NVIDIA Earnings Blow Everyone Away

0:01Tyler Crowe:Oh boy, did NVIDIA's earnings deliver. Motley Fool Hidden Gems Investing starts now.

0:09Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Jon Quast. Guys, I think this has kind of been the thing we've all been waiting for this week. It was NVIDIA's earnings report. It came out after the close yesterday. Probably the most anticipated earnings report, even more so than like the hyperscalers. And I think it's fair to say that the report did not disappoint. Shares are up for about 7 % as we're taping this morning. Somehow, the company smashed earnings expectations and guidance expectations, which at this point, I'm starting to think like, NVIDIA is arguably the most followed company on Wall Street.

0:49Tyler Crowe:If the company can blast past expectations like this, almost start to wonder, are Wall Street analysts not really good at their jobs or was this just an incredible quarter here?

1:01Matt Frankel:Maybe both. I'm not all Wall Street analysts, but maybe some. But yeah, this is just an incredible quarter. And I mean, it's every investor's birthday today with NVIDIA. You look at the largest company in the world reporting 106 % revenue growth, like it's some sort of scrappy startup. It's utterly unbelievable. And then you look at the guidance for the coming year. So it's guiding for 70 % revenue growth on top of what it's reporting this year. We're talking tens of billions of dollars. And the thing with that guidance is that Wall Street was expecting good stuff. Wall Street is expecting 45 % growth in the coming year.

1:44Matt Frankel:NVIDIA is saying 70 % growth. And the thing with that is, it's indicating that it would even be higher if it could physically make the stuff, but saying that it is supply constrained, that it's a supply constrained outlook. In other words, if we could make more, if we could have more supply, then perhaps we could deliver more revenue growth in the coming year. We can't. So we're saying around 70%. Unbelievable. The top five hyperscalers spending roughly$800 billion in CapEx this year, and many investors believe that's been unsustainable, that pace, but NVIDIA is saying they expect the hyperscalers to spend$1.3 trillion in the coming year, so$500 billion more than what they are going to spend this year.

2:32Matt Frankel:So there's your headline numbers.

2:34Jon Quast:Yeah, so companies that grow revenue at 106 % year over year generally don't trade for 25 times forward earnings like NVIDIA does. It's fair to say that the stock is pricing in an eventual deceleration. You mentioned the original estimate was for 45 % revenue growth last year, which is a pretty big deceleration from 106%. So now that we're getting 70%, or they're saying 70%, which they have a good history of low-balling their estimates, that's the real reason the stock is rising. The company said itself that it can only satisfy about 70 % of the demand it's seeing for its products. So it's not the earnings themselves.

3:13Jon Quast:Everyone expects NVIDIA's earnings to be slightly better than the guidance and analyst expectations every quarter. In fact, NVIDIA initially fell when the report came out before all those forward guidance numbers were revealed. There are margin compression concerns due to memory costs, but right now you're essentially trading about 300 basis points or 3 percentage points of your 75 % gross margin in exchange for roughly doubling your revenue growth expectations going forward. So the margins will be worth watching. NVIDIA's margins have been expanding pretty much without fail for quarter after quarter after quarter, and that's no longer the case.

3:53Jon Quast:But not much not to like about this report.

3:56Tyler Crowe:It's kind of strange. I'm a little bit at a loss for words for this, which makes for arguably the worst podcast media ever. But, you know, this guidance revision this large is obviously going to have like a profound impact on the entire AI infrastructure ecosystem, not just NVIDIA. I mean, we're seeing shares rise today. And this idea that we're actually supply constrained versus, I don't know, maybe some of these new entrants like Google's kind of these custom built chips that all the Hapriscarer is building themselves. There was like this concern that maybe demand might be there, but it is there.

4:32Tyler Crowe:So with that in mind, like all of this supply coming to the market from NVIDIA, from these other companies, and we're still supply constrained. You know, we've covered like the picks and shovels of the AI infrastructure build out a couple of times here. But I want to challenge you guys a bit because this is the biggest story over the next couple of years. It's hard to avoid. What are some of the companies in this picks and shovels part of the industry that this revision kind of signals to that are going to be like the winners and losers? And maybe let's focus on some of the ones that are a little lesser known here and really lean into our hidden gems kind of theme here.

5:11Matt Frankel:Well, Tyler, I want to just point out what Matt said here regarding the gross margin concerns going forward for NVIDIA. there's higher memory cost going into everything with AI, and that is going to impact some of NVIDIA's margins. And as you pointed out, maybe not a big deal with NVIDIA, but let me just latch on to that higher memory cost thing. I think that that becomes a little bit problematic for a company such as HP. And this is kind of a loser here because of what's going on here. And I'm not just saying that because HP stock is down today, but you look at consumer devices, many of these memory companies, maybe not many, but some of them have pivoted away from the consumer market entirely because there's so much demand in the AI infrastructure trade.

6:04Matt Frankel:So these memory companies pivoting exclusively to that. So not only are memory prices going up generally, but now some of the companies supplying the consumer market have exited that. So there's even a bigger shortage in the consumer part of the market. The memory costs are going to be a higher and higher percentage of the overall cost going into making a personal computer. So the cost of a personal computer going up, that is really hard for a business like HP. You look at Dell, at least it has the tailwind from its AI server business that is supporting its growth. HP doesn't really have that.

6:38Matt Frankel:So I would say that's a tough place to be if you're HP. On the other side, let's talk about a hidden winner here. And we're talking about potentially, I don't know how many extra GPUs that NVIDIA is saying it's going to sell in the next 12 to 24 months. It's going to be a lot. Let's put it that way. So GPU interconnectivity is a bigger and bigger trend. I look at a company such as Credo Technologies, ticker symbol CRDO. This is a company, one of the several companies out there that can benefit from increased need in GPU interconnectivity. But when I look at Credo, one of the things that I do like about it is how small it is.

7:19Matt Frankel:NVIDIA is saying$1.3 trillion potentially in spending in the next year from the top five hyperscalers. Okay, Credo technology only has$1.3 billion in revenue right now. And it's tripled in the last year, expecting 80 % growth in the coming year. I believe this stock can be a good performer, let's say, if it reaches$5 billion in revenue within the next several years. that is just a drop of the gush of spending that nvidia is projecting here and so that is one that i think can be under the radar maybe a hidden winner here i mean i'll call out a few hidden

7:53Jon Quast:winners and losers here so a couple of winners they're both roughly 15 billion dollar market cap companies and both are companies that most people haven't heard of the first one's onto innovation o-n-t-o they make the inspection tools used in making all these memory products that are fueling that supply challenge. And kind of a between the lines takeaway is Vidya's 70 % expected growth rate next year. It implies that the company is going to need a lot more memory than expected. So that could be a positive tailwind there. Another one's called IES Holdings, tier symbol is IESC. They design electric systems for data centers.

8:29Jon Quast:We've talked about comfort systems. It's kind of similar story here. Among other end markets they serve. And I mean, And if hyperscale or CapEx goes from$800 billion to$1.3 trillion next year, power is a big constraint for data center development. And so companies like this are going to have not only a lot to do, but a lot of pricing power. But on the loser's end, John really hit the nail on the head when he said that any company that needs memory for any type of consumer electronics could be a loser. So although I love the company and its management team, I got to call out Garmin here, G-R-M-N.

9:04Jon Quast:they rely on third-party memory for all their products. And as much of a great job as they've done, with companies like NVIDIA scooping up more and more of the memory capacity, it could raise prices on Garmin devices or result in margin compression if they don't want to pass along price increases. It's likely to be a pretty temporary problem, but it's definitely one that's worth watching for companies like that.

9:26Tyler Crowe:It'll be interesting to see if the manufacturers, you know, NVIDIA is a chip company, but they outsource everything to Taiwan Semiconductor. I will be fascinated to see with the memory companies as well as the chip manufacturers, the foundry companies, if we start talking about significant expansion of production because everywhere we look, we're looking at these constrained bottlenecks, whether it be electricity, whether it be GPUs, CPUs, memory. Name your chip. We seem to be running short right now. So I feel like one of the stories we're going to be really following in the coming quarters is are we going to see significant expansion of capacity from these companies to actually meet this demand?

10:06Tyler Crowe:Because otherwise, we're just going to be stuck in this demand short on supply, short on supply sort of thing. And a lot of these companies are going to have the winners and losers continue down this path unless there is some significant change. Coming up after the break, we've got another earnings report coming up. We've got CrowdStrike, who is also having an awesome day in the market.

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12:17Tyler Crowe:For problems worth solving, get started with Claude at claude.ai slash fool. That's claw.ai slash fool. And check out Clawd Pro, which includes access to all of the features mentioned in today's episode. Clawd.ai slash fool. Shares of CrowdStrike are up 18 % as we're taping right now after company reported earnings. Another great earnings report similar to what we saw with NVIDIA here. And this pairs rather nicely with a lot of things that we've been talking about with AI because there was this kind of story around like AI and hacking. and the idea of like basically most of cybersecurity these days is going to be rendered obsolete by AI agents.

12:58Tyler Crowe:But based on these earnings reports and NVIDIA's guidance, that doesn't seem to be the actual issue here. It seems as though AI may be pushing customers to spending more instead of less. Guys, what did the report say?

13:13Jon Quast:Yeah, so I mean, well, NVIDIA's reaction was generally based on its forward guidance. CrowdStrike just reported a blowout quarter, period. period, not because revenue grew 26 % year over year, which was an acceleration. The real number is that net new growth in annual recurring revenue was up 51 % year over year. That's a company record. That's something CrowdStrike has never been able to do, even in the much earlier phases of its growth ramping up. Net new ARR, that was about 17 % higher than even management's own guidance. So AI is clearly fueling demand for cybersecurity at a much stronger rate than experts thought.

13:52Jon Quast:The remaining performance obligation, which is kind of the technical word for the backlog, grew by 49 % year over year to a little over$10 billion. Adjusted operating margin grew by 350 basis points. Management raised its full year guidance significantly on both the top and bottom line. There were very high expectations going into this report. It's a highly valued stock, but CrowdStrike really delivered another great quarter.

14:18Matt Frankel:I love this not so subtle zinger from CrowdStrike CEO here from the conference called AI is driving a clear divide between the cybersecurity companies that solve problems and those that compound problems. And I'll let you decide which one CrowdStrike says it is itself. But what is so interesting here is, to Matt's point, this was a great new quarter for net new business during the quarter. And the management team saying that this is as a result of the Mythos moment. So if you remember, Mythos coming out, and this is one of those AI models out there, supposedly broke containment and caused some problems and they had to pull it and yada, yada.

15:00Matt Frankel:Investors saw this initially as a threat to the cybersecurity space. CrowdStrike management saying this is actually going to be a benefit for us. And right now the numbers are backing that up. You see the timing of the mythos being released and all that buzz. And then you see the uplift in CrowdStrike's business. That said, I will put on my skeptical hat here because there are some changes, some recent changes in the last couple of years to CrowdStrike's billing methods. And so all new customers are now coming in in this flex billing model. So whereas before they signed contracts maybe for the year and they picked which modules they wanted to adopt from CrowdStrike's roughly two dozen cybersecurity module options, now you kind of have a spending commitment.

15:45Matt Frankel:You can flex that into modules that you're experimenting with, flex away from the ones that aren't working for you. So you can, and then within that timeframe, you can reflex. In other words, when you spend all the money that you had committed, you can just re-up at the same rates that you've negotiated with CrowdStrike. So that really does allow for faster adoption. It allows for, rather than waiting for, let's say that you're a business and you see this mythos moment, you're scared, you're wanting to try some things to protect yourself. Whereas before you might needed to wait till your contract was up or that whole thing.

16:21Matt Frankel:Now you can just reflex and you can experiment with things. So management pointing out that new customers who are entering by the flex business model billing method, that's the one that they have to choose if they're a new customer. There's a significant uptake in the annualized recurring revenue right from the get go. So maybe this is more of a billing thing that Mythos is showing us why this is such a good way to bill its customers, at least if you're CrowdStrike. But we'll see if that is actually great for both CrowdStrike and its customers long term.

16:52Tyler Crowe:One of the more interesting things about AI actually is the way that it's changing the way a lot of software companies bill or charge how they're doing. You know, we had this software as a subscription model, but now it's even starting to go almost like on a usage basis, similar to what we're seeing with like token usage with AI. So who knows, maybe one of the biggest innovations with AI is new billing processes here for these companies. CrowdStrike is another one of these darling companies. It's done incredible for investors. It's up like 114 % over the past year. There's plenty of Motley Fool members who've had recommendations on this round, crowds like who've done very well.

17:28Tyler Crowe:But this is like, I want to put the rubber to the road here for investors because another great quarter, it seems to continue. And this is the crux of the challenge here is shares trade for 37 times sales. That means right now it would take 37 years for the company to generate its market cap and revenue. Now, granted, that's if revenue stayed flat, the expectation is would grow, but that's still huge. This was like a discussion during the dot-com bubble with like some microsystems where they're like, this isn't our earnings, this is our sales before we have to actually deduct anything right now.

18:07Tyler Crowe:So this has been the story with CrowdStrike. It's a great business. It's growing a lot, but the valuation is crazy. So with this valuation today and everything you guys read from the earnings report and what you saw, is this stock an actual buy now? And if not, is there something within, it doesn't have to be cybersecurity, but maybe like the Venn diagram of what you could call CrowdStrike's tangential areas, where investors should consider instead if you think that this thing is just way too expensive.

18:40Matt Frankel:Well, I mean, Tyler, you're calling out valuation. I will say that I have sold stocks in the past based solely on valuation concerns, solely on valuation concerns. And every single time I have done that, I've lived to regret it in hindsight, because generally speaking, when the business is great, the market is great, everything is great except for the valuation, selling on that basis alone, it's always been wrong for me. And so I tend to stay away from that more now. I really do try to sell businesses that are performing poorly or industries that I believe are under long-term threat. I'd let that be more my deciding factor.

19:18Matt Frankel:if ever there was a company to not ignore the valuation entirely, but to push it way down your concerns list, I think CrowdStrike is one of them because it has demonstrated such an ability to compound its business over time. And I can't think of maybe a more important long-term industry than cybersecurity, one that's growing very, very nicely. And so CrowdStrike is one that if your only concern is valuation, I'd hit pause on that because it really is a phenomenal business and industry. I will say, though, if you are concerned about the valuation here, but want to stay in the same general area, it's not a direct competitor, but I would just point out Rubrik, RBRK.

19:58Matt Frankel:This is a cybersecurity company, but not a direct competitor to CrowdStrike. Trades at only 14 times sales. That's about a third of the valuation, and yet it is growing faster than CrowdStrike. So I think that is something to look at. It does generate free cash flow. It's got a pretty good balance sheet. So that would be one I'd look at. Yeah.

20:20Jon Quast:So I'm going to push back a little bit. So if the pandemic era SPAC bubble and the bubbling high growth tech stocks taught me anything, it's that valuation always matters at least a little bit. So, I mean, contrary to what John just said, there are several stocks that I regret not selling on ridiculous valuations during that era. I mean, CrowdStrike, just to kind of put the numbers in perspective, CrowdStrike, they previously targeted 20 % long-term revenue growth, like in perpetuity. And at the current valuation, that tells us that the stock trades for about seven times the revenue it will generate in a decade from now.

20:55Jon Quast:So on one hand, growth is accelerating, which you're right, is rare at this scale. The forward book of business is growing faster than current revenue. That implies acceleration in the near term. And that AI cybersecurity thesis, it's one that I completely believe in. But the math here is brutal. Even if, let's say, CrowdStrike's revenue were to triple over the next five years, which I think would be a stretch, the company would still be at about 12 times sales at the current price. So there's a lot not to like here. And I know Tyler's going to be with me on this one. Their stock-based comp is massive enough to completely wipe out that operating income that we talked about.

21:32Jon Quast:And the company actually reports an operating loss on a gap basis. Their diluted share count grew by almost 5 % over the past year. That's even after some buybacks to help offset it. And I would expect a similar rate going forward. Even though they're a leader, they're not without competition. So to kind of modify a Warren Buffett quote that I love, CrowdStrike is a wonderful business at an uncomfortable price right now. I wouldn't start a new position here today if you absolutely want to It's definitely a great case for dollar cost averaging into a position. But as an alternative, I recently bought Zscaler.