some balance sheet figures by the total amount of shares, Photronics, Inc. appears significantly undervalued. The current cash per share is close to $7.99, and the tangible book value per share stands at $16.75. It means that the price is approximately 1.5x the tangible book value per share. Negative Net Debt, And Interest Rate Paid of 1.08% And 1.58% Shareholders saw a decrease in the total amount of debt from $142 million in 2014 to $20 million in 2023. The net debt is also negative, and the total amount of liabilities also declined from $289 million in 2014 to $235 million in the last report. In sum, everything seems to indicate that the company is getting more wealthy every year. The company is that wealthy that the interest rate paid for lease agreements is close to 1.08% and 1.58%. With these figures in mind, I assumed cost of capital of 7% because I tried to be as conservative as possible. In February 2021, we entered into a five-year $7.2 million finance lease for a high-end inspection tool. Monthly payments on the lease, which commenced in February 2021, are $0.1 million per month. Upon the payment of the fiftieth monthly payment and prior to payment of the fifty-first monthly payment, we may exercise an early buyout option to purchase the tool for $2.4 million. The interest rate implicit in the lease is 1.08%. Source: 10-Q As of the due date of the forty-eighth monthly payment, we may exercise an early buyout option to purchase the tool for $14.1 million. Since we are reasonably certain that we will exercise the early buyout option, our lease liability reflects such exercise and we have classified the lease as a finance lease. The interest rate implicit in the lease is 1.58%. Source: 10-Q Some Competitors Trade At 9x-23x FWD EBITDA The company's competitors include companies like Dai Nippon Printing Co. (OTCPK:DNPCF), which trades at 9x FWD EBITDA, and HOYA Corporation (OTCPK:HOCPY), which trades at 23x FWD EBITDA. Unfortunately, other competitors are not public companies such as Shenzhen Newway Photomask Making Co., Ltd., Shenzhen Qingyi Photomask, Ltd., SK-Electronics Co., Ltd., Taiwan Mask Corporation, and Toppan Electronics Products Co., Ltd. In any case, I think that PLAY appears significantly undervalued at the current EV/EBITDA. As of July 19, 2024, the company appears to trade at close to 4.4x FWD EBITDA, and the sector median is close to 15x FWD EBITDA. Previous FCF, And My Expectations About FCF Growth My DCF model includes assumptions about future growth driven by new applications for semiconductors thanks to the new AI and IoT revolutions. In addition, according to the last presentation to investors, the company is also expecting demand for its products thanks to supply chain regionalization and differentiation by design. More in particular, I would say that the ongoing mobile demand could accelerate the company's net sales growth and unlevered growth. In addition, demand for FPD could also accelerate thanks to growth in the AMOLED market. Amoled market was estimated at USD 16589.69 million, and it's anticipated to reach USD 78832.94 million in 2030, with a CAGR of 21.51% during the forecast years. Source: Amoled Market Size, Research [From 2023 to 2030] I would be expecting further increase in net sales, net income, and FCF growth driven by further increase in IC capacity and efficiency. In the last annual report, the company reported that 2024 capex will most likely be $140.0 million. Management said the following about the role of these investments. We estimate capital expenditures for full year FY24 will be approximately $140.0 million; these investments will be targeted towards high-end and mainstream IC capacity and efficiency and enable us to support our customers' near-term demands. Source: 10-k In my view, we could see new stock repurchases because the company did buy in the past. I think that the company appears significantly undervalued, and there is a significant amount of cash in hand standing in the balance sheet. With new stock repurchases, I think that we could expect lower cost of capital driven by new demand for the stock. In this regard, investors may want to take a look at the lines below. In August 2019, the Company's board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act. The share repurchase program commenced on September 25, 2019, and was terminated on March 20, 2020. Source: 10-k In September 2020, the Company's board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1. As of October 31, 2023, there was approximately $31.7 million remaining under that authorization. Source: 10-k From 2014 to 2023, the company reported long-term growth and FCF growth from $6 million in 2014 to $122.8 in 2023. We only saw negative FCF in 2019. I took into account previous free cash flow to assess future financial figures. Hence, please take a look at the figures reported in the past. I also took into account previous net income growth, changes in working capital, capex, and the outlook given by the company in the last presentation. My DCF model includes the following assumptions. First, I assumed long-term FCF growth in line with FCF seen in the past. I also assumed cost of capital of 7% because the company reports negative net debt. Besides, I included long-term growth of 2% from 2029. The results included a total enterprise valuation of $2.87 billion, equity of $3.4 billion, and a target price of $54.85. NPV of TV: $2,223.14 million Total: $2,873.36 million Net Debt: -$538.10 million Equity: $3,411.46 million Shares: 62.20 million Target Price: $54.85 Other Analysts See Upside Potential In my view, it is always worth taking a look at the expectations of other analysts. According to Seeking Alpha, the average target price given by Wall Street stands at around $32 per share. The average analyst rating was also strong buy. The number of analysts covering the stock is not significant. However, most of them believe that the company is a buy. The following is also information obtained from Seeking Alpha. Risks The company appears to work with a limited number of suppliers, which could bring significant problems in the coming years. Lack of equipment, late delivery, or an increase in the price of supplies could lower future net sales growth as well as lower unlevered FCF growth. In this regard, the company reported the following commentary. We rely on a limited number of photomask equipment manufacturers to develop, supply, and repair the equipment we use. These equipment manufacturers usually require lead times of twelve months or longer between the order date and the delivery of certain photomask imaging and inspection equipment. The failure of our suppliers to develop, deliver or service such equipment on a timely basis due to internal issues, supply chain constraints or government imposed restrictions could have a material adverse effect on our business and results of operations. In addition, the manufacturing equipment necessary to produce advanced photomasks could become prohibitively expensive, which could similarly affect us. Source: 10-k The company works with a significant number of suppliers, customers, and finances manufacturing facilities outside the United States. In my opinion, changes in the laws regulating imports and exports as well as increase in tariffs in the United States, China, or other territories could damage the company's net income growth and FCF growth. Besides, if analysts lower their expectations due to the result of elections in the United States, I think the demand for the stock could lower, and the price could fall. Conclusion Photronics, Inc. could see significant product demand coming from the growth of the use of AI and IoT technologies. Besides, I think that headcount growth, long-term net PP&E growth, assets growth, and FCF growth indicate that Photronics is quite a successful business. In my opinion, the company could offer IC capacity and efficiency thanks to recently announced capital expenditures, which may also lead to higher FCF growth. With these assumptions and previous financial figures, my DCF model indicated that the company could be worth around $54 per share. Competitors' EV/EBITDA is also significantly higher than the company's current EV/EBITDA. In my opinion, as soon as more investors take a look at the company's financial figures and current valuation, the stock price could trend higher. London Stock Market Research is a service offered by an ex-investment banker from the city of London. After around 11 years in the industry, I decided to drop out, and made dollars out of what I learned in business. I appreciate value investments, and I usually buy companies that trade at close to 10x earnings, and offer dividend yield. I mainly research small caps, and mid caps from the United States, Canada, South America, UK, France, and Germany.-------------------------------------------------------------------------------------Disclaimer: I do not offer financial advice. This is only my opinion about the price of stocks. Readers may want to hire an investment adviser. My articles may also include mistakes about future EPS forecasts, EBITDA forecasts, net sales forecasts, and other expectations. My valuation models may also include assumptions about the cost of capital, cost of equity, or future growth. These assumptions may be too optimistic, or too pessimistic. Analyst's Disclosure: I/we have a beneficial long position in the shares of PLAB either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

NICE: Don't Let Management Transition Distract From Cloud And AI Growth Story (NICE)

The chief risk is increased competition from Amazon, Genesys, and Microsoft. NICE Ltd. Adr. (NASDAQ:NICE) is one of the leading call center as a service (CCaaS) providers. The company is based in Israel, but most of their revenue comes from clients in the United States. It came onto my radar as a potential investment last fall when shares fell to around $170. Since then, shares climbed to $260 before falling back to my purchase price. I'm writing, therefore, to reevaluate the investment. I think that NICE is still a BUY. I'm initiating coverage with a 12-month price target of $260. My thesis is that the short-term uncertainty over the CEO transition has distracted from the company's strong prospects, and that when the transition team and its strategic plan are announced, shares will rerate higher. Over the last decade, NICE has built an impressive record of growth. Revenue growth has accelerated from under 10% to around 13%. As the business has scaled, margins have likewise expanded: EBITDA margin from 22% to 26%, operating margin from 13% to 18%, and net margin from 11% to 14%. So far this year, NICE has beaten earnings twice, but the stock is down 10%. Shares were up in the spring, but dropped 40% after Q1 earnings because longtime CEO Barak Eilam announced his retirement. This - and some concern about AI and competition from Amazon (AMZN) and Microsoft (MSFT) - has the market worried about whether NICE's growth can be sustained. NICE is probably the market leader in the CCaaS space. Morningstar estimates that they have about a 30% market share (used by 1 million of 3 million call center agents on the cloud). According to the investor presentation, more than 85% of NICE's customers are Fortune 100 companies. Sell-side reports project that this market will grow at a ~17% CAGR in the next 5 years; NICE projects 22%. The impetus for sustained growth is the large number of companies still transitioning to the cloud, which promises much lower infrastructure costs and better cross-channel integration for customer service. Only 20% of companies have migrated so far, leaving ample room for future growth. Even if NICE doesn't take market share, it can still grow at 17% CAGR. Moreover, NICE is well-positioned to capture this opportunity. Here is what management had to say on a recent call: I think we see a very favorable environment for us in terms of the competitive landscape similar to what I highlighted last quarter. The reasons, obviously, I think at the end of the day, the offering that we have in, and that's the number one reason now [Indiscernible] will charge by NICE [ph]. But yes, the other consideration, we continue to grow our employee base while others are going through multiple rounds of layoffs. This assessment is backed up by industry reviews. Gartner has ranked NICE as one of the leading CCaaS providers, along with Five9 (FIVN) and Genesys (private), since 2017. Recent reviews from ISG and Spark Matrix confirm this. The three have similar NRRs according to Morningstar, but NICE's CXOne gets the best marks from customers: 4.6 stars on Gartner. The biggest players are winning out, while smaller competitors like Sprinklr (CXM), Five9, and RingCentral (RNG) have been struggling. For example, Sprinklr is down 23% YTD. It has only 3.2 stars on Glassdoor (to NICE's 4.0). Net margins are 700 bps lower, and NI per employee is about one-third. Recent articles on SeekingAlpha have highlighted macro headwinds, slowing growth, and operational problems. RingCentral, down 9% YTD, has slightly better Glassdoor and Gartner ratings, but still lags NICE. Morningstar notes the increasing competition in its core UCaaS (unified communication as a service) business and SA articles note increased competition and industry headwinds. Five9, another player which had been a CCaaS leader several years ago, is down 44% YTD. It is probably the strongest of the three, but still is awarded no moat from Morningstar due to its inconsistent profitability. Last year, NICE management noted that two of its smaller competitors are looking to sell themselves. I could imagine that these companies could be on that list. Instead, NICE's real competition is coming from Amazon, Genesys, and more recently, Microsoft. Genesys is privately owned, so information is less available, but it has very high customer reviews on Gartner, and had $2 billion in 2022 revenue, which would suggest that its market share is about comparable to that of NICE. It is owned by the same PE firm as ZenDesk. AWS's CCaaS offering gets high marks from customers on Gartner, and one of my industry contacts say that they're winning share from NICE. This hasn't shown up in the data yet, but it's worth noting. Microsoft recently announced that it will also be launching a contact center service using copilot and the cloud. Like AWS, we can imagine Microsoft quickly becoming a major player, since they have already built out many call center services internally. Will NICE be able to successfully compete against Genesys, Amazon, and Microsoft? The area in which I think their competitive edge is most evident is AI. In 2020, NICE launched its Enlighten Copilot for customer service agents, and it is the only such product from a major player which already won numerous awards. Opus Research described Enlighten as "highly differentiated and innovative" and based on "rich breadth of both data collection and analysis driven by the industry's most comprehensive CX datasets" (more on this point below). NICE was the only major CCaaS player to win anything at the 2024 CXToday awards, which note innovative products in the space. Enlighten bookings are exploding: up 375% in Q4 2023 and 200% in Q1 2024. I think this growth will continue going forward (if at a more moderate pace), because of NICE's rich set of customer data. From the Q1 '24 call: We have a lot of data assets and dots. If you would like the secret sauce or the important part, you have to have a very solid platform. You have to have all the information in one place, well organized, well federated, categorized, but then you have to have a lot of historical data that is both current and related to the past in order to make the AI working. CX is complicated. CX is not a generic industry... No one managed to commoditize CX in the past, and I don't believe it will be commoditized in the future because of this complexity. So while there are great use cases to where general purpose AI can help us as human being and to enterprises in general, there is clear understanding that when it comes to CX enterprises, come to us... And we have a great example we probably presented in the upcoming Investor Day of what happens when you take -- just as an example, you do an auto summary with our Enlighten. This is just a very simple, smaller use cases, do it with Enlighten, do it with a generic Gen AI or any one of our competitors, the differences are just staggering. And it's a huge difference that makes an end of every conversation with the consumer much easier saving about a minute. And if you multiply it here, you see why customers are willing to come to us... I'm sitting on those demonstration of our CXone versions every six weeks. And I remember sitting them and seeing some -- the many features we are adding. Now this meeting used to be 1.5 hours. Now we take 4 hours because the pace of the innovation just drew dramatically. And I can tell much more, but that's kind of some highlights of this excitement. I think that AI adoption should accelerate the current trend towards industry consolidation around the big players with scale and reach. NICE has maintained its market leadership for years, and recent results suggest that this trend has not abated. As management has highlighted on recent calls, their customers aren't spending more money on customer service as a result of AI, but since 90% of their spending is still on labor, there is lots of room for a higher portion of that spending to be on software. In short, I think that NICE's strong competitive position will help the company continue capturing growth in this market for at least the next 3-5 years. Relative to its industry comps, historical averages, or future growth expectations, NICE looks cheap. While NICE's share price appreciation has exceeded its competitors in the software application industry for the last 5 years, it has underperformed in the last three and one years, largely due to the sell-off in the last few months. This is clear if we chart NICE's shares against several competitors it has tracked closely: While it is probably unreasonable to expect NICE to perform as well as Amazon, even returning up to the average one-year performance of its competitors (I chose a sample of 80 using Morningstar data) would put NICE shares up ~35%, or at $220. It makes sense that the market was treating NICE as an "average" software company over the last few years, since its profitability and growth were average for its industry. Going forward, I expect revenue growth and profitability to continue improving, which should justify a higher multiple. One major growth driver has been NICE's transition to the cloud. In 2023, cloud revenue grew 22%. This has led to NICE's cloud business becoming a larger portion of overall revenue (69% vs. 63% in 2022) and driven recurring revenue (88% of total vs. 85% in 2022). This growth accelerated in Q1, with cloud revenue up 27% YOY on higher margins. This is why the $220 price target is probably too low. Given that current multiples are only around 2/3 of the industry average (P/E of 30 vs. 50), there is plenty of room for the valuation to expand as growth accelerates. If NICE's multiples matched industry averages, shares would trade at 50% above current prices, or about $280/share. Given the company's slower growth, this may be too optimistic for the time being. But we get a similar set of price targets looking at NICE's own historical valuation. According to Morningstar data, NICE is trading 47% below its five-year P/E average, 35% below the P/CF average, 32% below the P/B average, and 34% below the P/S average. In other words, returning to historical valuation multiples would imply a $270 price target. I think this is probably about reasonable, although the COVID bubble probably means that these averages are a bit higher than reasonable. Finally, it is worth looking at analyst estimates. Probably due to the high percentage of recurring revenue, NICE's earnings have been very predictable over the last five years. Analyst estimates have been highly reliable, and NICE has routinely beaten them by a few percent. Add to that the fact that several of the analysts covering the stock, such as Michael Latimore and Timothy Horan, are very highly rated, and I'm inclined to believe that their projections are credible. Going forward, they forecast approximately EPS growing at a 15% CAGR through 2030 - again, reasonable given overall industry conditions. Morningstar adds to that an estimate of significantly higher profitability (ROIC increasing from 10% to 20%) due to the cloud transition and increased economies of scale. Morningstar's fair value estimate is $265, not far from the analyst consensus price target of $270. Latimore and Horan have price targets closer to $300. My price target is $260, because I think that growth will accelerate from its recent lows (meaning that $220 is too low), but will not be fast enough to justify a premium multiple (of $280 or $300). Aside from the usual execution and macro risks, I think the biggest concern from NICE will be competition from Amazon and Microsoft. Both companies already have huge cloud businesses with wide adoption, and CCaaS is a natural addition to their offerings. For at least the next several years, I think that NICE's strong product offering (and integration with both of these platforms) will enable them to maintain their market position, but I remain uncertain about the longer term. There are advantages both to being a giant conglomerate as well as to being focused on a single type of business. It remains to be seen which model wins out in this space. The first is technical. NICE shares have been trading in a range around $220 for several years. At some level, shares were overbought when they hit $260 in March, and the sell-off was just a retreat with the range. Needless to say, it's better to buy near the bottom of the range. The second is management. Glassdoor shows that 89% of NICE employees approve of Barak Eilam, so his retirement is indeed a blow to the company. But there are two reasons I remain confident in NICE even without him. First, the remaining senior executives have, by my calculation, been with the company an average of 11 years and held their current roles for an average of 5 years. Since the average C-suite executive only has a tenure of about 4 years, this suggests that there is an above-average degree of continuity in NICE's senior management, even without Eilam. Second and related is the fact that Eilam has been with the company for 25 years - more than half his life. He is staying on in an advising capacity through 2025. It seems highly likely to me that he will ensure a smooth transition and choose a good replacement. I think investor sentiment is well captured in two recent investor letters. Investors like Vulcan Value Partners highlight NICE's strong long-term prospects and see it as a buy: NICE is a global enterprise software company that provides mission-critical contact center software. NICE was a material contributor last quarter. As we said last quarter, the company continues to perform well, and fundamentals are strong. Cloud revenue has grown in line with our expectations. We believe that generative AI will continue to drive cloud adoption and that AI is an opportunity rather than a threat to NICE's business. As the leading platform in the space, the company has many competitive advantages that position them well to win. Cloud penetration is in the low 20% range today and AI will likely accelerate cloud adoption, which should benefit NICE. We believe that this growth will more than offset any seat count attrition due to automation. Furthermore, data and customer examples show AI is driving higher levels of revenue per customer and that AI specific product adoption is increasing rapidly." But others like Times Square Capital want certainty and have sold: We see NICE benefiting from continued adoption of its new services, including AI-enabled ones, though want more information on the future CEO before rebuilding the position. Markets hate uncertainty, and I think that they won't be satisfied until there is a compelling CEO choice made and plan announced. But in the meantime, shares are overly depressed because of the uncertainty, presenting patient investors with a buying opportunity.

Palantir's Stock Is Priced For Perfection

We are no strangers to Palantir's story, saying as far back as September 2020 prior to Palantir's public offering that the "commercial sector is the growth story" for the company as it expands beyond government clientele. Heading into 2024, Palantir was exhibiting "multiple signs of acceleration" stemming from strong growth in its US commercial segment, driven by AIP, Palantir's Artificial Intelligence Platform that lets customers lever Palantir's AI and ML tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham. AIP and US commercial growth are still the main storyline for Palantir investors to watch moving through 2024, given the two are the pr imary growth drivers this year. A closer look in Q1 reveals that momentum is not slowing down for AIP, and US commercial revenue growth remains intact. Government revenue also bucked its trend of decelerating growth throughout 2023, rebounding from under 11% YoY growth in Q4 to 16% YoY growth in Q1. However, Palantir's management shed light on some potential hiccups in AIP's sales cycle, which we outline below. Meanwhile, the market is pricing in a perfect story this year, which puts pressure on the stock to execute. Palantir's US commercial segment remained strong in Q1, with AIP driving strong customer growth as revenue growth accelerated on a sequential basis. Management continued to drill home AIP's momentum in the quarter by saying: "US commercial business continues to see unprecedented demand driven by momentum from AIP." US commercial revenue rose 40% YoY and 14% QoQ to $150 million in Q1, accelerating 100 bp on a QoQ basis. While this was technically a deceleration from 70% YoY growth last quarter, that came against an extremely weak comp, with the QoQ growth acceleration more reflective of Q1's strength. Management explained that the segment is "where we're seeing the greatest transformation. While Q1 is seasonally our slowest quarter, AIP adoption by new and existing customers helped drive notable growth in customer acquisition and revenue in our US commercial business." Palantir added 41 net new customers in the segment, an increase of 69% YoY and 19% QoQ. This accelerated from 55% YoY growth in Q4. We also saw customer additions broaden beyond the US this quarter - the commercial segment (including international) reported total net new adds of 52. As a whole, commercial customer count rose 53% YoY and 14% QoQ to 427 customers. This means that the commercial segment, driven by US commercial, once again dominated net new adds in the quarter. US commercial contributed 41 (and commercial 52) of Palantir's 57 net new additions, or ~72%, compared to more than 90% of net new adds last quarter; the entire segment still contributed more than 90% of net new adds with international growth. As has been the case since its launch just over a year ago, Palantir is continuing to witness elevated interest and high demand for AIP, and is offering developers a free trial to explore and build on AIP, but it is limited in user size and Ontology quantity. Management said that "continued interest in AIP is loud and clear," and shared an update on AIP bootcamp progress, saying that they have sustained the "high volume of bootcamps with over 915 organizations participating to date to meet inbound demand." Palantir had completed 560 bootcamps across 465 organizations by February, tacking on an additional 450 organizations in just the past five months. Palantir did not share an updated bootcamp total. Palantir also said that AIP was aiding in customer conversion and expansion, aligning with trends observed earlier in the year, where management said AIP bootcamps were "quickly converting to paying customers" or expanding existing customers' contracts. US commercial deals rose 94% YoY to 136, and total contract value (TCV) increased 131% YoY in Q1 to $286 million. Overall, commercial TCV bookings increased 187% YoY to $505 million, with the US driving more than half of that. In addition, Palantir said that it is "seeing substantial deal cycle compression. As one example, a leading utility company signed a seven-figure deal just five days after completing a bootcamp. Another customer immediately signed a paid engagement after just one day of their multi-day bootcamp and then converted to a seven-figure deal three weeks later." We have seen Palantir's quarterly deals accelerate following AIP's launch, but we have also seen a larger proportion of deals on the smaller end, between $1 million and $5 million. Despite the optimism and reiteration on elevated interest in AIP, CEO Alex Karp shared one key shortfall that the company has - which is difficulties in selling AIP. Karp explained that Palantir is "at the way early days of figuring out how to actually get customers to buy our product. We are good at educating customers on what is the art of the possible, and then some portion of those customers buy it. So, I expect as we get better and better at that, our numbers will increase. But it is really early days. It's not -- we're not flawlessly executing on our sales motion." While this could be viewed as a positive given the high interest in AIP, implying that Palantir is not closing as many deals as it potentially could, the market is pricing in perfection this year, and essentially looking for a beat and raise in every quarter this year. Having a sales model where management is still figuring out how to market and sell AIP to interested customers while the market wants acceleration sets the stage for a potential shortfall if Palantir cannot meet these elevated expectations. Palantir is also facing some headwinds internationally, primarily in its European business. International commercial revenue grew 16% YoY, but declined (3%) QoQ to $149 million, "as a result of continued headwinds in Europe and the revenue catch-up in Q4 that we noted last quarter." Management further clarified that they "do have headwinds in Europe, 16% of our business in Europe. Europe is gliding towards zero percent GDP growth over the next couple of years. That is a problem for us. There is no easy remedy for that." Shifting into a low or no GDP growth environment may continue to pressure customer deal expansion and present headwinds to larger deal sizes if budget scrutiny persists. With Q1's beat in store and US commercial still strong, the market is looking ahead for a strong year - essentially pricing in beat and raises each quarter this year, though Palantir's extended valuation for barely 20% YoY growth enhances downside risk to shares given the international headwinds and the noted friction in its sales process. Palantir reported $634 million in revenue in Q1, and guided fiscal Q2 revenue between $649 million to $653 million, an increase of 22.1% YoY at midpoint. For FY24, management guided revenue of $2.677 billion to $2.689 billion, up 20.6% YoY, with US commercial revenue of $665 million, for at least 45% YoY growth. This translates to $1.285 billion in revenue in 1H, and $1.398 billion in revenue in 2H. However, analysts are expecting Palantir to generate $1.414 billion in 2H, with FY24 revenue estimates ranging from $2.68 billion on the low end to $2.80 billion on the high end. That's about 4.4% higher than Palantir's guide, suggesting analysts are expecting business momentum to accelerate each quarter with a beat and raise, and increased FY24 guidance. Palantir's valuation leaves little to no room for error here, trading at elevated levels compared to AI-exposed large-cap enterprise software stocks with similar top-line growth and bottom-line margins. For example, Palantir's stock trades at more than 24x forward sales, versus less than 14x forward sales for ServiceNow, which has been reporting revenue growth of >24% the last three quarters, versus 17% to 21% for Palantir. Other 'best-of-breed' software stocks trade at lower multiples, despite having stronger top-line growth rates than Palantir - CrowdStrike has pulled back to below 21x sales after hovering at 24x. Snowflake and Cloudflare trade at 12.9x and 16.3x forward sales, respectively. Since the start of 2023, best-of-breed software has repeatedly struggled to achieve or maintain a valuation above 24x sales, with most rerating back to the 16x level. While investors can argue that Palantir deserves an 'AI premium' from its product suite, investors will still have to value it as a mature company rather than a hypergrowth SaaS, as it's no longer in that basket. This is the most expensive Palantir has been on a top-line valuation since November 2021, with revenue growth nearly 30 percentage points slower. Down the line, Palantir trades at nearly 89x forward earnings (non-GAAP), again at its most expensive level in more than a year, with adjusted EPS expected to grow 32% YoY to $0.33. ServiceNow trades below 55x forward earnings for 25% EPS growth, while CrowdStrike trades similarly to Palantir at 85x forward earnings. Snowflake and Cloudflare, both not profitable on a GAAP basis, trade far above 100x forward adjusted earnings. If Palantir's adjusted EPS growth does slow to <20% as currently estimated by analysts, its premium multiple risks rerating lower. In terms of cash flow, Palantir trades at more than 100x operating and free cash flow multiples, with an operating cash flow margin of 20% and an adjusted FCF margin of 23% in Q1. ServiceNow trades at less than half of Palantir's multiples, despite having a superior margin profile, at a 52% OCF margin and 47% FCF margin. CrowdStrike trades at 67x OCF with a 42% margin, while Snowflake trades below 49x OCF with a 43% margin. Across the board, Palantir trades at elevated valuation multiples, whether it be on the top-line, bottom-line, or on cash flows, not only relative to peers, but also relative to itself, trading at its highest levels or near its highest levels of the past twelve months. Palantir continues to exhibit strong momentum in its US commercial segment, with Q1 results reflective of this with sequential growth accelerating alongside customer count. While AIP demand remains elevated and a core driver of Palantir's growth, management highlighted a pitfall in that there is friction in selling the product, a key risk to watch moving forward as the market is looking for nothing short of perfection through the end of fiscal 2024. For more insights on Palantir, consistent deep dive research on AI stocks and mega-trends, weekly webinars with AI stock and broad market outlooks, real-time trade alerts on AI stock buys and sells, consider taking a look at the I/O Fund's premium services here.

Snowflake: As Cheap As It's Ever Been (Ratings Upgrade) (NYSE:SNOW)

Looking for a portfolio of ideas like this one? Members of Best Of Breed Growth Stocks get exclusive access to our subscriber-only portfolios. Learn More " With the generative AI hype cycle still somehow in full swing, Snowflake (NYSE:SNOW) is an important reminder that stocks in general cannot remain disconnected from their fundamentals forever. Many tech peers have bounced strongly from the 2022 lows, but SNOW is one of the few tech stocks still struggling around all time lows. Even here, the stock is still not obviously cheap, but it certainly is as cheap as it ever has been. The company maintains a net cash balance sheet and is generating positive free cash flow. Generative AI has not led to the anticipated payoff from the implied growth in data, but perhaps investors need to be patient as more AI applications are built moving forward. I doubt many investors still have confidence in the previously aggressive financial targets laid out by management, but at these valuations, that might not be necessary for satisfactory returns. I might end up being early, but I am now upgrading the stock to buy as I see market-beating potential over the long term. I last covered SNOW in May, where I reiterated my hesitance in spite of the ongoing correction. The stock has underperformed the broader markets by over 20% since then, and nearly 50% since I first downgraded the stock in January. While these calls proved timely, my profitable bullish calls leading up to these downgrades look like pure luck in hindsight. There's no reason to "back up the truck here," but the stock looks as interesting as it ever has on a valuation basis. SNOW is a data warehouse offering data storage and analytics services, sometimes known as "data as a service." In the most recent quarter, SNOW generated 33% YoY revenue growth to $829 million, including 33.9% YoY revenue growth in product revenue (coming ahead of guidance for $750 million). I note that the 33% YoY growth rate was a slight acceleration from the 32% rate posted in the sequential quarter, however management's guidance implies that the acceleration will be short-lived at least in the near term. The company saw its net revenue retention rate decelerate sequentially to 128%, marking a continued step decline since pandemic levels, but still representing a high watermark for the tech sector. SNOW saw remaining performance obligations grow 46% to $4.998 billion, including 30.9% YoY growth in cRPOs. On the conference call, management noted that a large $100 million deal helped drive the growth, which accelerated from 41.4% in the sequential quarter (and 28.5% cRPO growth). The company posted a 4% non-GAAP operating margin, slightly exceeding guidance for 3%. This represented a 400 bps improvement YoY and the company has maintained non-GAAP profitability for five straight quarters. SNOW ended the quarter with $4.5 billion of cash versus no debt, representing a bulletproof balance sheet. Looking ahead, management guided for the second quarter to see up to 27% YoY product revenue growth, representing some sequential deceleration. Management raised full-year guidance to 24% YoY product revenue growth to $3.3 billion, up from the prior guide of $3.25 billion. A guidance raise is welcome, but I suspect that many investors may be growing impatient waiting for the "inevitable" generative AI-induced acceleration in growth. Management noted that 40% of their customers "are processing unstructured data on Snowflake," helping to, among other things, drive growth through collaboration. Management cited their strategic collaboration with customer Fiserv, in which the company earned 20 Fiserv financial institutions and merchant clients as customers, due to them wanting to "enable secure direct access to their financial data and insights." Investors may have been eager to hear more discussion on Iceberg, which has been blamed for some of the slowdown in revenue growth. While management acknowledged the impact, they reiterated their view that these headwinds would be short term and weighted to the second half, with expectations that it may eventually become an accelerator for long-term growth. At their 2024 Investor Day, appeared to suggest that their investments in AI may have a negative near term impact on margins but lead to "meaningful" revenue generation over time. I suspect that at this point, many investors need to see a sustained acceleration in revenue growth before believing again in the growth story. SNOW has been in the headlines on news of a cybersecurity breach, though it appears to have been cleared of any deficiencies on their own part. It is not clear if SNOW may nonetheless suffer any reputational impact from the cybersecurity incident. At Seeking Alpha's inaugural investing summit, fellow analyst Joe Albano made the case for "downstream AI software plays" to eventually benefit as AI applications are built for future use cases. That certainly appears to have been the investing thesis over the last many quarters, but it is possible that some investors have lost patience waiting for that projected acceleration to take place. Even after the poor recent stock price action, SNOW still finds itself trading at around 13x sales. Consensus estimates call for an eventual and sustained acceleration to the 30% range. Recall that it was just last quarter, in which management formally withdrew their $10 billion product revenue target for fiscal 2029 (but indicated that they were still "internally" driving towards that goal). With consensus estimates expecting $8.8 billion in FY29, it looks like analysts have come to accept that SNOW will not be crushing that previous guide. SNOW trades at just around half of its 2020 opening day price, but that distinction does not fully capture the multiple compression here. SNOW now finds itself trading at among its lowest price to sales multiples since it came public. The interesting point here is that even if SNOW only generates 20% YoY annual revenue growth over the next 5 years, the stock may still generate solid returns. The company might be generating around $8.7 billion in revenue under this scenario, with the stock trading at around 5x FY30e sales. Because of SNOW's ever-growing importance to its enterprise customers in a world of data, I can see the stock sustaining at least a 30x earnings multiple by then, supported by double-digit revenue growth and the net cash balance sheet. Based on my projection for 30% long-term net margins, that implies a 9x sales multiple by then, or roughly 13% annual return potential over the next 5 years. I still remain hopeful that SNOW eventually does see a tick-up in revenue growth, which may make the potential upside even more attractive, but stunning outperformance is no longer needed to make this story work. As I noted previously, SNOW stock remains richly valued even after the poor price performance. The stock might not deliver the anticipated returns for a multitude of reasons, including a poor macro environment and increasing competition. Databricks is a notable competitor which recently reported 60% ARR growth to $2.4 billion. These two companies do not have a direct overlap, but it might be concerning that Databricks is able to show much stronger top-line growth rates even at scale. It is possible that Databricks or other competitors release products that disrupt SNOW, which may impair the growth thesis as well as the target valuation multiple. SNOW is not yet profitable on a GAAP basis, which may subject it to greater volatility in periods of market distress, even if the stock has not seen so much volatility in the past. It is possible that the company never sees the projected generative AI-induced acceleration in revenue growth, at which point the stock might re-rate lower as investors grapple with the new growth reality. SNOW continues to trade among the richest valued among tech peers, but its relative premium has declined to a low point during its limited history as a public company. The stock looks quite buyable here even if revenue growth does not accelerate, and I am of the view that the company may eventually see an inflection in growth as more generative AI use cases are fleshed out. Due to the improved value proposition, I am upgrading the stock to buy.