Tech Sector Outlook: AI, Datacenters, and E-commerce Drive Growth Amid Market Challenges

AI Datacenter And PC Demand Make AMD A Bargain (NASDAQ:AMD)

Its acquisition of Silo AI enables it to offer a seamless and comprehensive AI software and hardware System-on-Chip. I last wrote about Advanced Micro Devices, Inc. (NASDAQ:AMD) on March 30th, 2023, recommending it as a Hold at $98 per share, to buy if the price dropped between $75-$80. My thesis was that it was on the comeback trail, and while its two cyclical divisions would take time to come out of their troughs, overall, the company had enough strengths to do well in the upcoming years. I did buy in the mid-eighties in May, and then added over $100, believing that it also had a shot at AI Data Center revenues. I've summarized below the main reasons for liking the company from my previous article. It's making a lot of strides in the Data Center and Embedded segments and with a floundering Intel, has captured a decent chunk of the Data Center market. While it has a small presence in Generational AI for now, I can see a lot of growth coming its way as well, with their new processor the MI300, which was built for their Datacenter clients needing supercomputing and other high-performance computing applications in. AMD's prowess with hybrid computing through APU's (Accelerated Processing Units) is a major factor that puts them front and center with generational AI for data centers. One of the biggest competitive advantages with the merger is AMD's ability to offer customized solutions from a much wider repertoire, which now includes FPGA's, adaptive SOC's and DPU's and the use of common software platform. Not only that, but I believe in all of these reasons and am excited to see the momentum with a run rate of $4.5Bn a year in AI Data Center revenue. For AMD to do well, all four segments need to grow. Otherwise, the cyclical segments destroy all the positive momentum from AI; $4.5Bn in annual AI sales is just 18% of total revenues. Data Center: The first half of the year did show an impressive turnaround, as overall revenues grew 6%, with a big 97% gain in Data Center revenue. There was a steep ramp in MI300X shipments, which competes with Nvidia's (NVDA) Hopper series, and, similar to Nvidia, also faced supply constraints. At this run rate, management was confident of a $4.5Bn run rate for 2024. Should supply pick up, this could be a conservative estimate. Data Center generated 25% operating profits, and while this is lower as AMD uses lower price points to penetrate hyperscaler clients' Data Centers, it will improve over time. Client: The other good news was an average 14% price increase in mobile and desktop processors. Coupled with a 44% increase in unit shipments, Client revenues jumped 65% to $2.9Bn YoY. Operating margins also moved into the black to 6% after dropping in 2023. Gaming: Gaming continued to struggle for the 1H of 2024, dropping a huge 53%, on weak console sales, which are now at the end of a 5-year cycle. Q2 was worse -- while it is also a seasonally weak period, the drop was 59%, and it will take a while to clear inventories and return to growth. Nvidia grew gaming revenues by 18% for the quarter ended April 2024 but expects only 8% growth in Q2-2025, and 5% overall growth for the year ended Jan 2025. So, not quite out of the woods yet. Embedded: Another weak quarter with a 41% drop, and an overall 43% drop for the 1H, a slight improvement. However, the embedded segment's big problem is a glut of post COVID-19 inventory, which hasn't cleared yet but should get better in 2H of 2024, to a total decline of 17%. Most of it will come at a cost, its operating margins have dropped to 40% from 49% last year. Company Wide: The first six months have shown AMD turning around. Besides the 6% growth, AMD has improved margins as well, gross margins have improved to 48% compared to 45% in the first half of 2023, with Q2, improving further to 49%, a great sign in the right direction. GAAP operating income increased to $305Mn, from a loss of 165Mn, with the bulk of $269Mn coming in Q2. Low margins for sure, but improvements from one of its worst years in recent history, 2023, when AMD earned only $401Mn on 22.68Bn in sales. While I laud the impressive strides in Data Center, the other three segments have to get back on their feet for AMD to get anything close to a decent valuation. AMD will exceed $4.5Bn in AI revenue in 2024, about 35% of Data Center's total revenue of $12.8Bn. In Q2-24, GPUs accounted for $1Bn and CPUs and others for $1.8Bn of total Data Center revenue of $2.8Bn. This is the first time GPUs have taken such a large share of Data Center revenue, it is the fastest ramping product in AMD's history and a harbinger of the future as AI demand continues to improve. AMD could have sold more if it weren't for supply constraints, which will improve over the next two years. The other notable positive is that Nvidia's price increases will help AMD, which can also increase prices as the second supplier because it's discounted to Nvidia's Hopper and Blackwell series. AMD's average prices are around $15,000 as compared to over $30,000 for Nvidia. AMD does have AI strengths distinct from Nvidia, The MI300x series has more memory, which is better suited for inference. The thicker HBM memory of the MI300X makes it the preferred choice over an H100, when you need fewer devices for the work - it's cheaper and more efficient to use AMD GPUs. Hyperscalers like Amazon (AMZN), Alphabet (GOOGL) (GOOG), Meta Platforms (META), and Microsoft (MSFT) have been spending Capex like drunken sailors. The demand for Data Center GPUs and CPUs is truly humongous. From a Next Platform interview between Timothy Prickett Morgan and Forrest Norrod, General Manager of AMD's Data Center business, emphasis mine... Forrest Norrod: I understand that. The scale of what's being contemplated is mind-blowing. Now, will all of that come to pass? I don't know. But there are public reports of very sober people contemplating spending tens of billions of dollars or even a hundred billion dollars on training clusters. But some of the training clusters that are being contemplated are truly mindboggling.... TPM: What's the biggest AI training cluster that somebody is serious about - you don't have to name names. Has somebody come to you and said with MI500, I need 1.2 million GPUs or whatever. Forrest Norrod: It's in that range? Yes. AMD grabbed 5.6% from Intel (INTC) in Q1-24 in Data Center Servers with its EPYC CPUs, growing from 18% in Q1-23 to 23.6% in Q1-24. What's even more impressive is the revenue share, which is a whopping 10 points higher at 33%, clearly, EPYC is more in demand. Historically, AMD has been gaining market share in servers in units and revenue, as we can see from the steady progress below. The 23.6% it stood at the end of Q1-2024 has grown from a minuscule 1.4% in Q1-2017. That's a remarkable performance against a giant incumbent. In 2017, Intel had 12x more revenues at $62.7Bn compared to AMD's 5Bn. In this growing market, AMD is gaining. Cloud deployments to Hyperscalers are key -- they're begging for more power, and AMD is gaining traction in the higher-end, expensive machines with advanced CPUs. Intel is falling short of products to compete with AMD's 96-core and 128-core processors. If this trend continues, it will be AMD's battle to lose. AMD has grown fourfold in the last decade from $5.5Bn to over $22Bn in revenues today, whereas Intel (INTC) has stagnated at $56Bn in the same period. I have faith in AMD getting a decent share in AI PCs, similar to how it constantly took market share from Intel in PCs. As we can see below, AMD grew its PC market share from 13.8% from 2012 to 24% in 2024. AMD's Ryzen AI300 is their flagship product in this market. With an estimated 50 TOPS performance, it is their third-generation processor with deals with OEMs like Acer, ASUS, Lenovo, and HP. While Arm Holdings (ARM) chips are more energy (battery) efficient, the current PC market is dominated by X86 processors, which have over 80% market share, dominated by Intel and AMD. While AMD is confident that X86 processing will hold its own, it has made a smart move by also making ARM-based chips from 2025. It doesn't make sense to be stuck behind when the user would prefer a longer battery life. Furthermore, advances in AI and chip production technology from ARM could make them more powerful and energy efficient. Standard-bearer Apple replaced Intel's CPU with its ARM-based SOC's (System on Chips) more than 4 years back, Qualcomm followed suit with its Snapdragon series and its CEO believes that 50% of PCs will run on ARM's architecture. AMD has a hard time generating high margins, GAAP operating margins are in the high single digits, and adjusted operating margins, are stuck below 20%. AMD's products don't have pricing power, with even the new AI GPUs selling for 50% of Nvidia's Hopper series. Similarly, we saw client and gaming operating margins at 6% and 15% respectively, cleaning out excess inventory. The Client, Gaming, and Embedded segments are subject to economic cycles, with little product differentiation, inventory gluts and price reductions. These still total 50% of AMD's revenues and hamper its growth and valuation. Going forward, these will pick up and overall, I do expect 2025 and 2026 adjusted margins to be around 22-24% as gaming and embedded segments return to growth. In server CPUs, AMD's largest competitor is the struggling incumbent Intel, but in GPUs, it competes with Nvidia with more than 90% market share. In PCs, there are three other major competitors such as Qualcomm, Apple, and Nvidia. We also have rosy forecasts for AI PCs, which may not materialize, there is a limit to AI that can be done locally, you need serious computing power from the cloud. I made small tweaks to my earlier model, I was expecting a faster turnaround in 2024, but was a tad conservative through 2027; instead, the next three years will be a lot better according to consensus analyst estimates. Overall, the differences are nominal. AMD, assuming it grows at 36% for the next four years, is a bargain at 43x 2024 earnings. The P/E drops to 16 and the PEG ratio drops to 0.6 by 2027. It's also reasonable from a P/S valuation of 5.7x for a 19% grower in the fastest-growing sector in the world right now, where it's not demand but supply constraints that are reducing sales! It is a strong and growing number two in market share for AI Data Centers, an enviable position to be in. Valuations aside, AMD has proven to be an extremely scrappy competitor, grabbing 24% of the CPU server market from Intel in a short 7 years, against an opponent that was 12 times its size. That too, while it was dealing with cyclical PC and Gaming markets and a post-COVID inventory glut, which it will come out by 2024. Its share of the CPU server market will only grow. In GPUs, its MI300x series is a solid competitor with its memory strength. AMD will keep chipping away in this market and starting from less than 5% market share, it has only one way to go, up. Nvidia can't supply 100% of the market, and AMD at about 50% of Nvidia's price will cater to a portion of the market that does not need massive computational workloads. Its purchase of Silo AI is an excellent move to beef up its AI and software capabilities. Silo AI's team has a lot of expertise in AI solutions and large language model development for marquee customers like Allianz (OTCPK:ALIZF), Ericsson (ERIC), Finnair (OTCPK:FNNNF), Nokia (NOK), and Unilever (UL). It enables AMD to compete with Nvidia's CUDA and offer a seamless and comprehensive hardware and software package to Hyperscalers and CSPs.

Microsoft Stock: Why Now Is A Good Time To Invest In The Shares (NASDAQ:MSFT)

Interpreting the Microsoft quarter: Will generative AI be the business driver that has been expected? Microsoft reported its fiscal Q4 results on July 30 and provided guidance for the coming quarter and year. The company's overall results were considered to be uninspiring; its guidance for fiscal Q1 was also marginally short of prior expectations. Does that mean that the AI revolution is a chimera? And why does Microsoft need to grow its capex so substantially? Before starting the analysis, I think a comment about the market meltdown and subsequent recovery is in order here. The meltdown had its genesis in two unrelated factors. One of those were the succession of poor metrics with regards to employment and construction activity. The July employment report was a shock to many market participants of the bad kind. The other factor, apparently, was the unwinding of the Japanese carry trade. This is not a place to discuss that, but the combination of weak macro data and the unwinding of the carry trade proved to be toxic for stocks. After excessive volatility in Japanese markets, the Vice Governor of the Bank of Japan has rolled back expectations for future rate increases and this has calmed markets resulting in a significant bounce. And in addition, after a fairly decent ISM non-manufacturing survey, a decent retails sales report, and declines in 1st time unemployment claims, expectations for a recession have been rolled back by a bit. A couple of weeks ago strategists and hedge funds were focusing their investment bets on cyclical stocks and even small caps. Now, investors seem to feel software is a decent investment based on some decent earnings and a less dire macro outlook. IT stocks were valued below historical averages before this latest valuation implosion according to the latest Meritech analysis to which I have linked here. Do I expect a recession will impact the growth rate of software companies? Perhaps, although I make the case in this article that Microsoft, in particular, is already starting to see a positive growth inflection from GenAI tailwinds. This is an article about Microsoft and specifically the reality of its genAI tailwinds which I believe are underappreciated by some. This last quarter had a number of positive metrics regarding the progress of the genAI solution and how that revolution is and will be impacting Microsoft growth. The reality belies much of what has recently been written, particularly by some click-seeking financial journalists who simply are unaware of the opportunities that are already developing in this space. I have a significant position in Microsoft dating back 8 years now, and my take on their latest earnings report was substantially different than the consensus. I haven't sold a share and I have no intention of doing so in the near term. If my overall weighting in Microsoft wasn't quite elevated, I would already have bought more shares. In writing about high growth IT companies these days, I find it important to note a caveat. Over the last 4 months, these shares have under-performed "tech" to a greater or lesser extent. This isn't due to any lack of growth, or deterioration of the outlook for these companies. In fact a series of earnings reports from 8/6 were consistently better than feared. That said, for several months, investors wanted their AI fix straight, and pivoted noticeably to what I might call AI hardware shares and the so-called Magnificent 7. And then, when those shares had been priced to perfection, the market rotated to small cap and cyclical non-tech shares. That put enormous pressure on valuation. Microsoft is of course one of those Magnificent 7 and like many of its brethren in that select group, it hit a high for the year on July 5th. The high that day was $468/share. And then the valuation fell victim to the 2 pivot and the shares had fallen by about 10% over the last 3+ weeks before its marginal fall on the day after its earnings release on what was a strong day for most tech shares. The shares fell by another 7% over the last 6 trading days before the bounce being seen on Tuesday, August 6 and over the following 10 days. So, at this point the shares are down by about 10.5% from their high. Based on my revenue and margin forecasts which are not materially different from the consensus-at least in the short term-the shares have an EV/S based on 12 months forward revenue of about 9X, a 3 year CAGR of 18%, and a free cash flow margin for the next 12 months of 29%. It is that 3 year CAGR estimate that really is key assumption undergirding my share purchase recommendation. The shares do trade as analogs of the other Mag 7 even if each one of these has quite different business drivers. I find Microsoft's metrics to be attractive, particularly as I believe that the CAGR estimate is likely to see upward revisions as genAI bends the demand curve beyond what is currently in my forecast. I certainly do not have the temerity to suggest that I have second sight and thus have an ability to know when the next market pivot might come and who will be favored when it does come. Personally, I think the concept of buying what are described as blue chips or cyclical non tech is more than a bit illogical-but I have seen plenty of illogic that can persist for months in my years of participating in equity markets. The fact is that the just ended spike in the valuation of AI hardware ran several months beyond its sell-by date, based, at least in part, or so it now has become apparent, on the Japanese carry trade. This article is about the long-term prospects of Microsoft and not how it will trade relative to other Mag 7 shares, or what group might be in favor over the coming weeks. Simple answer is that I don't know and have no idea as to where to obtain such knowledge. The combination of these factors have led the shares lower although the actual daily pull back was 1.1% on the day of the earnings release. But the real picture is that demand signals for AI are accelerating. In fact my math, based on what the company has disclosed regarding the generative AI contribution to revenues, is that growth was probably more than 20% sequential last quarter within Azure. Azure AI customers grew 60% year over year; and these customers are coming back for more seats and greater usage. AI customers in other parts of Microsoft's business have grown even more rapidly-the company called out that its GitHub co-pilot was already generating more revenue than GitHub had generated when Microsoft acquired the company (about $250 million +). The CEO called out its Copilot for Dynamics transforming that business. It is difficult to quantify just how much co-pilot means to Dynamics 365 in terms of revenue growth: what is hard to dispute is that Dynamics 365, with constant currency revenue growth of 20%, is growing at least 4X more rapidly than the ERP/CRM spaces. This article will not try to analyze every nook and cranny of Microsoft's business; there are far too many and most of them are not particularly meaningful in analyzing the company's future growth prospects. While almost all Wall St. analysts rate Microsoft shares a buy or a strong buy, the shares are a bit more controversial amongst SA authors with 7 buy recommendations and 4 hold recommendations that have been published over the past month. The issue for those authors publishing hold ratings is generally one of valuation and the valuation concern is based on growth concerns. And these growth concerns are mainly based on a belief that AI is a chimera, at least in part, and a bubble, and that Microsoft will not achieve the growth inflection that justifies its valuation. Now, as previously mentioned, I am a Microsoft holder and have been for 8 years now. It ranks amongst my top holdings and has done so partially based on appreciation. I share that to be transparent and to provide a context for my comments. I personally have a strong belief that AI/gen AI will be one of the more seminal events of my lifetime-which at this point extends to a time when telephones had rotary dials that clicked and were made of bakelite. Over time, and without hyperbole, genAI will change, and for the most part enhance, most phases of the human experience. I have, in one way or the other, been a stake holder in the IT space for more than 50 years. The other day I read a blog post from the folks at GitLab about software that wrote itself. The reality is that the headline was a bit of hyperbole-I can't quite ask the GitLab product to create a holistic supply chain management application tuned for my company. But it is now on the horizon-5 year's maybe. But to the point of Microsoft, its GitHub product with co-pilot is close to similarly enabled-that is why GitHub growth has inflected so much higher. I think it is hard to convey just how revolutionary that development is. And then to relate it back to Microsoft, and look at all of its gen AI products. There are some investors who are of the "show me the money" camp. Microsoft's latest quarter didn't do that, quite. But Microsoft's latest quarter did suggest that a growth inflection based on AI was on the horizon. I do not believe that Microsoft's current valuation, and even most published price targets, really reflect the AI opportunity. So, this article will try to look at what that opportunity is and why I believe that Microsoft shares, at their current price undervalue those prospects. I recommend Microsoft shares as a fresh money buy, at this time and at this price. Zeroing in on what Microsoft reported and how it guided While my enthusiasm for the growth opportunity of gen AI for Microsoft and for much of the software industry is substantial, that enthusiasm is ultimately grounded on specific financial attainment. Last quarter's headline financial attainment was a bit meh, so to speak. Microsoft reports it revenues in several categories. The largest of these is what Microsoft calls the Intelligent Cloud, which is about 44% of the total, and which grew by 20% in cc last quarter, marginally greater than the prior forecast. This is where revenues from Azure are reported, and where much of the current contribution from AI is found. The second largest segment reported by Microsoft is that of Productivity and Business Processes This segment, about 31% of total revenues grew by 12% in cc. This segment includes the Office products, LinkedIn and Dynamics, the Microsoft ERP/CRM solutions. Finally, there is the More Personal Computing segment. This segment, which is where Microsoft reports gaming revenue was 25% of the total and grew by 15% in cc. This segment includes search and news advertising as well as Windows. Almost all of the revenue beat was concentrated in this segment, probably not what most investors prefer, as this segment has more limited growth opportunities than the other 2 segments. Overall, Microsoft's beat on revenues was about 1%, smaller than most prior revenue beats for the company. The company's EPS was $2.95, an upside of $0.01 and which was also smaller than most prior quarters. The company provided what was seen as a muted outlook. Specifically, the guidance works out to be for EPS of $3.08 for this quarter vs. the prior consensus of $3.19. The revenue forecast for the quarter has gone from $66.3 billion to $64.8 billion. By the end of the year, the implied revenue and EPS forecasts have been revised upward. Some key points around these forecast: CapEx growth is starting to rise-dramatically, perhaps, as it grew by 78% last quarter with the company CFO forecasting continuing growth this current fiscal year. Commercial bookings growth of 19% cc, was quite a bit above prior management expectations. The company is signing larger and longer contracts for Azure which will ultimately show up in revenue growth. The company's opex forecast is for single digit growth; the company is practicing renewed discipline on opex growth in order to partially offset the growth of the cost of goods expense due to the capex needed to support Azure and genAI workloads. For the most part it hasn't quite happened yet, or perhaps better said, it hasn't happened in the way wished for by investors. And that left some cohort of investors impatient. High growth investors are rarely anything other than impatient in my experience, but in terms of AI they seem more impatient than in the past when similar paradigm shifts were being born. Generative AI is software that dramatically enhances the productivity and the experience of users. When it first burst into the consciousness of investors, the immediate reaction was to buy anything related to the technology. Some commentators decried this and called it a bubble mentality. Other commentators started to say that the technology wouldn't/couldn't be monetized and started to write about spurious data comparing the investment in GPUs and the revenue contribution from gen AI. I think, perhaps, a typical genAI use case might provide readers at this point with how the technology works and why the leadership at Microsoft has been willing to make a huge bet on providing infrastructure so that users can run their newly created genAI on Azure. I think most readers will be very familiar with call centers and how they have worked. Many call centers these days are powered by bots, the kind of bots that have proliferated in recent years and which often come from UiPath (PATH). The problem with bots is they lack intelligence by design, and are thus notoriously inflexible and that often leads to frustration on the part of customers when trying to deal with an issue. With genAI, life can be very different. Sam's Club is an early user of genAI in some of its call center applications and where it has been partially deployed according to a story relayed to me by a colleague. One real life story concerns an adventure with a kind of healthy oat product. Those readers who have any familiarity with this author know it isn't me-I am neither a Sam's Club member nor a consumer of healthy oat products. But I have friends who are, actually. In a this particular use case, an order for a healthy oat product had gone astray. The call center genAI app can determine that the warehouse app didn't correctly allocate the product and that it hasn't shipped to the customer. The consumer is told what happened, and when, and is asked if the app can resubmit the order for the customer and make sure it reaches the customer on a certain date. Sometimes, the app will provide the customer with a promotion on additional products. The result is a customer whose order problem is resolved promptly, without frustration and without any human intervention. These kinds of genAI applications are proliferating rapidly; a similar one that has become a reference for Microsoft is that of a German retail chain. Most software executives, and that includes leadership at Microsoft are excited about genAI technology because of the use cases it can animate. Very typically software has been sold to enterprises on their need to stay competitive. If one call center works better than another, it will inevitably result in market share gains. Needless to say, in time, essentially all call center apps for almost all kinds of consumer facing interaction, will be rewritten to incorporate this technology. I recognize that investors want to see the money from this in current operating reports. There apparently is a temptation to believe that genAI is just a myth or another tech bubble. The results from Microsoft, specifically suggest that this is not the case. Most 3 party analysts who had written on the subject had always believed that 2025 would be the year in which the GenAI growth inflection became visible. That really hasn't changed and the fact is that it hasn't changed for Microsoft either. But investors seem to believe that something not foreseen is retarding the growth of GenAI, both broadly and at Microsoft, clearly a pioneer and share gainer in this space. This past quarter, Microsoft reported that the cc growth in Azure was 30% compared to a forecast of 30%-31% growth. The prior quarter, growth had been 31%. This quarter, 8 points of the 30% growth has been attributed to AI compared to 7 points of growth last quarter. As mentioned earlier in this article, this implies that AI revenue showed a sequential growth of a bit more than 20%, basically an annualized triple digit growth rate. That isn't bad performance for an infant technology whose deployment is complex, costly, and lengthy. In addition to AI on Azure, and AI as part of GitHub, Microsoft has what it calls co-pilots that are genAI add-ons in many other components of its offering. Copilots exist for Microsoft365, for Dynamics, for finance, for Windows, in healthcare, in security and AI capabilities have been added to Teams and to LinkedIn. I would point out two things. One is that total revenues from AI are quite a bit greater than the specific calculation of AI revenue ($5 billion in total) as reported for Azure. But more than that, it is Microsoft's genAI capabilities that are driving much of the growth in the intelligent cloud and in productivity and businesses processes. For example, Microsoft has a product it calls Fabric. Fabric isn't considered as part of Microsoft's AI revenues; it is a unified data and analytics platform that includes data movement, processing, ingestion, transformation routing and event routing. Fabric has seen mass adoption-there are currently 11,000 users. But the need for Fabric is being driven substantially by users deploying genAI applications on Microsoft infrastructure. Another example of this drag is seen in the results of Microsoft 365 where ARPU is rising due to the purchase of co-pilots to go along with the MS 365 suite. This phenomenon is basically seen across every segment of Microsoft's software offerings. Microsoft's total bookings rose by more than 31% in constant currency. Bookings to be recognized as revenue in the next year rose by 20%. The backlog has increased to $269 billion, up by 14% sequentially and has grown as a percentage of revenues. Those numbers were above expectations and reflected Microsoft customers making larger, multi-year commitments for Azure as part of their establishment of their own infrastructure to support their AI applications. One of the more unique features of Microsoft's current financial performance is that it has indicated that it is been experiencing capacity constraints that have limited its ability to grow Azure revenues to match actual demand. Azure growth included 8 points from AI services where demand remained higher than our available capacity Therefore, our Azure consumption business continues to grow faster than total Azure. And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand. There was no indication of the precise amount of revenue that was foregone last quarter because of capacity constraints. Similarly, there was no indication of the precise growth ramp to be expected in 2H of this current fiscal year. Interestingly, the revenue consensus does not at all reflect this expectation for accelerating Azure growth. In fact the 1 call consensus shows a peculiar pattern in looking at percentage revenue growth in the next several quarters with an acceleration next quarter, a sharp deceleration in the December quarter and then an acceleration in the last 2 quarters of the fiscal year. Some of this reflects the anniversary of the Activision acquisition. Expectations for FY' 2026 show no growth acceleration from percentage revenue growth expectation for FY 2025. That seems improbable, specifically given the company's conference call comments. The company is not increasing its capex by 78% without a very specific line of sight with regards to demand for genAI/Azure workloads and usage. Microsoft is made up of many moving pieces of which Azure is but one. There are more than a few moving pieces in the Intelligent Cloud segment, although Azure is now the principle component of this segment which was 44% of revenue last quarter and which is likely to be 46%-47% of total revenues this year. If indeed, Azure growth accelerates as capacity becomes available, and as the strength in current bookings translates into reported growth, than there should be a noticeable acceleration in revenue growth to greater than the current forecast level of 14%. Last quarter Microsoft's capex was $19 billion. This compares to capex of $10.7 billion in the year earlier period, an increase of 78%. Almost all of the capex has been to grow the company's cloud and AI capacity. Half of the capex is for data centers and the balance is for servers, both CPUs and GPUs. Microsoft hasn't projected specific levels of capex; its statement is simply that the company expects capex to be higher in the current fiscal year. than its most recent levels Ultimately, capex impacts Microsoft's cost of goods sold through higher depreciation expenses. So, the company is indicating it will tightly manage opex in order to manage the company's operating margin performance. There has been some comment that the investment required to support the growth of genAI revenues will pressure margins and ultimately impact the company's business model. About half of the company's capex is a product of building new data centers. Data centers have extended useful lives; Microsoft typically keeps datacenters in operation for 15 years before they are physically replaced. The balance of capital expenditures are "dependent on demand signals and adoption of our services that will be managed throughout the year." Basically, Microsoft gets orders for Azure and AI services, and then in turn places orders for CPUs and GPUs. In that regard, capex is an excellent leading indicator for future growth of Azure and AI So I would say - and obviously, the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal because you got to remember, even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal, right? So that's, I think, the key way to think about capital cycle even. So if you look at it, we have both the landing of the seats itself quarter-over-quarter that is growing 60%, right? That's a pretty good healthy sign. This issue, i.e that of demand signals being received vs. the growth of capex was one that occupied much of the conference call and vexed some analysts. Personally, it is hard for me to understand investor angst about genAI demand. To paraphrase an ad that was popular 40 years ago-the beef is in the productivity. The CEO called out call centers as an almost universal use case for genAI. It is almost impossible for me to imagine that over the next 5 years call centers will not entirely be migrated to applications based on genAI. Microsoft suggested that it is already saving several hundred million a year-in its own call centers-based on the use of genAI applications. Of course developing a genAI call center for a call center is a process requiring lots of iteration, lots of model training, lots of inferencing, lots of capex, and a fairly intense deployment process. These factors can and will result in some variability and ups and downs in the cadence of actual revenue growth for genAI for Microsoft specifically. But Microsoft, which obviously has a better specific line of sight when it comes to understanding the demand signals it is seeing, is making a very substantial bet that its capex will be needed because current demand is, and has been exceeding supply, for Azure and for genAI. Is Microsoft overvalued? Of course I don't think so and I have quite a bit riding on that evaluation. The real issue is the whether or not genAI is or will precipitate a significant growth inflection and if so, by just how much. I am certainly not a fortune teller. I don't believe that the results from this past quarter are at all indicative of what genAI will mean to Microsoft in terms of growth. There are bits and pieces of a glimpse of the impact that genAI is having and can have. Some of that shows up in the spike in commercial bookings which to repeat rose 20% year on year and by 14% sequentially. Some of it shows up in the growth in seats shown above in the commentary of CEO Nadella. The company talked about accelerating growth from Azure and AI in 2H of its fiscal year. That is not really reflected in the models of most analysts, at least as those reported to 1 call. And growth of 14% projected for what will be FY'26 does not show any growth inflection either, after adjusting for the impact of the Activision acquisition on the company's reported growth this past year. Of course, not all of Microsoft is AI and Azure, but as noted it is, these days 45%+ of total revenue and that percentage continues to increase. During the course of the conference call, the CEO and the CFO reiterated a theme that this transition is similar to the transition from 8 years ago as the company moved its offerings to the cloud and saw a substantial increase in its growth rate. There is a difference in this transition in that most of what is happening is based on new applications, new workloads, and significant market share gains that are being seen in many of the company's existing markets. I don't want to pretend that I have some special formula to quantify the spike that I expect in terms of revenue growth due to the advent of genAI. It is clearly significantly greater than the numbers being reported in terms of the genAI percentage growth on Azure. And given just how difficult drag revenue can be to identify and forecast that is likely to remain the case. And at this point the company hasn't provided specific guidance as to the acceleration in revenue growth as capacity becomes available to support Azure/AI consumption demand in 2H. I acknowledge that I had to make some assumptions in modelling what will happen when capacity does become available. Overall, I think the combination of capacity additions and genAI demand growth will lift the growth in the Intelligent Cloud segment from 19% to 27% as a run rate by the end of the current fiscal year, i.e. a year from now. I think the productivity segment of the company business may continue to grow at 11% while the more personal computing segment will grow at 12%, which eliminates the last impact from the Activision acquisition. This brings expected revenue growth to about 19% as my base case assumption rather than 14% which appears to be the current consensus forecast for that metric by the end of the current fiscal year. But to be conservative, in my valuation model, I used a revenue growth assumption for the next 12 months of 16.5%. Overall, my model includes a 3 year CAGR assumption of 18%, a free cash flow margin assumption of 29% which accounts for the growth in capex necessary to support higher revenue growth and a current EV/S estimate of 9X. This combination yields a valuation of about 20% below average for the company's growth cohort. It is likely, in my opinion, that Microsoft shares will ultimate trade at a premium to average for the company's growth because of the conservative nature of company projections and its strong line-of-sight with regards to future demand. Of course the major risk to this thesis is my view as to the potential growth rate for genAI. I don't pretend that my forecast is set in stone, or is in any way part of any specific company guidance. As with any new technology, and especially one like this which is so revolutionary, quantification is at least as much of a guess as anything else. I have tried to present the view that genAI will become a necessity which is embraced by almost all enterprises with use cases as yet to be developed, or even imagined. But simply looking at the use cases which are visible today such as the enhancement of call centers yields an exceptional opportunity. The other risk to the thesis is the ultimate ratio of required capex to revenue for genAI. This is still very early in the evolution. Initially capex growth will exceed the growth in dollars of genAI revenue. Just when and to what extent that crosses is still really unknown. Obviously the spike in capex last quarter to $19 billion, up 78% year over year, would, if continued, challenge free cash flow margin assumptions. Estimating future capex growth is another guess, and thus another risk to the thesis. Finally, it is possible that macro-economic conditions deteriorate far beyond current consensus expectations. If they do, the genAI revolution may be delayed, but certainly not denied. Simply put, I believe that investors are under-estimating the growth inflection that genAI is and will bring to Microsoft. Last quarter revenue growth was slightly less than forecast. Most of this can be laid at the door of Azure growth-but Azure growth was capacity constrained. GenAI is already having a material impact on Microsoft revenues-outside of Azure. In particular, growth of GitHub, and growth of Dynamics are already seeing acceleration because of genAI. Other segments of Microsoft's business will benefit as well. I think the visible and identifiable use cases for GenAI such as its ability to improve both the productivity and the user experience in call centers is far greater than generally realized. This has led me to boost my 3 year CAGR estimate for Microsoft about 200-300 basis point to 18%. That is obviously significant for a company of this scale. With that change, and even after adjusting for capex growth needed to support that kind of revenue growth, Microsoft's valuation is noticeably below average for my estimate of its growth cohort. Thus, I reiterate my buy recommendation for the shares and expect them to produce significant alpha over the coming 12 months and beyond

Lam Research: Finding Opportunity Amidst Q4 FY 2024 Post Earnings Dip (NASDAQ:LRCX)

For the quarter in progress [first quarter FY 2025], Lam Research expects earnings per share ranging from $7.25 to $8.75 versus the estimate of $8.10. The semiconductor company anticipates revenue ranging from $3.75B to $4.35B versus the estimate of $4.04B. Yet, the stock dropped 17% two days after the company reported earnings. The market was less than enthused with Lam's fourth quarter FY 2024 report because of the potential rebound in Wafer Fabrication Equipment ("WFE") spending that many expect will likely not take place in calendar year 2024. Additionally, virtually all hardware companies have declined over the last month due to fears that Artificial Intelligence may be in a bubble. The market also doesn't like that the risk of a recession is still on the table. Last, Lam has company-specific risks that are large in investors' minds and have caused some to steer clear of the stock. However, experts still expect WFE spending to emerge from its downturn in 2025. Lam specializes in equipment that manufactures memory chips, and it already looks like the memory industry is potentially coming off a bottom. The company has invested heavily during this industry downturn in products that could help it gain market share during an upturn. I wrote about this stock in early July, and my thesis that the stock will rise due to a cyclical upturn over the next year remains intact. This article will discuss how the company has prepared for a cyclical upturn and the company's fourth quarter FY 2024 earnings report. It will also examine a few company risks, the valuation, and why the stock should remain on the growth investors' buy list. Semiconductor market forecasting company Yole Group projects the WFE market to stabilize in 2024 before meaningfully rebounding in 2025. After Lam's fourth-quarter earnings, Seeking Alpha published an article that stated (emphasis added): Analysts led by Joseph Moore noted that Lam reported a mixed June quarter supported by trailing edge spend from China, and September quarter guidance was in-line. They expect Lam to outperform in 2025 but see a tricky set-up in the second half of the year. The analysts said Lam will likely outperform the wafer fab equipment market in 2025 on the back of a recovery in NAND spending. Analysts seem more worried about the company's risks than the potential upside in 2025. Lam characterizes 2024 as an "investment year," rather than a growth year. One of the initial comments that Chief Executive Officer ("CEO") Timothy Archer made on the fourth quarter earnings call was (emphasis added): As previously communicated, 2024 is a year of strategic investment for Lam, where we are prioritizing product development for key technology inflections, global R&D infrastructure close to our customers and digital transformation for operational efficiency at scale. We believe these investments will put Lam in a position to outperform as the industry moves into a period of multiyear WFE spending expansion. Like the Yole Group assessment, Lam expects WFE spending to remain muted in calendar year 2024. The company forecasts WFE spending in the low to mid $90 billion range, boosted by Chinese customers spending more than initially projected and ramping demand for equipment to manufacture high-bandwidth memory ("HBM"). Lam also expects foundry logic, DRAM (Dynamic Random Access Memory), and NAND (non-volatile memory) to show growth in 2025 compared to 2024. The company also expects spending for older chip technology to flatline this calendar year. Management projects AI to boost WFE spending in the calendar year 2025. CEO Archer said on the earnings call (Emphasis added): Looking ahead to 2025, we see a positive environment for continued growth in WFE spending. The power of AI is a transformative business tool is still yet to be fully realized. Today, the focus on AI model training is driving strong demand for GPUs and HBM. However, as AI use cases expand, we believe inferencing at the etch will spur content growth of low-power DRAM and NAND storage in enterprise PCs and smartphones. Investments for AI-enabled etch devices play particularly well to Lam's strengths. We anticipate that memory customers looking to scale capacity and lower bid cost will bias WFE spending toward technology upgrades of the installed base. If CEO Archer's statement about low-power DRAM and NAND memory customers being biased toward upgrades rather than new equipment purchases is authentic, that's beneficial to Lam, as it means existing customers will purchase upgrades from Lam instead of potentially opening up bids for new equipment from competitors. During the industry downturn, Lam has been busy. It has made multiple product investments to manufacture smaller, more powerful chips. DIRECTDRIVE is a new tool for plasma etching (dry etch) wafers that the company believes is the best in the industry. This new tool is excellent at removing thin slices of material from the surface of a semiconductor wafer, which is necessary for producing the newest advanced memory chip, 4F2 DRAM, a more compact and efficient version of DRAM compared to previous generations. On the earnings call, the CEO highlighted the importance of precise tools designed for 4F2 DRAM: "In 4F2 devices, the nature of the bit line placement requires precise etching of ultra-small high aspect ratio silicon structures to avoid device shorts or leakage." For generative AI's Large Language Models (LLMs) to learn quickly and give speedy responses when queried, they require a memory that can retrieve large data sets rapidly. DRAM chips are a computer's short-term memory, and the chip industry developed 4F2 DRAM to improve the performance of generative AI and other computing needs that require top-of-the-line short-term memory performance. Another product that the company worked heavily on is a conductor etch ("CE") for EUV (Extreme Ultraviolet) patterning for gate-all-around ("GAA") and DRAM chips. These chips require precise material removal (etch placement) in the etching process. CEO Archer said about the CE tool (Emphasis added): Conductor etch is becoming a critical enabler for EUV patterning for gate-all-around and DRAM due to the need to reduce etch placement error. For nodes below 2 nanometers, the requirement is for roughly 40% tighter control than at 5 nanometers. Our new conductor etch tool delivers a 30% reduction in feature roughness, which is one of the main contributors to etch placement error. In addition, we can achieve one to two orders of magnitude improvement in defectivity for a given EUV dose, further helping customers reduce the overall cost and improve the capability of the EUV patterning process. Computer manufacturers use GAA as logic chips in applications requiring energy-efficient and speedy processors. One of the worries with LLMs is the massive power consumption in training and inferencing. GAA chips help lower the power consumption for generative AI uses while speeding up the data processing times. On the date of the fourth quarter earnings call, the company announced several products for 3D NAND chips. Memory manufacturers construct next-gen 3D NAND by stacking tiny memory chips horizontally and vertically. Lam designed a product to help manufacturers stack memory chips wider and higher more logically. The name of this product is Cryo 3.0, the company's third generation of cryogenic etch technology. Lam's website states (emphasis added), "Since 2019, Lam has been the only company with cryo tools running in production for NAND manufacturing worldwide, boasting an install base of nearly 1,000 chambers." The second product that the company designed for NAND technology is a deposition product for gap-fill, a process that fills in the space between the memory chips stacked on top of each other. The industry has traditionally used polysilicon and tungsten to fill the gap. CEO Archer discusses the problem with polysilicon and tungsten gap filler and Lam's solution in the earnings call: Polysilicon and tungsten gap fill materials have typically been used to enable tier stacking in high-layer count NAND. Integration of these materials, however, has resulted in poor control of critical dimensions and overlay, negatively impacting yield and performance. Lam's innovative PECVD-based pure carbon and gap-fill process provides an attractive alternative material. With the unique combination of high etch selectivity, superior mechanical properties, and simplified dry post-process removability, it also reduces the number of process steps required in some cases by approximately 50% compared to traditional approaches. Computer manufacturers often use NAND memory chips as solid-state devices (SSDs) for long-term memory. Like DRAM, generative AI requires faster read/write times of information stored in memory, which requires 3D NAND. Another benefit of 3D NAND is it can store more data than regular NAND chips and has the endurance to withstand repeated reads and writes to the long-term storage device. Solid-state memory can wear down over time. Lam is one of the most innovative companies in WFE. It heavily invests in research and development (R&D) to develop cutting-edge products to improve NAND, DRAM, and logic chip manufacturing. These investments should position it to potentially gain market share in WFE in the medium to long term. The company referenced Lam Malaysia in the above image because it's a new manufacturing facility built near its most significant Asian customers. It's likely that the better this plant performs, the better the company's long-term fundamentals. The company references that the Malaysian plant shipped 5000 chambers. A chamber is a sealed environment where Lam's etching, deposition, or cleaning occurs. Sometimes, the company's communication with investors will reference the number of chambers sold to customers. This number is important for the initial sales figures and CSBG (Customer Support Business Group) sales. Lam manufactures highly specialized equipment that chipmakers integrate deeply into its manufacturing processes. Chipmakers don't often switch suppliers because it would be expensive, time-consuming, and disrupt the chip manufacturing processes. So, the company enjoys a high switching cost moat. One of the benefits of that moat is that when the parts for its equipment wear down, customers only have one source for replacement parts and upgrades. CSBG provides Lam's customers various support services, including spare parts, upgrades, technical training, software upgrades, and service calls. This business segment includes Reliant Systems, Lam's specialty and legacy products provider. Specialty products are products outside of logic and memory chips. The company describes the types of products that manufacturers would use Reliance tools for on its website: For Specialty Technologies, we are enabling customer roadmaps by developing new solutions, including critical steps. Specialty Technologies is a growing market, covering devices such as power, CMOS image sensors (CIS), radio frequency (RF), optoelectronic, analog and mixed-signal, and micro-electromechanical systems (MEMS). The following table shows that CSBG generated $1.7 billion in the June quarter, 44% of its total revenue. The segment grew around 14% year over year. Although CSBG grows slower than systems revenue in an upcycle, this revenue source provides a stable revenue source in a downturn. Lam's fourth-quarter FY 2024 revenue increased by 20.71% to $3.87 billion, returning to quarterly year-over-year growth after multiple quarters of declining growth. This revenue was above the company's fourth-quarter guidance mid-point and beat analysts' estimates by $39.92 million. Lam's fourth-quarter earnings call and the accompanying investor presentation emphasize non-GAAP (Generally Accepted Accounting Principles) metrics. I'm not fond of some companies emphasizing non-GAAP numbers because non-GAAP metrics appear to be there primarily to exclude stock-based compensation ("SBC"), which makes GAAP profitability look worse. However, that's not the case with Lam. Lam's GAAP to non-GAAP reconciliation table shows that the company has multiple one-time or non-cash expenses that could make comparing profitability over different periods challenging. The company also lacks SBC. EDC likely refers to Employee-Deferred Compensation plans. These plans are not the same as SBC or a pension plan. An EDC is a benefit that allows employees to defer a portion of their salary into a tax-deferred savings account. The company holds these funds until a specific date, usually retirement. Multiple factors can change an EDC valuation, but the likely culprit in this case was the increase in interest rates across 2022. Transformation and restructuring are similar concepts with only a slight distinction. A transformation may change a company's processes and technology, while a restructuring focuses more on changing the company's organizational structure and the people running those new divisions. Amortization is a non-cash accounting technique for gradually writing off the cost of acquiring intangible items, such as trademarks, patents, copyrights, and goodwill, over time. This article will primarily look at non-GAAP metrics to better understand how its core profitability is trending. June 2024 gross margin showed a 280 basis point ("bps") year-over-year increase to 48.5%, at the top end of the company's guidance. Chief Financial Officer ("CFO") Douglas Bettinger said on the earnings call, "June quarter gross margin benefited from continued improvement in factory efficiencies, which largely offset the headwind we saw in customer mix." Operating expenses for the June quarter increased $99 million from the prior year's June quarter to $689 million. Most of the operating expenses came from R&D. CFO Bettinger said the following on the earnings call (Emphasis added): We continue to prioritize spending in research and development to extend our technology differentiation as well as expand our product portfolio. I'd just point out that more than 70% of our total operating expenses were concentrated in research and development. June 2024 operating margin improved by 40 bps year over year to 30.7%, above the company's guidance range. Non-GAAP diluted earnings-per-share ("EPS") of $8.14, up 36.3% over the previous year's June quarter. GAAP diluted EPS was $7.78, above the midpoint of guidance. The company reduced diluted shares from 134.39 million in the June quarter of 2023 to 131.11 million in the June 2024 quarter, increasing the EPS for existing shareholders. The following chart shows that Lam has cash from operations ("CFO") to sales of 31.21%, the second-highest WFE company I track. The higher the CFO-to-sales, the greater the potential for increasing free cash flow ("FCF"). Lam generated $4.256 billion in trailing 12-month FCF in the June quarter. The company ended the quarter with $5.84 billion in cash and cash equivalents against $4.47 billion in long-term debt and finance lease obligations. The company had $4.983 billion in total debt and $4.685 EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Its debt-to-EBITDA ratio is 1.06, meaning it has enough EBITDA to repay its debt in a reasonable amount of time. The larger this number, the longer it will take for a company to repay its debt. When this number goes over 4.0, the company may be on the verge of financial distress. The following table shows the company has a June 2024 inventory turn of 1.9, which means it sells its entire inventory 1.9 times per year. This number was 1.5 in June and September of 2023, around the bottom of the cycle. These low numbers indicate sales were likely poor in June and September of 2023. During the company's last upcycle, in the March 2021 quarter, Lam had an inventory turn of 3.2. A higher inventory turnover often means the company has a better sales performance. Investors should monitor this number in future earnings reports. A rising inventory turnover potentially indicates the company is in an upcycle. During the June 2024 quarter, the company returned capital to shareholders through $382 million in share repurchases and $261 million in dividends. In FY 2024, the company returned $3.7 billion, or 88% of FCF, to shareholders. The company's long-term plan is to return 75% to 100% of FCF to shareholders. Some consider Lam Research an AI infrastructure stock. Over the last month or two, sentiment toward AI infrastructure companies has declined. Sequoia published an article in 2023 titled AI's $200B Question, later updated in June 2024 to AI's $600B Question. These articles discussed a growing gap between companies investing in AI infrastructure and the lack of enough AI applications and services to provide value to customers. This growing gap has created fear among some that the AI infrastructure market may be in a bubble. The following chart shows that many of the most significant AI hardware infrastructure stocks have declined over the last month. A potential perception that the AI infrastructure market may be in a bubble could hurt the stock's near- to medium-term performance. Another risk that investors should consider is the concentration of revenue from China. The chart below shows China made up 39% of the company's June quarter total revenue, which is $1.5 billion. In 2022 and 2023, the U.S. instituted export controls on sending advanced semiconductor manufacturing equipment to China. Today, China is buying as much legacy equipment as it can before the U.S. government potentially decides to create even more restrictive rules on semiconductor manufacturing equipment sales to China, which the U.S. government has considered. Additionally, Lam's customers in China might eventually switch away from the company's products the longer these export controls remain in place. The U.S. has spent much political capital getting foreign countries like the Netherlands on board with restricting companies like ASML Holdings (ASML) from sending equipment to China. However, how long can the U.S. government continue getting foreign governments to follow this policy? For instance, Tokyo Electron (OTCPK:TOELY)(OTCPK:TOELF), a direct Lam competitor from Japan, may be exempt from potential new upcoming export restrictions. Lam Research's price-to-sales (P/S) ratio is 7.155 at the end of the June quarter, well above its five- and ten-year median, suggesting overvaluation. When I wrote my last article on Lam Research, I ignored how much the stock traded above its P/S median in favor of what its forward price-to-earnings implied about what the stock should trade at. This time, I wanted to examine why the stock trades so much above its median P/S ratio. Before I go into this analysis, it would be helpful for you to understand that I am making a rather large and straightforward assumption that this stock will return to trading at its median five-year P/S ratio. This assumption is simplistic because not all stocks immediately return to their median, and the five-year median is not static. It has risen over time and is well above the ten-year median. It is possible that when Lam matches its five-year median again, it may be at a higher P/S ratio than 4.994 because the market may award the company higher P/S valuations over time. After all, the value of the equipment and services it sells may increase in the market's eyes. Let's look at what Lam's five-year median P/S ratio implies about the company's sales. For Lam Research to reach a five-year median PS ratio of 4.994, the price needs to drop to $534.50, or the company's sales will need to grow into that valuation. For instance, its latest trailing 12-month sales per share is $107.03. The company would need to achieve trailing 12-month sales per share of $161.77 to match the median of 4.994 without the stock price declining from its closing price on August 9, 2024 of $807.90. Multiplying $161.77 times 131,112,000 diluted shares the company recorded at the end of the June quarter equals $21.21 billion in TTM revenue. The chart below shows that at the end of its fourth quarter FY 2024, it had an annual revenue of 14.91 billion. The highest TTM revenue it had ever achieved was in the December quarter of 2023, where the number reached $19.05 billion. So, Lam has a long way to go to reach $21 billion in TTM sales. Although the stock beat revenue estimates in the fourth quarter, some who value the stock using metrics like the P/S ratio see that sales must increase 42% to reach the five-year P/S median at the current stock price -- a potential reason the stock slid after earnings. On a TTM basis, Lam's revenue appears to have already begun to rebound. There are several things that investors must consider here. Lam is a cyclical company. Cyclical companies will often look the most highly valued on a P/S basis at the bottom of a downturn because sales are depressed from the downturn. At the same time, investors will drive up the price in anticipation of a rebound in sales. A cyclical stock like Lam can sometimes have sales rebound faster than the market expects, which is why some investors buy in anticipation of a rebound instead of waiting to see proof that a sales rebound has taken place. Now, let's look at what analysts expect. The following table shows analysts' revenue estimates for Lam over the next three fiscal years. If you believe analysts' revenue estimates, the company could reach $21 billion in sales within two to three calendar years. Right now, the market is erring on the side of caution because it's not outside the realm of possibility that the U.S. market will have a recession. According to the Estrella and Mishkin indicator, the recession probability is 56.29%. However, because analysts are cautious, they may be understating Lam's revenue estimates if the economy avoids recession and achieves a soft landing. In that case, if the Federal Reserve starts lowering interest rates in September 2024, by FY 2025, FY 2026, and FY 2027, actual revenue may be far higher than current analysts' estimates for those years. The company could achieve $21 billion in TTM revenue, far faster than the market expects. Let's look at the current P/E ratio. Lam's price-to-earnings (P/E) is 27.83, above its five- and ten-year median of 20.71 and 18.89, respectively. Lam's five-year median P/E implies a stock price of $563.11. However, the price doesn't necessarily need to decline to that level to reach its five-year median EPS. The company can also get to its five-year median by growing into its current valuation. By raising its TTM diluted net income per share (same as EPS) 34.51% from the $29.00 it recorded in its fourth quarter FY 2024 report to $39.01, the stock would reach its five-year median P/E of 20.71 at $807.90. This EPS growth is feasible. So, although its P/E is below its median, the market may not necessarily overvalue the stock. The memory chip industry was last in a down market from 2018 to 2019. The following chart shows that once the business cycle turned upward, EPS quarterly growth peaked at nearly 100% year-over-year in about a year. The lesson is that earnings growth can ramp rapidly when the business cycle turns. If it is true that the memory chip industry has already bottomed, Lam may not look overvalued at these current prices a year from now. Today's prices may eventually look like a good entry point using hindsight a year or two from now. The following table shows Lam's forward P/E ratio and EPS growth estimates. One simple rule that investors can use to determine whether the market overvalues or undervalues a stock is observing a company's forward P/E and EPS growth estimates for a given year. When the two numbers match, the company would have a forward Price-to-Earnings-to-Growth ("PEG") ratio of one, which many consider fairly valued. The market may undervalue the company's potential EPS growth rate when the consensus EPS estimated growth rates exceed the forward P/E. Alternatively, if the consensus EPS estimate growth rate is lower than the forward P/E, the market may overvalue the stock. In FY 2026, when Lam should be well within a rebounding memory market, the stock looks undervalued with a one-year forward PEG ratio of 0.62. If it traded at a forward P/E equal to its EPS growth estimate in FY 2026, the stock price would be $1298.68, up 60.15% over its August 12 closing price. Be aware that analysts can underestimate a cyclical stock's EPS growth estimates coming out of a downturn, and the actual EPS growth rate may be much higher. Let's examine the company's reverse discount cash flow analysis ("DCF"). I set the terminal growth rate, which is the rate at which I expect the company's FCF to grow in perpetuity, at 3%. This number shows an expectation of the company to increase revenue and FCF growth rate above the U.S. gross domestic product growth rate over the long haul. I use a discount rate of 10% because I consider Lam's risk normal. A higher discount rate would mean I assume the risk is higher than the average stock. A lower discount rate would mean that I believe the risk was lower than average. I also use the company's levered FCF in the following reverse DCF. Lam Research Reverse DCF At an average FCF margin of 28.55% over the next ten years, the company would need to achieve an annual revenue growth rate of 10% over the next ten years to justify the August 12 closing price. However, the company's median FCF margin over the last ten years was 21.83%. Assuming an average FCF margin of 22% over the next ten years, the implied revenue growth rate is 13.5% to justify the current stock price. Lam has achieved a 17% annual revenue growth rate over the last ten years, from $3.6 billion in FY 2013 to $17.43 billion in FY 2023. The big question is how long the company can maintain a 17% revenue growth rate with competition increasing in its primary deposition and etch markets. The company must navigate potential market share loss to competitors like Applied Materials (AMAT) and Tokyo Electron. The company may also face pressure to lower its prices to compete. Alternatively, Lam has invested in unique technology enabling its customers to manufacture advanced logic chips like Gate-All-Around transistors and DRAM chips. The company has potentially positioned itself to gain market share within the markets it competes in. Suppose I assume a few percentage points of growth loss and use a 15% revenue growth rate at an average FCF margin of 22% over the next ten years; the intrinsic value would be $901.26, up 11% over the August 12 stock price. Although Lam may look overvalued based on several valuation metrics and Seeking Alpha Quant rates the valuation a D-, investors should be careful about labeling a cyclical stock overvalued at the potential bottom of a cycle because as the cycle turns up, the company could go from looking overvalued to looking undervalued in a short period as fundamentals improve. Although this company faces risks and challenges, Lam has invested significant amounts in R&D to put itself in a position to benefit from the increasing adoption of 3D NAND chips, faster DRAM chips, and high-bandwidth memory, essential for high-performance computing and generative AI. The company could gain share throughout a potential upcycle with some of its newest products. If you are a growth investor interested in investing in AI infrastructure companies, consider an investment in Lam. The stock remains a buy.

Coherent Corp. Q4 Earnings: Potential AI Beneficiary Is Priced Accordingly (NYSE:COHR)

Additionally, this "bonus" seems largely priced in when applying relatively high discount rates amid the stock's high volatility. In the current hype phase surrounding the potential beginning of an AI revolution, Nvidia (NVDA) clearly stands out as the most prominent example, often described as the "shovel seller in the gold rush." However, in such a gold rush, everyone suddenly wants to find someone who also sells shovel handles, and Coherent is being touted in some circles as a "hidden gem" in this regard. Allow me to clarify right from the start - I am not a technical expert in the fields where Coherent operates. Instead, I evaluate what the recently reported fiscal Q4 2024 numbers reveal, what the management says, and whether all of this truly indicates a hidden beneficiary. My conclusion will be that while Coherent appears to be benefiting, from what we see today it is not a hot AI stock or a hidden gem. Those interested in the company should analyze it in its entirety rather than getting caught up in the AI hype. I also analyzed Nvidia two months ago from a non-tech-expert perspective, focusing on valuation and market expectations. Nvidia is fundamentally in an entirely different league than Coherent, and in part, its hype is justified. However, my call for an overdue double-digit correction turned out to be correct, with an interim 19% correction from the time of publication and 27% from the top to the correction low. I initiated a small position below $100, approximately as my transparently laid-out strategy in the article indicated. Q4 2024 revenue came in at $1.31 billion, surpassing consensus estimates of $1.28 billion and even exceeding the upper end of the range, which was set at $1.3 billion. This brings FY-24 revenue to $4.71 billion, a decline of 9% from the previous year's revenue of $5.16 billion. However, Q4-24 revenue grew by 9% year-over-year, primarily driven by mid-teens growth in the company's largest segment, Networking, which is becoming increasingly important. While the company's technologies are used for laser welding of EV batteries, advanced medical devices, and UV lasers for mobile and high-end TV displays, among other applications, the core area of investor interest is currently the Communications market. This segment is expected to benefit from the expansion of cloud computing, AI, and machine learning, with its datacom transceivers that must handle increasingly higher data throughput rates. See below that, with 52%, Communications was the most significant market recently and also the one growing double digits year-over-year, driven by double-digit increases primarily in North America and China. I applied the company's researched market CAGRs of each market to the respective market revenues of the company and arrived at a 12% weighted total company revenue CAGR through 2028 using these assumptions. This also implicitly assumes maintaining its market position. One can compare the resulting $5.9 billion in revenue for 2026, for example, with analysts' estimates, which are in approximately the same range, around $6 billion. More about analysts' forecasts in a second. See below the AI story that investors seem to be mainly focusing on. The demand for datacom transceivers overall is expected to double over the next five years, driven by increasingly powerful 800G, then 1.6T, which the company expects to ramp next year and has already delivered samples of, and eventually emerging 3.2T transceivers. Coherent, however, is not solely defined by this allegedly rapidly growing group of products, which is why overall revenue is only expected to grow in the low mid-teens, as previously derived. Below is a summary of the latest actuals and estimates per quarter. I've again highlighted last quarter's beat, but the outlook for the next quarter didn't significantly differ from existing estimates. This does not appear to be a skyrocketing AI story comparable to Nvidia's. Next, I have prepared a similar overview for EPS, which exceeded expectations slightly at $0.61 in Q4-24. The new outlook for the next quarter, Q1-25, has even slipped slightly below previous expectations. For the full year, EPS for 2024 has declined by about -45%, which also puts future growth rates into a somewhat sobering perspective. Additionally, it's important to note that we are referring to Coherent's own Non-GAAP EPS, which adjusts for share-based compensation, amortization of acquired intangibles, and integration and restructuring costs. That is why I find it particularly critical and insightful to compare these adjusted EPS figures with the free cash flow (FCF) per share. I will use this comparison to ultimately attempt a simplified valuation of Coherent based on the FCF. While revenue is estimated to grow in the low teens, EPS is expected to increase by around 80% and 40% over the next two years, partly due to favorable comparisons as mentioned earlier. Furthermore, new transceiver models are generally more profitable than older ones, as the latter become increasingly commoditized. Another positive factor is the CEO's proactive focus on expanding gross margins. According to CEO Jim Anderson, the company's "sustainable gross margin" should exceed 40%, though recent figures were at 37%, with similar expectations for the next quarter, partly due to underperformance in some business areas. However, Anderson notes that improving gross margins takes time. The company plans to host an Investor Day in the upcoming quarters to outline its strategy, business model targets, and focus on gross margins. About strategically overthinking some make-or-buy decisions, Anderson said, "(...) there's a number of places where we're vertically integrated. And we build, for instance, not just the datacom transceiver but we build a number of the components that go into that transceiver. And to the extent that, that provides us differentiation or faster time to market or generates real value for our customers, that's fantastic and we will continue to do that. But what I want to make sure that we're careful about is not just building it internally for the sake of building it internally (...)" Coherent has been a particularly volatile stock, exhibiting significantly elevated 24M and 60M Beta Factors according to Seeking Alpha. After averaging these Betas and applying the lowering blume adjustment, I arrive at a beta of 1.8, which drives the cost of equity up to around 13%. The WACC is lower at 11%, as the company's cheaper debt load plays a significant role. I rely on FCF forecasts from DividendStocks for 2025 and 2026, which closely align with Seeking Alpha's EPS consensus estimates. For 2027 and 2028, I apply the previously calculated 12% market growth rate at the company level, assuming that margin expansion will be fully realized by then. In the Terminal Value calculation, I use a Free Cash Flow conversion of less than 100% of the adjusted EPS. This reflects historical observations and the need for long-term growth CAPEX, while FCF in the forecasting period from 2025 to 2028 is fairly close to the adjusted EPS. Additionally, I apply a generous terminal growth rate of 7%. This results in an enterprise value of $13.9 billion. From this, I deduct net debt of $3.377 billion, preferred convertible stock of $2.365 billion, and minority interest of $0.371 billion to arrive at an equity value of $7.8 billion, compared to a market cap of $10.9 billion. While this valuation doesn't scream "run," I will refrain from buying and consider Coherent an expensive and speculative company, whose growth trajectory requires strong belief to justify investment. At the end of the day, Coherent certainly benefits from the increasing performance demands driven by AI and cloud services with its datacom transceivers. Growth in this area is also significantly in the double digits, and newer generations are expected to be more profitable than the older, less powerful models, leading to disproportionate profit growth. Market share gains, of which there are still plenty, would certainly have a surprisingly positive and accelerating effect. However, beyond that, the growth of the datacom transceiver segment somewhat blends into the overall company performance, mixed with other underperforming business areas. Additionally, much of this Coherent Corp. growth seems already priced in. I will pass for now and continue to monitor the numbers closely.

Shopify: Strong Returns Still Ahead, Buy Before It's Too Late (SHOP)

Investors should grab this opportunity to buy the stock while it is still over 20% below its 52-week high, and almost 60% below its pandemic peak. Shopify (NYSE:SHOP) stock jumped by over 22% on the day it reported earnings last week, surprising investors with the incredible strength of its e-commerce business, despite most competitors delivering underwhelming results, citing economic weakness. The commerce giant proved its ability to continue adding new merchants at higher subscription prices, while also offering the best-in-class software platform to enable merchants to thrive, even with consumer spending trends weakening across the economy. If Shopify can deliver such solid earnings results in a weakening macro environment, imagine what the commerce giant will be able to deliver as the economy picks up again. In this article, we will be highlighting key aspects of Shopify's strength, particularly relative to e-commerce king Amazon (AMZN). SHOP is being upgraded to a 'buy' rating. In the previous article, we had discussed Shopify's positioning in the AI revolution, and how the lack of insights relating to its generative AI-powered tools and assistant was concerning, particularly as other key players in the commerce space have already been offering statistical insights into their own Gen AI services. Since then, the company held its 'Shopify Editions' event, where it offered some visibility into the progress they are making on this front. Perhaps most notably was that its Gen AI-powered assistant 'Sidekick' was already being used by thousands of merchants, and that it will become available to more and more businesses in 2024. Although key statistical insights into measured performance improvements, such as enhanced conversion rates using automated image generation or increased sales for merchants, were still absent. Nonetheless, the company's robust execution through this weak macro backdrop gives me confidence they will indeed also deliver results on its generative AI-related investments. Shopify remains a solid growth stock, with the market projecting an EPS FWD Long-Term Growth (3-5Y CAGR) rate of 45.27%. And last quarter, the commerce giant reassured investors that it can continue growing at this high pace. Gross Merchandise Volume [GMV], which represents the total value of all products sold by merchants through its platform, grew by 22% year-over-year last quarter, with Shopify CFO Jeff Hoffmeister proclaiming on the Q2 2024 Shopify earnings call: The strong Q2 GMV was driven by same-store sales growth of our existing merchants, led by our Plus merchants, continued growth in the number of merchants on our platform globally ... We saw solid growth across verticals with robust performance in health and beauty and food and beverages. We also saw solid growth in our largest category, apparel and accessories. Notably, this strength in GMV came against a backdrop of mixed consumer spend. We continue to gain market share in the US e-commerce market and abroad. While Shopify saw healthy demand for merchants' products, Amazon executives cited weakening consumer spend on their own earnings call, with Amazon CFO Brian Olsavsky sharing on the Q2 2024 Amazon earnings call: We're seeing a lot of the same consumer trends that we have been talking about for the last year. Consumers being careful with their spend, trading down, looking for lower ASP products, looking for deals. That continued into Q2, and we expect it to continue into Q3. We're seeing signs of it continuing in Q3. From a positive perspective, Amazon CEO Andy Jassy proclaimed that: North America unit growth is meaningfully outpacing our sales growth as our continued work on selection, low prices, and delivery is resonating. Indeed, Amazon.com is striving to become a destination for cheap goods. In fact, earlier this year, Amazon cut "fees for merchants selling clothing priced below $20", in response to increased competition from Chinese rivals Shein and Temu. Consequently, the e-commerce behemoth's 'third-party seller services' revenue took a hit last quarter, growing by just 12%, compared to 18% over the same period last year. This indeed slowed Amazon's revenue growth last quarter on the e-commerce side. On the other hand, Shopify had raised subscription prices for its merchants over the past year, and CFO Jeff Hoffmeister boasted high retention rates on the Q2 2023 earnings call back in August 2023: We are seeing our merchants, continue to remain on the platform rather than using the price change to move off-platform and largely remain on monthly plans versus moving to annual. For Shopify it provides us with more gross profit dollars to invest back into the business balanced with improved profitability. The higher subscription prices have continued to boost Shopify's top-line growth over the past several quarters, with 'Subscription solutions' revenue growing by 27% last quarter. Moreover, not only have merchants largely decided to stay with Shopify despite the price hikes, but the commerce software giant has also continued to attract more and more new merchants onto the platform, as Jeff Hoffmeister highlighted on the last earnings call (emphasis added): For the quarter, the key drivers of our revenue growth were the GMV strength I just discussed, growth in subscription solutions revenue stemming from the growth in the number of merchants on our platform, the pricing changes that have been implemented in the past year The fact that Shopify has continued to deliver strong merchant growth at higher subscription prices is testament to the rich value proposition of its software platform. Furthermore, executives also cited their new marketing technology and strategy as key drivers of merchant growth, with Shopify President Harley Finkelstein sharing on the earnings call that: We relentlessly test and optimize every single channel, keeping well within our average 18-month guardrail. Our tools and our AI models are crafted not just to operate but to excel leveraging emerging technologies to enhance our feedback loops. These tools provide sharper, more iterative feedback, enable more precise analysis, and deliver quicker signals, letting us identify patterns faster than ever, so we can swiftly adapt and respond. Now to give some examples of this agility and this discipline, consider this. After experimenting in a leading digital channel, a new emerging social platform in Q1, and observing substantial growth, we intensified our efforts in Q2. This led to a 51% increase in merchant acquisition quarter-over-quarter on that platform, all while staying within our financial guardrails. This proves Shopify's ability to innovate to continue driving top and bottom-line growth for shareholders. So while Amazon is competitively pressured to lower its own merchant fees and striving to drive down the cost of their goods to appeal to consumers, Shopify boasts strong pricing power on its merchant base, and continues to take market share with notable marketing technology advancements. AI race is heating up: Shopify is undoubtedly proving the fortitude of its software platform, with continuous growth in its merchant base and GMV, coupled with strong pricing power. However, we are in the middle of an AI revolution, and while Shopify had rolled out various generative AI-powered tools last year that help merchants with their day-to-day tasks, such as automated product descriptions and image generation, executives have barely offered any insights into whether and how these new services have boosted merchant performance. While Shopify was successfully able to raise prices on its merchants last year while proclaiming high retention rates, the commerce giant's ability to raise prices again on its merchants in a several years' time will highly depend on the value proposition of its generative AI-powered tools and services. Consider the fact that recently, furniture retail giant 'Ikea' (which is not a Shopify customer) reportedly proclaimed the higher sales it is witnessing through its app using generative AI models provided by cloud providers: On the IKEA app, the company introduced an experience called IKEA Kreativ that lets users capture visuals of their rooms, delete existing furniture and then visualize what IKEA furniture would look like in that space. ... On the initial version of Kreativ, customers who engaged with the experience were four times more likely to make a purchase than those who simply used the app, and seven times more likely to make a purchase than those who only went on the website. These are the kind of insights we need to hear from Shopify executives boasting about how their AI tools are helping merchants boost their own sales. As this will be the kind of technology that will be essential to continue attracting large enterprises, as well as smaller businesses, to the Shopify platform in the generative AI era. The point is, the AI race is moving fast, with new, more powerful AI models being released on a frequent basis, unlocking new commerce capabilities with quantitative results. So from this perspective, Shopify executives merely mentioning progress on its generative AI features during earnings calls is discouraging. The software giant has yet to convince both merchants and investors that its own generative AI-powered services will be promising revenue drivers going forward. With cloud providers making it progressively easier for businesses to build their own generative AI-powered apps and features, supported by natural language coding assistants (e.g. Microsoft's GitHub Copilot), there is a risk that enterprises become increasingly inclined to build and deploy their own generative AI-powered commerce features, making them less reliant on Shopify's services. Therefore, Shopify will need to move faster on this front to sustain share price performance from here. Of course, this is not to say that we should underestimate Shopify in the AI era, either. The commerce giant has certainly proven its ability to leverage the power of its platform and extensive merchant base, conducive to a large commercial database, to innovate new, unique products and services. A great example of this would be 'Shopify Audiences', whereby it leverages anonymized sales data from its merchant base to predict customer demand for other adjacent products, feeding into other merchants' advertising campaigns to help them target high-conversion consumers. Additionally, as discussed earlier, Shopify's own AI-powered marketing technology has helped it attract more and more merchants to drive sales revenue growth for itself. So the software giant boasts a track record of innovating and driving continuous growth, which gives me confidence that Shopify will be able to sustain this prowess in the AI era, leveraging the massive database it possesses to innovate unique, generative AI-powered commerce tools. Macroeconomic risks: The stock's performance over the next few years, and the valuation multiple the market will assign it, will highly depend on economic conditions as well. For instance, a higher interest rate environment due to a resurgence in inflation would subdue the prospects of multiple expansion for growth stocks like SHOP. The market is also anticipating a recession soon, which could also potentially undermine Shopify's ability to achieve the high EPS growth projections, or curb investors' enthusiasm around growth stocks overall, restraining stock price performance. Now a key reason why Shopify stock fell into bear market territory, down by 42% from its 52-week high earlier this year, was the concerns around slowing top-line revenue growth. Back in May 2024, earnings guidance from the company for Q2 2024 projected that the revenue growth rate would be in the "low to mid-20s". The company delivered at the top of this guidance range, with revenue growing by 25% last quarter, excluding the impact of the sale of its logistics business in the first half of last year. The top of the range results surprised Wall Street, amid underwhelming results from key e-commerce rivals prior to Shopify's results, consequently catapulting the stock higher post-results. The stock is now only down by 21% from its 52-week-high. Now for Q3 2024, the company has once again guided revenue growth to be in the "low to mid-20s". Though, investors can be confident that Shopify will be able to deliver growth rates near the top of the range again, particularly as the company's new marketing technology pays off in the form of on-boarding more and more merchants onto the platform, as discussed earlier. Moreover, given the 18-month payback period of its marketing strategy, CFO Jeff Hoffmeister guided that: as we think about the marketing spend, we do, based on the 18-month average payback periods, think about this as something which drives 2025 more than it does 2024 Therefore, while revenue growth has been slowing this year to around the mid-20s, it is expected to re-accelerate higher next year as the company attracts a growing number of merchants onto its platform thanks to its targeted marketing strategies paying off. Though over the near-term, the increased marketing spend means higher operating expenses, as the CFO guided on the earnings call: The largest drivers of our Q3 operating expense growth compared to the prior year are marketing and compensation expenses. On marketing, we plan to continue spending on opportunities that fall within an average 18-month payback period and the opportunities to support our key growth initiatives, including international markets, enterprise and point of sale. Investors should not be too concerned about the rising operating expenses, as the increased marketing spend is clearly already paying off in the form of new merchant additions and consequently higher top-line revenue, as per the citation from Finkelstein earlier in the article. Shopify's executives doubling down on a well-tested marketing strategy with proven results is an encouraging development for shareholders, as it is conducive to higher top and bottom-line growth going forward, driving the stock price higher. In fact, the rising marketing costs are well-aligned with revenue growth, as the CFO outlined: Increases in marketing, we had a year-over-year increase in our affiliate partner payouts. And since these payouts happen only upon a new merchant joining, there's a clear sign of adding more merchants to the platform This is testament to executives' discipline of driving future revenue growth in a cost-efficient manner. Now with the company delivering encouraging results and offering an improving growth outlook, Shopify's valuation is certainly not cheap, with SHOP trading at a Forward Price to Cash Flow multiple of 58.93x, and a Forward Price to Earnings ratio of 63.66x. Though, it is not unusual for a growth stock to trade at such high multiples, with the commerce giant having more than doubled its free cash flow margin to 16% last quarter. Furthermore, Shopify's EPS FWD Long-Term Growth (3-5Y CAGR) rate is 45.27%, and adjusting the Forward PE by this expected growth rate gives us a Forward Price-Earnings-Growth [PEG] multiple of 1.43x. Below, we compare this Forward PEG ratio to those of competitors and other key players in the digital commerce space. I have included Google and Meta in the comparison as well, because in the AI era, the services provided by these two tech giants will increasingly overlap with what Shopify strives to offer its merchants; generative AI-powered solutions to help them sell more products. Shopify stock is cheaper than commerce-software competitors Salesforce and Adobe, and also cheaper than e-commerce king Amazon on a Forward PEG basis. With regards to Google and Meta, the two digital advertising giants are particularly cheap at the moment, as covered in my previous articles covering each stock. Though, what is of greater value here are the 5-year average Forward PEG ratios of the large and mega-cap commerce stocks, providing us comparative indicators as to what multiple SHOP stock could trade at as it grows larger. Shopify is currently a $90 billion company, though with earnings expected to grow at such a fast pace of 45% over the next 3-5 years, the stock is expected to become as large as Salesforce and Adobe in a few years' time, which are both worth around $240 billion, and boast 5-year average Forward PEG multiples of around 2.20x. This suggests room for potential multiple expansion for Shopify shares from here. Being the leading commerce-software platform provider, and analysts at BofA recently also affirming Shopify's "market leadership with a number of defensible competitive advantages", it would not be out of question for SHOP to also trade at a Forward PEG multiple of above 2 going forward. This would be in line with what large-cap tech stocks, with strong market positioning and defensible moats, have historically commanded. Alternatively, even if it continues to trade at a Forward PEG ratio of around 1.50x, in line with what digital advertising giants Google and Meta have been trading at, there is still scope for lucrative multi-bagger returns ahead. As mentioned earlier, Shopify's EPS is expected to grow at a Compounded Annual Growth Rate of 45% over the next 3 to 5 years. Assuming that the stock price grows commensurately with earnings, rallying 45% annually over the next 3 years and thereby sustaining a Forward PE ratio of around 64x, then the stock is set to triple over this period. Moreover, if Shopify can sustain a 45% EPS compounded annual growth rate over the next 5 years, then the stock price could multiply by almost 6.5x. That being said, the reason SHOP is able to command a Forward PE ratio of 64x today is because of its attractively high EPS growth rate projection of 45%. Though at the end of the 3 to 5-year period, future growth rate projections could potentially be much lower, as companies' earnings growth rates naturally slow down as they grow larger. For example, Salesforce and Adobe's EPS FWD Long-Term Growth (3-5Y CAGR) rates are projected to be around 17% each. So let's say Shopify's EPS growth rate projections in 5 years' time halves to around 22.5%, with the stock correspondingly trading at a Forward PE ratio of around 30x instead of over 60x. In this scenario, instead of a 6.5x stock investment return, the stock could return around 3x, which would still enable investors to triple their money in 5 years' time. Additionally, this projection is assuming that Shopify stock maintains its current Forward PEG ratio of 1.41x. But as discussed earlier, the market could indeed assign a Forward PEG multiple of over 2x going forward, given Shopify's strengthening market position as it grows larger, and in line with how large-cap stocks with strong moats have traded historically. Even if we assume a ratio of 2x going forward, it would imply multiple expansion of around 43% for the stock price. So on top of the stock potentially tripling over the next 3 to 5 years based off of a high EPS growth rate of 45%, the stock price could also see an additional 40%+ uplift over this period from Forward PEG multiple expansion, creating the possibility of the stock returning around 4x in 3-5 years' time. Although, as discussed earlier in the risks section, worsening macroeconomic conditions over the next few years could make it more challenging to realize multi-bagger returns for SHOP investors. And Shopify will also need to step up its game in offering new, innovate generative AI-powered services and features to sustain the value proposition of its platform and achieve the high earnings growth rates expected of it. Nonetheless, with Shopify proving to the market that it can continue growing its merchant base and maintain healthy financial performance even amid a weakening macro backdrop relative to competitors, the company is certainly winning investors' confidence that it can achieve the 45% average EPS growth rate projections over the next several years. Hence, setting the stock up for multi-bagger returns ahead. Shopify stock has been upgraded to a 'buy'.

Fiverr: Expanding Revenue Opportunities And Margin Growth Should Push Stock Higher

Fiverr is a digital services marketplace that connects businesses (buyers) with freelancers (sellers) in over 700 categories. It reported its Q2 FY24 earnings in late July, where revenue and Adjusted EBITDA grew 6% and 16.8% YoY, respectively, beating estimates. Although the company saw a decline in its Active Buyers once again along with weakness in its "complex services" category from macro volatility, it still managed to expand its spend per buyer, which grew 10% YoY to $290, while its take rate rose 230 basis points YoY to 33%. During the earnings call, the management emphasized its focus on progressing upmarket while gaining market share in complex services through robust product innovation in their Summer Product Release. Simultaneously, the company is also expanding its product portfolio in the long-term freelance hiring space while growing its footprint in the fast-growing dropshipping-related categories with the acquisition of AutoDS, thus unlocking new revenue opportunities. Although macroeconomic uncertainties persist, I believe that the management's target of reaching an Adjusted EBITDA margin of 25% by FY27 is a positive sign. Assessing both the "good" and the "bad," I believe that the stock is attractively priced from a risk-reward standpoint. Therefore, I will upgrade it back to a "buy" rating with a price target of $37. Fiverr reported its Q2 FY24 earnings, where it saw its revenue grow 6% YoY to $94.7M, beating estimates, as the company continued to expand customer wallet share while simultaneously expanding their take rate through effective monetization of their Seller programs that include Promoted Gigs and Seller Plus. During the quarter, the company expanded their spend per buyer by 10% YoY to $290, which indicates that the company's strategy for attracting and engaging high-value customers is yielding results while driving robust product innovation. In my previous coverage on Fiverr, I discussed that the company has two strategic priorities that include progressing upmarket to attract more businesses with higher lifetime value and increasing their market share in complex service categories where projects tend to have a longer duration with higher transaction sizes. While the management discussed that they saw some weakness in complex services during the quarter from macro volatility, they continued to drive robust product innovation with their Summer Product Release, where it introduced its professions-based catalog, allowing businesses to find profiles that exactly fit their job descriptions, especially as they look to capture the portion of the addressable market that lies in a long-term engagement with a freelancer. As the company increasingly moves upmarket and drives penetration into complex services, expanding into the long-term freelance market will open up growth opportunities by unlocking more freelance hiring budgets. In my opinion, this is a win-win for all parties involved, as businesses will get access to the best human talent around the world, while freelancers will get opportunities that empower their career and success. Simultaneously, the company is also creating additional growth catalysts with their latest acquisition of AutoDS, which is a leading platform that provides an end-to-end solution for dropshippers. This acquisition will enable Fiverr to diversify its revenue model to include a new subscription-based revenue stream where AutoDS brings tens of thousands of dropshippers into the Fiverr ecosystem, thus expanding Fiverr's footprint in categories where it is currently seeing strong momentum, such as dropshipping, website development, e-commerce management, and more. I believe this acquisition is in alignment with Fiverr's ethos of empowering the creator community to be successful, while demand in dropshipping-related categories should continue to grow from rising trends in fast-fashion e-commerce sites and social media. Shifting gears to profitability, Fiverr generated $17.8M in Adjusted EBITDA, which grew 16.8% YoY, with a margin improvement of 180 basis points to 18.9%. The company continued to showcase its commitment towards its 2027 Adjusted EBITDA margin target of 25% as it streamlined its operating expenses, which grew at 3.5% (on a non-GAAP basis), a much slower rate than overall revenue growth, allowing the company to unlock operating leverage. Simultaneously, the company is also benefiting from strong cohort behavior, with 67% of core marketplace revenue coming from repeat buyers, while its payback periods continue to become more efficient, with the LTV to CAC ratio reaching over 2.1x, much higher than previous years, as businesses deepen their adoption of the Fiverr platform. However, its Active Buyers continued to decline both year-over-year and on a sequential basis to 3.9M. Although the company is focusing on driving wallet share among high-quality buyer cohorts with a larger lifetime value, it is slightly concerning to me that the decline in Active Buyers has not yet troughed. Plus, the company also saw some pullback in traffic in June as macro volatility persisted in the SMB segment with poor NFIB sentiment and declining job openings, particularly in the Information Sector. In my previous posts, I have discussed the company's strategic priority to increase market share in complex services that have generally benefited from the large capex spend in GenAI, where they have been seeing a double-digit growth rate with longer-duration projects along with higher transaction values. However, the management outlined that they saw weakness in higher-ticket projects during the quarter from macro volatility and thus did not provide the figures for revenue contribution from complex services and the rate of growth in its high-value buyers cohort that spend at least $500 annually (like it did until the prior quarter). However, the management continues to remain positive about the long-term prospects of AI and expects it to be a tailwind for businesses demanding access to AI talent and services, which should benefit Fiverr in gaining greater market share in the complex services category. Looking forward, the management has raised its FY24 revenue guidance from $384M to $385M, which represents a growth rate of 6.5% on a year-over-year basis. As the company continues to move upmarket and push into complex services that benefit from genAI through robust product innovation, it should be able to gain a higher market share as macro volatility subsides from interest rate cuts in the coming quarters. Simultaneously, I am optimistic about the company's expansion into the long-term freelancer hiring space, while the addition of subscription-based revenue from its latest AutoDS subscription will help it diversify its revenue model. As it continues to gain a higher customer wallet share while expanding its value-added product portfolio, it should grow in the high single-digit to low teens over the next 3 years to generate approximately $508M in revenue by FY27. From a profitability standpoint, the management raised guidance to an Adjusted EBITDA of $71M, which represents a margin of 18.4%. Given the management's commitment to reach an Adjusted EBITDA margin of 25% by FY27 as it unlocks higher operating leverage from greater spend per buyer across customer cohorts and efficient payback periods, it should generate close to $126M in Adjusted EBITDA, which will translate to a present value of $95M when discounted at 10%. Taking the S&P 500 as a proxy, where its companies grow their earnings on average by 8% over a 10-year period, with a price-to-earnings ratio of 15-18, I believe that Fiverr should trade at least on par with the index. This will translate to a PE ratio of at least 15, or a price target of $37, representing an upside of 55% from its current levels. Although the company saw a decline in Active Buyers along with macro volatility leading to weakness in complex services, where it did not provide revenue contribution from complex services as well as growth rate in high-spend buyers, I believe that the weakness will likely be temporary. In the latest reading, the NFIB Optimism Index rose to 93.7, the highest level since February 2022. Meanwhile, the Fed's interest rate easing cycle should spur growth in the economy, leading to further improvement in business confidence and spending cycles. Moreover, I believe that demand for AI talent and services is likely to remain strong, especially as we move from the infrastructure-building phase towards deploying AI applications. To this, I will also add that I am optimistic about Fiverr's initiative to expand its TAM into the long-term freelance hiring space, especially as they move upmarket and into complex services, enabling it to capture a higher share of the total freelance hiring budget. Simultaneously, its revenue expansion opportunity with the acquisition of AutoDS will also help it diversify its revenue model. Although macroeconomic uncertainties persist, I believe that the management's commitment to reach 25% Adjusted EBITDA by FY27 demonstrates their financial discipline when it comes to driving efficient marketing programs to streamline payback periods while driving higher spend per buyer across customer cohorts. Assessing both the "good" and the "bad," I believe that the stock is attractively priced at current levels, with sufficient upside for long-term investors. Therefore, I will upgrade my rating from "hold" to "buy" with a price target of $37.