Chip Stocks and Bank Earnings Extravaganza

0:00Jason Hall & Earnings season has kicked off and we have updates from the biggest names in banking and semiconductors to digest. This is Motley Fool Money.

0:20Welcome to Motley Fool Money with the Hidden Gems team. I'm Jason Hall filling in for Tyler Crowe today. And I'm joined by Fool contributors that you guys hear a lot from here, John Quast, Matt Frankel. Before we get into the show, though, guys, there's something important I'm going to need to talk about. If you've been feeling uneasy about your portfolio lately, let's be honest, who hasn't? Our CEO, Tom Gardner, went live earlier today with something he's been building for months to address exactly that. If you haven't seen it yet, go to epicportfolio.fool.com. If you're already an Epic member, check your account.

0:54You might already have access. Again, that website, it's epicportfolio.fool.com. Let's get into it here. We've already talked about Goldman Sachs earlier this week. Matt, you're back from a Motley Fool event, and you're one of our bank experts here. You've owned Bank of America longer than any other bank in your portfolio. It's also become the largest bank holding that you have. How was the quarter?

1:18Jon Quast:They had a pretty excellent quarter. They beat estimates on both the top and bottom lines and pretty much everywhere else throughout their business. Their earnings were up 17 % year-over-year. Net interest income beat expectations, trading revenue, investment banking fees, asset management fees. They were all better than expectations, all increased. Equities trading was really strong, grew 30 % year-over-year. It's not surprising, given how volatile the market's been. People trade more when the market's volatile. Investment banking fees grew 21%. We hear about the upcoming wave of IPOs. A lot of them have hired investment banks.

1:53Jon Quast:That's not too surprising. Net interest income was up by 9%. All the profitability metrics, return on equity, things like that showed great improvement. The only spot where they missed expectations was fixed income trading, but interest rates were pretty stable and predictable. That's relatively minor, considering that the bank outperformed its expectations virtually everywhere else. We saw Goldman Sachs reported the same thing in FICC. That seems more of an industry trend and not a bank-specific trend. Right. I think it was expected going into it because Bank of America was, I think, the No. 3 or 4 bank to report.

2:28Jon Quast:The best news might be that consumers seem to be holding up well, not even a company-specific thing. The bank's provision for credit losses was about$200 million less than expected. Brian Moynihan, the CEO, he said that credit quality is good and improving. The numbers back that up, the bank's net charge-off ratio, it improved six basis points year-over-year to 0.48%.

2:49Matt Frankel:Matt, Jason and I were on the show earlier this week, and we were looking at Goldman Sachs. We saw that Goldman Sachs actually increased credit loss reserves. Is this different from that, or can you just explain it for those of us who don't follow the banking industry as closely as you do? Yeah.

3:06Jon Quast:The reserves are the total amount they're holding in the tank for anticipating loans to default. The provision is really what they're putting aside this quarter. It is the same essential concept. They're setting money aside. If consumers default, it's not like it's coming out of their pocket. This is a pool of money that's already there. It's something that every bank has, and it's really an indicator of where they see the consumer weakness or strength. Matt, we also heard from Schwab, which is a bank, but it's probably better known to most non-Schwab bank customers as a brokerage and investing services provider.

3:42Specifically, the brokerage services, how did that business do?

3:46Jon Quast:Just like I mentioned with Bank of America, trading activity was very elevated. Not surprising. The market was down a lot in the first quarter, especially after the Iran conflict started. We saw average trading volume up 34 % year-over-year on a daily basis. That was a new company record. Revenue was also an all-time high for Schwab, up 16 % year-over-year. But it was actually lower than experts thought it would be, and that's why we're seeing the stock under pressure after earnings. But overall, Schwab seems to be doing pretty well. They added 1.3 million new brokerage accounts in the quarter.

4:19Jon Quast:Schwab is a growing business. $140 billion of net new assets. Their total client assets are up 19 % year-over-year, and that's not all due to stock market performance, I can tell you that. Plus, Schwab announced a new crypto trading feature today that will bring retail investors the ability to trade crypto on its platform. Matt, if we go back a few years ago, investors were really worried about Schwab's balance sheet. Interest rates were skyrocketing, created fears that Schwab's bank was going to follow Silicon Valley Bank and First Republic in failing. We just saw the stock reach new all-time highs late last year.

4:56The business and the balance sheet seem to be on very solid footing. But if we look at multiples, both on earnings multiple and book value multiples, it's still well below where we've seen it in prior peaks. Do you think there's room for further multiple expansion, or should investors really be focused on earnings growth as the main driver for future returns?

5:14Jon Quast:Chris Hilliard, on one hand, Schwab seems to think that its own stock is cheap. They spent$2.4 billion on buybacks in the quarter. That's about 1.5 % of their shares in one quarter, which is a pretty aggressive pace. But on the other hand, it's not a cheap bank stock. It trades for about 20X earnings, which is a lot higher than Bank of America, Goldman Sachs, or any of the other ones that have reported, in a somewhat uncertain economic environment. It might sound odd, but if the market volatility calms down, let's say the Iran war ends and things like that. The market just calmly makes new highs, as I would put it, like it was doing at the end of last year.

5:48Jon Quast:It could actually be a negative catalyst. We'd see lower trading volume and things like that. But the real thing that investors should know going forward is that Schwab's earnings, even more so than other banks, can be lumpy because they really depend on not only interest rates, but trading volume, what the market's doing, and things like that. So, investors should keep the lumpiness in mind. Yeah, there's a little bit of a compounded effect here when you're a brokerage and also a bank, which are both very cyclical, lumpy businesses. Matt, thanks for the insight there. After the break, we're going to dig into earnings from two of the biggest names in semiconductors, which right now, that also means AI.

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7:33Welcome back to Motley Fool Money with the Hidden Gems team. AI continues to be the driving force behind the stock market broadly. We just got Q1 results from two of the biggest names in chip manufacturing with ASML reported yesterday that was the 15th, and Taiwan Semi, TSMC in shorthand, reported this morning. John, let's bring you into the conversation here.

7:55Matt Frankel:Yeah. And for this conversation, can I just frame it this way? I think we should zoom out for our listeners just to make sure that everyone is up to speed on what's going on behind the scenes. And so many of us are using chatbots these day. Jason, I don't know if you have a preference. You got many to choose from there. I'm a Gemini guy myself. Okay. Let's say that you go to Gemini and you're looking to brainstorm activities for your kids. I know you got a couple of kids and sometimes we don't know what to do with them, right? So you ask Gemini, Hey, what are some things that I can do with my kids today?

8:26Matt Frankel:It's a sunny day, whatever. It spits out some ideas for you. That's simple for you. Yeah. Right. You just put in a couple of inputs. But computationally, that's actually pretty hard. And it's not just any computer that does that. You need something powerful. And that's why NVIDIA's GPUs are really the preference in the industry to make all this happen behind the scenes. There's a data center somewhere that's got a lot of these GPUs in them to make that happen. Here's the thing. NVIDIA doesn't make its GPUs. It comes up with the designs, yes, but it outsources the manufacturing. And one of the companies that is doing the work for NVIDIA is Taiwan Semiconductor.

9:06Matt Frankel:The company decided that this was going to be its thing. It wasn't going to design anything. Taiwan Semiconductor just makes the stuff for its customers, that its customers design. What's interesting about Taiwan Semiconductor, though, you take that a step further, it doesn't make the machines that make the chips. It needs many other companies manufacturing equipment, including equipment from ASML. This is a company that makes extreme ultraviolet lithography machines. And really, modern computing isn't possible without ASML behind the scenes making it happen. It's machines currently work down to the two nanometer.

9:44Matt Frankel:I don't have nanometers on my tape measure. So let me just put this in perspective for us. That's how much a two nanometers. That's how much your fingernail grows in two seconds. That's how small we're talking about here. It's going to go down to 1.4 nanometer within the next few years. This is incredible technology, and it is making everything happen in AI.

10:06Jon Quast:It's worth clarifying, John. I know you mentioned NVIDIA that they don't make their own chips and they rely on these two companies, but it's not just NVIDIA. It's tough to overstate how embedded these companies are in the entire semiconductor industry and how dominant they are, especially ASML with its technology is unmatched. So, these are the great picks and shovels plays. And they don't care if NVIDIA wins or AMD wins or whoever wins. If there's a winner, they're going to make money. So, they want the whole industry. Their rising tide will lift their ship.

10:36Matt Frankel:Yeah, and I think that's really good for many investors to say, hey, I'm not going to pick the winner in the front. I know that no matter what, the picks and shovels behind the scenes are going to make some money. Yeah, I think the other part of this is so important, too, is as much as we focus on the bleeding edge and the leading edge, which are massively important, These are also the workhorse businesses in the industry, too. ASML's machines that they made 20 years ago, more than 90 % of those continue to operate in memory manufacturing facilities and things like that. TSMC makes chips for pretty much every consumer device you can think about.

11:09So, they're so important. John, let's go ahead and make the transition here, though. Talk about the quarter. How did they do? Let's start with ASML.

11:16Matt Frankel:Yeah. So, for ASML, it sold 79 lithography machines. That's it. Just 79. That doesn't make sense when you think about the numbers that this business generates. Well, and that's the thing. That translates to just over$10 billion in revenue for the quarter. So, 79 machines. This was actually just a little bit more than what investors were expecting on the top line. But I think that investors need to be careful not to read too much into a slight beat or a slight miss any quarter for ASML, because these machines are so expensive. The difference between a beat and a miss on expectations could be a single machine.

11:54Matt Frankel:And that could just be a timing issue. Sometimes it just doesn't ship on time for a variety of reasons. So, you just need to be careful there. I think the high-level takeaway, though, for ASML's report is that demand is strong. Margins, gross margin, operating margin, very well within the normal range for both of those. So, ASML isn't necessarily seeing an incredible margin expansion like some other semiconductor companies are, but overall demand is strong.

12:20Jon Quast:I wanted to follow up on that. You mentioned the machines, which that's the big driver for revenue, but a significant portion of the revenue comes from what it calls installed base management sales. It's a fancy way of saying the professional services ASML provides to support the machines that they sell to their customers, which obviously you're buying a machine and do the math,$10 billion divided by 79 machines. they're going to need some maintenance. How do you see that? It grew 17%, but the system's revenue fell sequentially.

12:51Matt Frankel:I think that's important to note that it was sequential. System sales from the fourth quarter down to the first quarter, yes, there was a drop, but up year over year. It's not unusual to see a steep drop-off from the fourth quarter to the first quarter. In fact, that's what happened last year, too. The long-term trajectory is still up for the system sales. And of course, that translates to an ever-growing maintenance revenue stream. Yeah. And if we look at that both on a sequential basis and a quarterly basis, one of the things that stands out to me is that that services-based revenue in both cases is growing faster than system sales.

13:31And that indicates that customers are really leveraging ASML machines in their manufacturing operations, particularly as the machines become more advanced. John, let's go ahead and shift back over to TSMC. How was the quarter there?

13:45Matt Frankel:I think that Taiwan Semiconductor was a bit more exciting than ASML. The company beat expectations. That goes without saying 35 % growth in local currency. But what was so interesting here is that it is, in contrast to ASML, it is seeing this margin expansion. So gross margin at 66%, operating margin at 58%, net profit margin at 51%. Those are all record highs, indicating that demand is far beyond Taiwan Semiconductor's capabilities. High-performance computing is what is driving the numbers here. So, that's AI. It's just an incredibly strong quarter for Taiwan Semiconductor yet again. Yeah.

14:26Jon Quast:So, clearly, AI investment has been massive lately. And that's the driving force behind their results, behind NVIDIA's results, behind all these companies. I have a tough time wrapping my head around all these several hundred billion dollar figures that companies are spending on data centers and AI infrastructure. Do you see these growth rates like the one Taiwan Semi reported as being sustainable? Or are you a little skeptical, too, that there's going to be trillions of dollars in annual spending for years and years to come?

14:55Matt Frankel:That is the question, isn't it, Matt? And I think that just takes us right into the bottom line from these two reports that we're looking at here. Different companies, but interrelated. And I think what we can say if we're combining the two things is that there are some leading indicators in these reports that we just looked at when it comes to the AI infrastructure spend that you're just referencing there. So, for ASML, what is a leading indicator there? The orders. And right now, orders are very strong, particularly from computing memory companies. Some of them are using some older machines, and now they're trying to update their memory offerings to make them more AI compatible.

15:37Matt Frankel:So, they're trying their hardest to get their hands on ASML machines. That's a good sign. Then when you look at Taiwan Semiconductor, their capital expenditures just jumped 10 % from the previous year. This company can't keep up right now. And you look at the margins, right? And the record profit margins seem to indicate a cyclical top. And we know that the semiconductor industry is cyclical. But then you look at the capital expenditure spending. This company knows the industry very well. It would not be increasing its CapEx by 10 % if it thought that it was right at the cyclical top. It's telling us that it's still investing so that it can meet demand.

16:20Matt Frankel:That is a long-term driver for these businesses. And so I think these two reports are telling us, yes, the semiconductor industry is cyclical, but this is a cycle unlike anything we've ever seen before, and it can continue to go on for some time now. Maybe not atop of the cycle, but certainly later in the cycle than we have been. The big question, of course, how long is it going to play out? John, thanks again for bringing us some insights there. After the break, we're going to talk about the companies that we are most looking forward to hearing from this earnings season. More importantly, why?

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18:04A quick note before we dive into the three stocks that we're really interested in hearing from this quarter. We love it when we get to make you our listener part of the conversation. If you have a stock or investing question for John, for Matt, me, anyone else you've heard on the show, you can now email us at podcasts at fool.com. We love to have mailbag segments whenever possible, so send your questions, but remember, keep them foolish. That email again is podcasts at fool.com. That's podcasts with an S on the end at fool.com. All right, guys, we are just at the start of earning season. This is really the first full big week.

18:40And on one hand, it's important to remember this is a 90-ish day snapshot of businesses that we often intend to own for decades. And while we should always keep that perspective, it doesn't mean we can't be excited or look forward to hearing from our favorite companies. John, I want you to get us started here. What's a company that's set to report that you are most looking forward to hear from and why?