Motley Fool Hidden Gems Investing - 1 Chip Stock Making Bold Plans

Starting point is 00:00:00 We've got earnings galore on Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime contributors, John Quast and Matt Frankel. We're going to do a whole bunch of earnings reactions today because it's been a busy week related to earnings. And of course, we're going to hit our mailbag at the end of the show. First, as we're going to start, we're going to talk about basically semiconductor earnings because it has been one of the big talking points of the week. Arm Holdings and Advanced Micro Devices, AMD, both reported within the past couple of days. And after both earnings, we saw shares explode as they blasted past earnings

Starting point is 00:00:44 expectations, 15, 20% moves in the day. We're going to start with Arm Holdings today because shares are quickly retreating after the company mentioned on its call after hours that mobile growth was, well, not really growth, and that rising costs were going to impact commodity mobile device sales. John, Matt, you two played rock, paper, scissors to cover the two. John, you happened to pick Arm Holdings as a result. What did you see in the earnings release and the conference call? And was today's reaction to this, hey, maybe mobile growth isn't great, was that like an appropriate response, do you think, to what you saw? Well, Tyler, I think the market reaction is appropriate, but not for the reason that you

Starting point is 00:01:24 mention here. And so I just want to frame this. It is important that you mentioned the mobile aspect of the business, because if we zoom way out, I don't want to take for granted that all of our listeners know what Arm Holdings is. This is a company that really rose in prominence due to mobile devices. Its chips are more energy efficient than other chips on the market. And that's a really big deal when you're looking at battery life in a mobile device. So it was able to rise. It does not make its own chips. Historically, it licenses these products to the manufacturers of the mobile devices. But if you look at what we have right now in AI, we have a bottleneck. You've heard about many bottlenecks. The big one is electricity. Power

Starting point is 00:02:09 is scarce, and this is driving AI companies to try to find more energy-efficient solutions. And so ARM makes CPUs and it claims they're two times more efficient than conventional x86 infrastructure or architecture. And that's the kind that Intel makes, for example. And so ARM is claiming that they can save AI companies 10 billion per gigawatts in capital expenditures in a data center. So that's a really big deal. And I think the big news here lately with ARM has been it's not going to just license the technology anymore. It's going to make its own chips. It's going to actually be a chip maker. And it's kind of a no-brainer. According to the company, it can make 10 times the gross profit per chip than just licensing it. So, I mean, that's a huge thing. and if you look management says here in the most recent quarter it already has two billion dollars worth of demand over the next two years for its custom or for its in-house chips so that's a really big adoption curve that's really good but what is the hang up here the hang up here is that if you look out to fiscal 2031 which mostly overlaps with calendar 2030 so just four years away from now. It's saying that, look, by then we'll have $25 billion maybe in trailing 12-month

Starting point is 00:03:31 revenue. Maybe we'll have $9 in adjusted earnings per share. You look at where the market cap was before earnings, and it's gone up a lot, mostly due to competitors' earnings results already. It was trading at an over $250 billion market cap, projecting maybe $25 billion in annual revenue in four years. That's over 10 times its four-year forward sales. And you look at earnings, it's trading at somewhere in the ballpark of 23 times earnings on an adjusted basis, four years out into the future. That's a really pricey valuation for a company that a lot of exciting things are happening. And I do believe that its products are going to be more and more needed for AI data centers, but it just got way out in front of its skates here.

Starting point is 00:04:18 To say that high valuations, that seems to be par for the course for just about anything that's tangentially related to AI infrastructure or semiconductors, whatever. And, you know, in that vein, we have another relatively highly valued company here with AMD, whose shares jumped as much as 20% yesterday after earnings release. Now, Matt, I didn't get a chance as much to look over the details, but I bet it had to do with AI spend. I mean, prove me wrong. Yeah. And it's not just the 20% gain yesterday. AMD has tripled over the past year and yes, it has to do with AI spend. That's really the lazy explanation for it though. So I'm going to go a little bit into depth with that. So revenue, of course, grew significantly

Starting point is 00:05:03 faster than analysts thought. And the big driver was, as you say, the 57% growth in that data center segment, which is AI spend. But the guidance was a big part of the reaction to the stock. second quarter revenue guidance came in much higher than expected and implied a surprising acceleration in growth. And Lisa Su, the AMD CEO, said AMD expects server growth to accelerate and that the company should deliver tens of billions of dollars in just data center AI revenue next year alone. But really, the X factor here, and this is kind of what I meant by the AI spend just doesn't tell the full story, is the strong CPU business that AMD has. That's a big differentiator from NVIDIA. AMD is a distant second to NVIDIA on the GPU side of the business,

Starting point is 00:05:51 which is to this point has been generally synonymous with data center chips. But AMD is a CPU leader, and this is becoming an increasingly important part of AI compute power, especially in the agentic age that we're approaching. So although the data center segment is the main story here, it's also important to note that the client segment, which includes the chips that AMD puts in PCs and laptops and things like that, that grew rapidly and indicated that the AMD Ryzen processors continue to take market share from Intel. So that just kind of underscores the strength of their CPU business and why the market might be so optimistic on them right now. There's a lot to look forward to with AMD later this year. They're going to start shipping their

Starting point is 00:06:36 Helios full rack system for AI data centers. That's a direct competitor with products NVIDIA offers and charges about $3 million a piece for. And OpenAI and Meta have already placed large orders. Meta in particular is an especially interesting deal because it's literally one of the single largest AI infrastructure deals that has ever been announced so far. So there's a lot to like. It's tripled over the past year, but it's for a reason. I want to kind of expand on what John was talking about with Arm getting into building their own chips now. Because we're seeing more and more companies wanting to do this. Alphabet said they want to do it. I think Meta's even mentioned it. Tesla has floated the idea of the TerraFab. It all sounds ambitious, and I

Starting point is 00:07:21 understand why. But one of the things I think about with the semiconductor industry is that, yes, building fabs is nice and new. It definitely increased production. But also, there are bottlenecks behind the bottlenecks right you have companies like asml lamb research uh as well as kla corporations you know these companies that you know we think of like the bottleneck it's like oh taiwan semi or intel they're like the only game in town in terms of chip manufacturing well and asml is the only game in town when it is the equipment to make the chip factories and i'm very curious when i hear these companies saying we're going to do this that they're all going to to have to put in orders with these chip manufacturing equipment companies. And I do

Starting point is 00:08:02 wonder to ARM's ambitious goals, how long are they going to have to wait in line for this equipment? How long is it going to take to build out? We've been talking about cost inflation and things like that. And I bring this up specifically because I've been thinking about this a lot lately, that as much as this is an explosive growth and we have AI infrastructure, basically finding any chip that they can find it whether it's you know reused crypto mining or whatever it seems like whatever spare parts or compute power we can get their hands on they're going to use it but it is still a cyclical industry and as ambitious as all this growth is you know how much capacity expansion can we have in chip manufacturing before something really starts to like shift right because even if

Starting point is 00:08:52 we have this five-year growth period and we bring all this new capacity online we could be looking at it six seven years from now and all of a sudden we're way over capacity and i feel like that's a major risk for some especially somebody like arm holdings who doesn't have this yet and wants to get into it so you do you are you guys seeing something similar or is it like i think you're just kind of you know shaking at the wrong problem here i do see that as a problem i don't see it as a problem yet. I'll put it that way. So I, like I said, arm holdings is, is a different animal because they're building this chip business from scratch, essentially. You know, AMD already has enough capacity for what it's doing now. It has somewhat of a backlog, but it's very managed. And

Starting point is 00:09:37 I mean, the big question is, you know, how long can we see this exponential growth go for and how much are they going to invest in infrastructure and production capacity and things like that before things turn and and that's really you know because right now supply and demand are clearly not in equilibrium right i mean there's far more demand than there is supply in in the chip making industry that's why we're seeing companies like micron you know the memory companies um you know they literally can't build their products fast enough the same with nvidia and amd um you know nvidia used the word sold out in its latest earnings report several times uh to talk about products so for for now it's yes there there's a backlog on the you know asml the equipment that

Starting point is 00:10:19 that the chip makers are using to make their products but right now it's working out in the favor of of amd and and nvidia with arm and i'm curious to get john's thoughts here it's a little bit of a different animal like can they scale quickly enough while the demand is still on the rise while they they still have the the ability to turn this into a significant revenue stream and i don't know the answer to that. Yeah, I think that's the key, Matt. If these companies could snap their fingers today and increase the production to meet the current demand, then I think that it would be a higher risk of overcapacity. But because these things do take multiple years and because there are bottlenecks even to them increasing their production

Starting point is 00:11:04 capabilities, and you mentioned ASML, I think that's a good point right there, that is going to mitigate some of that risk because they can't increase the capacity as much as they would like to right now. So it's multiple years out into the future to bring the supply up. And I guess it really depends on where you fall personally on the growth curve of the ongoing AI revolution. Does the demand continue to increase from here for these products and services? If so, then the supply is still going to tend to lag behind for multiple years. But if demand is plateauing already while supply is ramping, yes, that is the higher risk right there. I'm personally in the camp that I think that the demand for the products are going to continue to

Starting point is 00:11:54 rise at least with the supply. So I don't see the big risk as much cyclicality risk as I've seen in the past. Yeah. And just wrapping it up here, I think I'm more or less in line with you guys but i'm i reserve the right on some curveball of like algorithm algorithmic efficiency where like power and compute use goes way down uh relative to what we're seeing out of anthropic open ai and the big power users today you know maybe they start seeing some sort of deep seek esque drop in compute power per token or however we want to measure it uh so yes i think it's there but I think we should all be ready for those curves that could happen. I mean, we've seen it in numerous other industries before.

Starting point is 00:12:39 After the break, Matt and John are going to walk me through what I don't understand in DoorDash's earnings. Stop wasting your nights on a mattress that doesn't get you. Experience the most comfortable mattress in the world, the Sleep Number Smart Bed. At the touch of a button, you can personalize your comfort. choose firmer or softer adjust cooler to warmer and right now save up to twenty five hundred dollars during our massive labor day event hurry into your local sleep number store today

Starting point is 00:13:12 because we have your number like i said before the break here i had a really hard time understanding what's going on with doordash's earnings and like the response that we're seeing in the stock based on what they released. So you're going to have to help me here. DoorDash order volume, it's gross order value, it's revenue. They were all up a nice clip, like 25, 30%. But operating profit, net income, operating cashflow were all down year over year on rising operating costs. Now, the market seemed to like this. Shares are roughly up, I think 2% as we are taping. And I'm a little perplexed by this because in theory, this is supposed to be one of those capital light economic scale businesses

Starting point is 00:13:57 where growth is supposed to outpace overhead costs and lead to expanding margins. I think at where we're at right now, was it like three, four billion over the past 12 months in terms of revenue? That's a pretty good scale for an online delivery company, but we're still headed in the other direction with operating costs. And so as you guys looked at, again, conference calls, earnings, maybe some press releases that you've seen over the past quarter, what's been going on with DoorDash. Is this just like a one-time blip? Is this something that there's something else going on here where costs are expanding because of what, who they're delivering to or something like that? What am I missing when I see this and the market reaction? First of all, everything you

Starting point is 00:14:37 said was right. And it's also rare for a company to miss revenue expectations on top of everything you just mentioned and then rise the next day. That's, that's pretty rare. I mean, in addition to Q2 guidance was a little stronger than expected. That's usually not enough to completely the offset of revenue miss and rising costs. But there are three specific things I see from kind of reading between the lines and listening to the conference call. So number one, the dash pass, the membership program, the growth rate of that accelerated. That was the one part of the business that accelerated during the quarter. And that's a good indicator that the company is creating a more engaged customer base and it should help drive future growth. Membership

Starting point is 00:15:16 growth is kind of a lagging indicator when it comes to revenue growth. So that's one thing. Second, the company, they reported an all-time high when it comes to engagement with its members using its services for things other than restaurant delivery, say groceries or drugstore deliveries. That's a crucial part of the future thesis, and it's still a relatively small part of the business. Restaurant delivery is the cash cow, so that doesn't show up as much in the numbers as, you know, enough to really move the needle yet. And finally, recall in late 2025, the reason DoorDash's stock originally took a dive was because management was planning to spend, quote, hundreds of millions more than expected on technology initiatives, marketing, things like that, the rising costs that you mentioned. In this report, we saw the first clear indicator from management that they're getting a decent

Starting point is 00:16:05 ROI on these investments, particularly when it comes to the international business, which is also a very big part of the thesis. So that was a really long way of saying that, yes, everything you mentioned is correct, but they're giving us a lot to like when it comes to looking to Q2 and beyond, not just the guidance numbers. Well, I mean, it's correct on a technicality, but there is a lot of one-time blip here that I think is worth highlighting. And when I say one-time, I don't mean quarter. I mean on an annual basis, there's a blip here. And that is due to an acquisition that DoorDash made in Deliveroo late in 2025. Because of the acquisition, we have a huge jump in expected depreciation and amortization expenses this year. In fact, it's expecting a greater than 50% jump from last year. And when you look at it, about 40% of what it's amortizing this year,

Starting point is 00:17:05 $450 million of that, that's from acquired intangible assets. Outside of this, you look at the operating expenses, and things actually look pretty good. So sales and marketing only up 27%, R&D up 30%, G&A up 30%. That is behind revenue growth of 33%. So Deliveroo brought some inorganic growth there to contribute to that 33% top line number, but DoorDash itself grew over 20%.

Starting point is 00:17:34 And I think at this stage of the business to still see 20% growth on its own, that's huge. So yes, you have to back out this one-time blip from the acquisition. Overall, the acquisition is a net positive so far. And you look at all the other operating expenses, they're actually, you're seeing that operational leverage that you referenced in the outset

Starting point is 00:17:55 of this conversation, Tyler. All right. So we have a big acquisition coming in Deliveroo. Also, it looks like the mix of deliveries might be headed towards ever so slightly compressing margins. So with kind of these, I would call them shorter term headwinds or elevated costs or whatever you want to call it, do you feel like the company is on track with what they want to do as an investment today? Like, if you were to look at this company and be like, if I wanted to buy shares today, would you say kind of like all green lights ahead? What are some of the things that actually may have concerned you that would make you either think twice or make you want to think a little bit harder before you actually make the acquisition yourself? I mean, on one hand, I want to see their Q2 numbers. I want to see that, you know, what they're talking about is actually translating into reality in terms of the engagement with, you know, non-restaurants with, you know, they're getting a better ROI on their on all these hundreds of millions they're spending. But at the same time, it looks like everything's progressing as they want. And I mean, I don't own shares of DoorDash yet, but it is definitely on my watch list.

Starting point is 00:19:08 And I think it's moving in the right direction. From a business perspective, I don't see any big red flags here, Tyler. In fact, DoorDash continues to surpass my expectations. What concerns me from a value or from a investment perspective is the valuation trading at 40 times free cash flow. I don't necessarily mind that. I just question how big is this market? I don't really know personally.

Starting point is 00:19:32 And when something is trading at 40 times free cash flow and I don't know what the growth trajectory looks like over the long term, that kind of concerns me. But from a business perspective, continues to just blow me away. After the break, we're going to do a dip into the mailbag. Hey, as always, quick reminder, if you have a question for us and you want to get and have it read on air, we'll do our best to answer as many as we can. We're getting a lot. We're trying to find ways that we can answer them all.

Starting point is 00:19:58 So we're actually going to do a little bit of an expanded version of this today. But if you want to get your own questions in, send them to podcasts at fool.com. That's podcasts at fool.com. My three requests, the list keeps getting longer, is keep it foolish, keep it short, and we cannot give personalized advice. That's a lawyer thing and we don't want to get in trouble with any regulators on giving personalized advice when we are not registered people to do so. So just keep those things in mind when you're asking questions. Now, our biggest question is about the SaaSpocalypse, and we had a couple people write in specifically about a couple companies, but I wanted to hit this one first because this one just absolutely tugged at my heartstrings because it's an esoteric balance sheet question. And it comes from Shannon. And the question is, Starbucks and Domino's Pizza currently have negative stockholder equity. Would you please address how an investor might interpret negative stockholder equity in a company and whether it's a sign of poor capital allocation? Guys,

Starting point is 00:20:58 I think I'm in love, but just give me a minute for here. And I'm going to explain this because this is kind of like wonky balance sheet stuff that I love to get into. So you can basically have negative equity for two reasons. You can lose money over time and have negative retained earnings. You have, you know, unprofitable companies for a long time, but you can also have negative retained earnings if a negative equity, if for example, you buy a company buys back a lot of its stock or it pays a generous dividend because dividends are not retained earnings and bought back stock is called treasury stock and it goes against the earnings of a company. So if you buy back more stock than you earn and retain in earnings, you can actually

Starting point is 00:21:41 dwindle down the equity in the company to the point of zero. As you mentioned, Domino's is a version of this and Starbucks is a version of this. And there's several other companies too. I think it's either Moody's or MSCI, both companies that have negative shareholder equity because they've done so much to reward shareholders with buybacks and dividends that they don't have shareholder equity anymore. So when you see this, you have to look at it as whether or not the company is doing it because they're unprofitable or because they're throwing a bunch of cash back to its investors. In this case, I would say, at least in Domino's and Starbucks' case, over time, it's been good capital allocation because they have been able to enhance shareholder returns

Starting point is 00:22:25 through buybacks and dividends to knock down the equity. So I hope that answers your question. I saw this question and I was like, I have to answer this one by myself. I'm sorry that I made you guys sit through that, but this was absolutely what I wanted to hit. But for you guys, we had a couple, this was basically an aggregation of about four or five different questions about SaaSpocalypse hitting software companies. And we had Daniel S ask specifically about Salesforce and Laura M asked specifically about Wix. I'm going to let you guys pick which one you want to discuss in relation to the SaaSpocalypse. John, you go first. Yeah, I picked Wix here, Tyler, and this is a online website building kind of a company, e-commerce, if you wanted to build your own

Starting point is 00:23:12 platform. I do believe that there is trouble coming for many software companies because of the capabilities of AI and just how fast they are accelerating, I wouldn't necessarily lump Wix in with that crowd personally. And here's why. If you're a software customer, you're asking, why am I paying for this when there is AI tooling out there? So why do I need this? And in the case of Wix, yes, it does offer software. And some of that could theoretically be replaced with AI, but there are other things that Wix offers, and I would lump GoDaddy in with this crowd as well. When you look at web domain hosting and you look at memory, these are things that you may need if you're building a website or building an e-commerce business, and Wix offers

Starting point is 00:24:03 those things. So I don't think that you're going to abandon Wix for an AI tool because of the things that you get from Wix that you really do need and that AI doesn't necessarily replace today. And in fact, I believe that AI can be additive for a business such as Wix because they can provide now AI enhancements to what they already offer, especially with like website design. You can just bolt on some AI and we can potentially get easier to develop websites and flashier and more like what you want. So I think that's a net positive in the end. now there are other concerns i have with wix in particular free cash flow i don't like how they backed out some corporate headquarter build out to their calculation of free cash flow i don't like that they tout that they're repurchasing shares and the share count is still going up i have other issues and i own this and i may consider selling it at some point in the future for those reasons but i'm not concerned about the ai taking over this business component of the what

Starting point is 00:25:06 what a lot of people are scared of here with Wix. I chose Salesforce, and it's a stock that I'm a little bit more on the fence about when it comes to AI disruption than John is with Wix. So it's certainly a stock that investors seem to be concerned about. For Salesforce to move down 35% from its 52-week high, as far as tech stocks go, it's generally a low volatility name, so that's a really big move. There are solid bull and bear cases to be made when it comes to AI disrupting Salesforce's business. I mean, on one hand, the company is still growing the top line by double digits, not by much, but 10% is still double digit growth and generating really strong cash flow. Plus the AI related metrics have all been moving in the right direction.

Starting point is 00:25:46 Annual recurring revenue from the agent force platform is now $800 million. Not a giant part of its revenue yet, but up 170% year over year. Plus, and this is probably the most interesting statistic, over 60% of agent force and data 360 bookings in the most recent quarter came from Salesforce's existing customers, not from outside of the ecosystem. So that indicates that it's using AI to expand its customer relationships. It's not losing customers and churning them. So on the other hand, the CRM business is growing at a pretty slow, just a single digit rate. And it remains to be seen if the headwinds are going to be more powerful than the AI tailwinds. Because like I mentioned, the AI part of the business is growing nice, but it's still a small

Starting point is 00:26:34 part. Management seems confident with an accelerated $25 billion buyback, but I'm going to channel my inner Tyler Crowe here and say that that also says that they can't find anything better to do with $25 billion than just buy back their own stock, which for a tech company that's supposed to be fast growing and leaning into AI is also kind of a little bit of a concern. So this is a long way to say that I think Salesforce will be relatively unscathed by the AI headwinds over the next few years. But beyond that, there are legitimate questions. Yeah, it seems like with a lot of software companies, it's like, oh, AI is killing us, when sometimes it might actually be something that's not AI related. That's the actual problem

Starting point is 00:27:14 here. Potentially, that's what's going on with Wix and Salesforce today. And that's why we see their stocks way down. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks for producer Dan Boyd and the rest of The Motley Fool team. For John, Matt, and myself, thanks for listening, and we'll chat again soon.

Starting point is 00:27:50 you

Motley Fool Hidden Gems Investing - 1 Chip Stock Making Bold Plans

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