Cisco & Cerebras Orders up, Stocks Down

0:02The wild ups and downs of earnings season continues. Motley Fool Hidden Gems Investing starts now.

0:13Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Jon Quast and Matt Frankel. Guys, it has been a wild up and down of the second quarter. Look, we could go into the several reasons and maybe once the earnings season dies down, we'll really kind of do a post more to them why this seems to be happening more uh with the ai trade recently and the volatility of the recent stock market but we're a little busy with earnings right now uh we had a couple big earnings reports we had cisco we had cerebros which is a new ipo a lot of investor incitement around that and then we really dug into some under the radar stocks doing a little bit of a lightning round letting us uh kind of indulge our analyst uh tendencies a little bit here.

0:56But let's start with Cisco. Shares of Cisco are down 7.4 % as we record. And considering the moves we've seen so far in the second quarter, that's actually a rather mild reaction for the stock. And as with anything that's selling equipment to data centers and AI, sales growth looks great, but it seems as though the fly in the soup was related to like service revenue, which came in a little lower than expected. So what, Matt, start with you, what stood out in the report.

1:23Jon Quast:Yeah, so about 85 % of the companies in the S &P 500 have beat earnings expectations this quarter. It begs the question, why do we have earnings expectations at this point? But an earnings beat alone isn't enough to move the needle, it seems, this quarter. Even a beaten raise is not enough to move the needle here. Cisco itself has now beaten earnings estimates for the past five quarters in a row, so it's kind of just expected at this point. I mean, the AI story was impressive. The latest guidance, which was already revised upwards several times was calling for about$9 billion in AI orders this year.

1:55Jon Quast:And Cisco produced$9.3 billion. But honestly, that's not as impressive of a beat as we've seen Cisco make in recent quarters. Remember, their original guidance was for$5 billion. They beat that through three quarters. That was an impressive beat. So maybe the market's starting to think that the growth is appropriately priced in. I mean, future revenue growth could be a lot stronger than the numbers suggest that Cisco's product orders in Q4 grew by 35 % year over year compared with just an 18 % revenue growth rate. That implies we might see an acceleration coming up. Notably though, management didn't provide new guidance for that AI order number.

2:32Jon Quast:I was certainly looking for that for the 2027 fiscal year, and I have to believe many investors were as well. Even after today's reaction, Cisco is trading for about 40 times earnings, and it's within still within a few percentage points of its all-time high. So it seems like the beaten raise, it just simply didn't live up to expectations. But I mean, all in all, a very solid quarter.

2:54Matt Frankel:Yeah. What decade is it? I mean, Cisco, Cisco, this is incredible revenue growth. And it's not just revenue growth that stood out for me, Tyler. It's also the earnings growth. So we did have the 12 % top line growth for the whole year. But you look at the earnings per share growth. That's profit. minus the share count, right? Divided over the share count, 31 % growth for earnings per share. That is a good sign when earnings per share are growing faster than revenue. And then for the upcoming year, also expecting maybe 16 % revenue growth. So a slight acceleration into the coming year, but then also that earnings per share growth, once again, projecting better than 20 % growth for the earnings in the upcoming year.

3:37Matt Frankel:So yes, Matt is right. It is trading at a premium valuation at 37 times earnings. That said, the top line growth is great. The profit growth is even better. And the strong demand that it is seeing certainly helps with that profitability. So that's what stood out to me. For what it's worth, forward estimates have it at about a price to earnings of about 26. But as Matt said, everyone's beating expectations all the time. So maybe that's even sandbagging you a little bit here, doing the dog and pony show of earnings expectations and all that stuff. Now, look, the stock is down. So I did try to like dig in and be like, well, why is that?

4:16Like everything you guys mentioned all seems pretty good. And something that stood out was remaining performance obligations. I mean, RPOs, if you want to use cool kid jargon, it grew about 7 % in the most recent quarter. And compared to other like hardware and software companies, that is rather light. As much as there is demand and it is incredibly fierce demand, At the same time, competition in this industry is getting stronger, as well as new technologies are coming out that could somewhat displace a little bit of what Cisco may be doing. So my question to you guys was, seeing those RPO numbers maybe being a little bit more tepid, is this a case where Cisco may be losing shares to the Arista networks or someone else in this industry that I might not be considering here?

5:02Matt Frankel:Well, I think we need to be very careful looking at the percentage numbers when it comes to Cisco, especially in comparison to other companies that are reporting percentages. So you think about Cisco and the reason I did jokingly say what decade is this is that this is a legacy business. This company has been around a while, already generates more than$60 billion in annual revenue. So this is a very large business, and many of Cisco's customers are more of these legacy customers. And so there is a component here that your remaining performance obligations, if they're being driven by AI, that's going to be somewhat lost in the overall mix of the business.

5:50Matt Frankel:because it has so many legacy customers. Whereas maybe a more pure play competitor isn't gonna experience that. So the percentage numbers are gonna look a lot different. I think we need to be careful from drawing too many conclusions with that. And if we can just zoom out, I think from a hidden gems investing perspective, we are looking for not necessarily a hidden company, but something hidden in the business analytics that maybe people are overlooking for this reason or the other, that we're looking for something hidden that will contribute to a stock performing well over time. I wanna give Dell as an example here.

6:28Matt Frankel:Just a couple of years ago, Dell's AI server numbers were just a very small percentage of the business, but they were really starting to uptick really rapidly. And you could kind of start seeing that, hey, Dell is this huge legacy business, but all of a sudden becoming an AI player. now that stock is up nearly 800 % in just three years, but some of the signs were there earlier for those who were going to dig beneath the surface. And I think that that generally speaking can be the case. When you see a legacy business that's all of a sudden benefiting from some booming industry, it might be getting lost.

7:06Matt Frankel:Those numbers, that narrative might be getting lost in the mix. And so taking some time digging deeper beneath the surface can sometimes yield something really important from a hidden gems perspective. And I'd say for Cisco, don't dismiss it. We are looking at AI infrastructure orders up nearly 400 % year over year, and it's fiscal 2026, looking for nearly 90 % growth in those AI infrastructure orders in the coming year. So that is hidden beneath the surface, and it's worth paying attention to.

7:36Jon Quast:So to unpack your question a little bit more, Tyler, Cisco was losing to Arista at first, when the AI boom first came up. Then they made a really smart decision to unbundle their full hardware stack, meaning that Cisco chips could be installed in devices they didn't make. That really helped them gain ground. You're right, the RPO looks light. But Cisco's RPO is majority made up of software renewals, the legacy business John was talking about. As John said, for now, AI is just a small percentage of what it does. The order book grew sharply, as I mentioned, 35 % year over year. and that doesn't show up mostly in the RPO numbers because Cisco is shipping these products honestly too quick for them to just sit on the backlog.

8:17Jon Quast:Arista is growing faster than Cisco right now if you look at just the top line but it's really a case of like pure play versus conglomerate. It'd be like comparing Berkshire Hathaway to a pure play energy company when you're looking at energy growth. The company's order book shows that it is still gaining AI traction as john just mentioned cisco their blended growth looks lower for sure but right now is the ride is the rising tide is lifting all shifts in ai networking well hopefully we'll have a repeat performance uh from cisco that we saw from the dell that over the past three years it's certainly uh trending that way with the stock up 62 percent over the past year so maybe seven percent seems pretty small pennies by comparison coming up for the break we're going to look into cerebrus's earnings.

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11:04It is not Cerebrus, apparently. I stay working from home way too much and don't get out and hear other people talking. Cerebrus Systems is the company we're going to be talking about. This is what I get for not listening on the conference calls again. So everyone can make fun of me in the comments for mispronouncing this company's name. Makes me look like I don't know what I'm talking about. But oh, well, we're going to do it anyways. So the funny thing is here is this is a company. It's gotten a lot of Wall Street and investor buzz, and it's not having a great day on Wall Street. Company reported earnings that were after the close yesterday, the stock's down about 13 % as we're taping.

11:39So this is a novel concept for computing and inference that recently went public. But guys, what did Cerebris' systems report say? And what were your reactions?

11:51Matt Frankel:Well, look, Tyler, everything about this company is confusing, from what it does to how it reports its numbers, apparently to how its name is pronounced. I mean, investors can be forgiven here if they needed a minute just to take some time and process what this report was all about.

12:08Jon Quast:So, I mean, at the core, the idea behind this business is simple, right? They build larger chips than any of the other ones that essentially take the place of several NVIDIA chips and other components being networked together. So that's the idea. And it would take less power, lower latency, things like that. The two revenue numbers in the report are uniquely confusing. They report gap revenue, which is what we all expect. And then a number called core revenue, which is actually not only different, but higher. So that could be confusing to investors. So GAAP revenue grew 74%, but that missed estimates.

12:44Jon Quast:Cerebrus' core revenue more than doubled and beat management's own guidance. Now their core revenue, it excludes the impact of warrants that the company issues to some of its largest customers, specifically OpenAI. So accounting rules say that you have to account for the value of those warrants and subtract them from your revenue. It's not really a revenue hit, which is why they choose to report core revenue, but it's confusing. um the during the quarter the revenue mix shifted toward cloud revenue away from hardware uh driven by its open ai deployments uh while hardware revenue actually fell by 23 so that could right there tell you why the stock fell um their core gross margins because of that felt or because of some other factors fell by nearly six percentage points uh it's temporarily renting back some of the hardware previously sold um so management said q3 should be the low point for margins and it should come up.

13:37Jon Quast:But with a money losing business that a lot of people don't really understand the accounting behind and things like that, it just adds to the confusion. Cerebras' bull case is it's got over a$25 billion backlog. It has nearly$9 billion of cash on its balance sheet. And management specifically said, and I'm quoting, that AI demand is through the roof and revenue will triple year over year in 2027. But I mean, this is a business that investors understandably simply have seemed to be having a tough time wrapping their heads around. And I really don't blame them with a revenue miss, margin issues, and a net loss that was surprisingly not great.

14:15Jon Quast:I'm not terribly surprised that the stock fell in reaction to this quarter's report.

14:19Matt Frankel:Yeah. You look at the guidance and I do want to just correct the record here from some of the chatter I've seen on social media. Some investors out there saying, oh, Cerebris is intending to 10x its revenue in the coming year. That is not what the company said. Matt pointed out the correct number. It expects to triple its revenue year over year in the coming year, which would be absolutely incredible. And I wish them well. But the 10x number, that is for the manufacturing. And so this is a fabulous semiconductor company, which means that it doesn't make its own stuff. That is made by other companies, specifically Taiwan Semiconductor is a supplier here.

15:00Matt Frankel:And so that 10x number is from its partners saying that they're going to increase the manufacturing and so you look at taiwan semi it's a pretty conservative company so i do think that in a way this is a vote of confidence to dedicate some energy to making sure that it can 10x the supply of cerebrus's products so um but i do want to point out the difference here the revenue and we're talking core revenue, not actual revenue, the core revenue looking to triple, but the manufacturing looking to 10x, there's going to be then that is a huge expected increase of revenue ongoing beyond the coming year.

15:38John, I'm shocked, shocked to discover that things that are said on social media aren't necessarily correct. Look, Cerebris hits at one of the challenges that I have been struggling with to work through with all of this AI spending, AI infrastructure build-out stuff. it you know it claims its ai chips which you know look closer to the size of the bathroom floor tiles than what we would normally see in cpus or gpos they claim they're faster they have higher chip on chip memory they require less power than current offerings if it is as powerful as it claims whether that's true or not it remains to be seen it would in theory solve a lot of the problems we see with memory and electricity demand because we can do more with less and one of the things i've always said is with the current spending and the trajectory of what we have with the equipment we have, it's not going to work because it just will take too much power, basically.

16:27So with me, to me, this seems to undermine a case for some of the biggest winners so far, like NVIDIA, some of the memory chip makers. And we can even go further down the AI infrastructure chain of like, maybe we just need a couple fewer data centers off the line here. Do you agree with this or am I perhaps reading it wrong?

16:43Jon Quast:It certainly feels like Cerebris doing more with less should hurt NVIDIA and the memory companies and the other chip makers. But I mean, so far in this cycle of AI adoption, every single efficiency gain we've seen has just kind of expanded the appetite overall. In other words, right now, there's so much demand that both Cerebris and NVIDIA can grow exponentially. NVIDIA might be, you know, nearing the end of its exponential growth because its revenue is, you know, more than Walmart. Not really, but getting close. But right now, cheaper AI has meant more AI, not less. And the disruption is real.

17:20Jon Quast:But I mean, the fact that Cerebrus is relatively tiny compared to NVIDIA and has some margin issues of its own and production issues and ramp up issues, it really shows NVIDIA's moat right now. So I don't think NVIDIA should be too worried for the time being. And NVIDIA is not exactly just kind of laying down and letting themselves be disrupted. They have a much deeper pockets than even Cerebrus for innovation. So I don't think they should be too worried.

17:46Matt Frankel:I don't think it's as simple as saying NVIDIA versus Cerebris. I think the answer is much more complicated and nuanced than that because of how these AI products are, how they actually work in the real world. So NVIDIA, of course, with its graphics processing units, GPUs. By the way, NVIDIA didn't invent those for AI. They pre-exist the current boom in AI. The reason that they were adopted into AI, specifically training, was because they were very good at general purpose activities. And what Cerebris is building is an ASIC. This is a custom thing. This is very good at a specialized activity and specifically inference, but for specific configurations.

18:40Matt Frankel:So this is why it's partner with open ai for example so that open ai can partner with cerebris for certain configurations for its custom hardware option you you look at that you're basically answering a question between generalization and specialization is the specialized is all the ai out there going to start specializing and that is going to give greater rise to a player such as cerebris or are all of these software products out there going to stay more general purpose, in which case that favors a more general hardware option. I don't know if that's an easy question to answer. I think that my answer is probably both.

19:24Matt Frankel:I think that you're going to see a rise, generally speaking, and that's going to be good for GPUs. But I do think that you're going to start seeing some specialization and that's going to give rise to some niche markets that Cerebras can fill. The question then becomes, how big are those niches? It's certainly going to be the battle of the AI data center space over the next couple of years as these models become more powerful and more stuff is custom built for these models. So coming up after the break, we're going to indulge our analyst tendencies a little bit and do a lightning round of earnings so far this quarter.

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22:35So we've been getting a lot of feedback from listeners that we should probably indulge that classical hidden gems sort of, uh, part of the phrase and, and, and indulge a little bit more here. So, you know, we're going to do basically the stock market equivalent of some deep cut or live album, indie band sort of stuff for this lightning round here. Earnings are starting to wind down. And so we're doing a lightning round of under-the-radar earnings reports. The companies that we love, we don't get to talk much about. So guys, you get to go full stock market sicko here. What do you want to highlight?

23:05John, we'll start with you.