Motley Fool Hidden Gems Investing - A Golf Clap for Google

Episode Date: October 30, 2024

The company’s cloud segment just got A LOT more efficient. (00:21) Tim Beyers and Mary Long discuss: - The transition from “search engines” to “answer engines.” - Google’s fast-improving position within the cloud computing market. - Lessons learned from SuperMicro’s steep rise and sharp fall. Then, (16:14) Ricky Mulvey and Bill Mann take a look at retail cycles and an investment idea that came about from coat shopping. Learn more about the Range Rover Sport at www.landroverusa.com Companies discussed: GOOG, GOOGL, MSFT, AMZN, SMCI, FRCOY, IDEXY, HNNMY, COST, NKE Host: Mary Long Guests: Tim Beyers, Bill Mann, Ricky Mulvey Engineers: Rick Engdahl, Desiree Jones Learn more about your ad choices. Visit megaphone.fm/adchoices

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Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. Is it a dumpster fire or a buying opportunity? You're listening to Motley Fool Money. I'm Mary Long, joined on this fine Wednesday morning by a Mr. Tim Byers. Tim, how you doing? Partially caffeinated.

Ready to go, Mary. You're partially caffeinated. I will admit that I am fully caffeinated. So together, hopefully, we're going to bring the energy this morning. There we go. Um, so let's get right to it. Alphabet. We got lots of big earnings coming this week. The first of the hyperscalers reported yesterday after the bell. Again, that's Alphabet boasting beats across the board, revenue up with gains across all business segments. This is a $2

trillion company. Growing revenue by 15%, all things considered, is pretty significant. Operating margins also improved. Like so many of its peers, Google has faced scrutiny for spending a boatload of money on AI. Are these results, Tim, an indicator that that AI spend is starting to pay off? It's way too early to say that, Mary. But it is clear that the push for AI buildout is well underway. You put in the notes before the show that CapEx was up 62% versus the same period last year. Last quarter, I believe it was up 90%. So they're just spending a boatload of cash to build out their AI capabilities, and they need to. Google does stand to benefit most from the shift from search engines to answer engines. We know that this is a thing. OpenAI wants to move the

industry to what we're calling answer engines. I'll just define that briefly, Mary. An answer engine is what we think of as a generative AI. Instead of me searching for a keyword, So like, let's say you are searching for like veterinary care. So you'll put into Google the keywords like local veterinarians or veterinary care or high rated veterinarians, like keywords. That's what you're looking for. And answer engine is find me a, you know, the highest rated veterinarian in my area And my zip code is, and you'll put that in and an answer engine would say, there are three, you know, veterinarians within the zip code that you cited that have a score of blank according to blankety blank.

And like the, sorry there, I tipped my mic over a little bit for, you know, listeners couldn't see that. I'm sure it was hilarious. But the idea here with an answer engine is that you're going to ask a very direct question and you will get a very direct answer instead of using keywords to get a number of results and then you decide what path you want to take to get the answer that you are looking for. It's very different. And so generative AI has brought us to this point. OpenAI absolutely wants to have answer engines. In order to get there and be there first, Google needs to invest heavily. It explains the CapEx spending. I think the growth that we're seeing is just proof that the core business isn't going away anytime soon here, Mary.

Google has no choice but to invest, but the core business is still pretty solid. I do want to zoom in on the state of Google's advertising business, but before we do, I have perhaps a cynical question for you. As Google and other, as the industry transitions from this search engine to answer engine, is it just the high, is it that, whichever veterinary, to continue with your example, is it whichever vet spends the most money on advertising that rises up to the top of that? Or are these machines actually taking into account the input that a searcher is asking them to? Well, today it's the input. Tomorrow, when answer engines have an ad business attached to them, it might be the former. Certainly today,

google is going to show you the top advertised result it's going to show you the promoted result i think we know for sure because all of them are getting into this the you know answer engines are coming search gpt is open ai's answer engine gemini is google's answer engine and we know that ads are coming to those they will be different it's very likely that you'll have something that doesn't just say the top answer is the one that pays the most money, but you might be paying for precision. Let me give you an example. You ask a question of the generative AI, give me the top three veterinarians in zip code blank, whatever it is. You get those top three, and it tells you how it ranked them according to some, you know, metric that it found in generating

its answer. And then you say, okay, do any of these specialize in, you know, cats? You know, yes. So, you know, two of them specialize in cats. Okay. Do any have experience? And let's say there's, you know, let's say you have a senior, you know, cat that has a condition. Does any of them have specialties or experience with X? And they'll say, in fact, let us introduce you. And now you have not just the three, now you have an ad that pops up and says, can we introduce you to our partner who has a specialty in dealing with senior pets? Let's say totally different one came out of the blue, but it's an ad and it's a sponsored ad because you triggered something in your questioning inside of the generative AI. So when you were getting closer to the true

answer you were seeking, that triggers an ad. We've also got revenue from the Google Cloud segment up 35% compared to last year. Management attributed these strong results to its artificial intelligence offerings. Still, Google's cloud business takes bronze to Microsoft's Azure cloud and to market leader, Amazon Web Services. As of last quarter, Google had about 12% of market share, Microsoft 23, Amazon 32. All of these companies, as we've talked about so much on this show, are spending gobs of money on AI infrastructure. With all that in mind, I have two questions for you. One, how much do those rankings that I just listed of market share, how much do those actually matter? And two, is the way to the top of those rankings simply to outspend?

I don't think they matter that much. Not in particular, because I think a lot of the three major cloud infrastructure providers provide a lot of the same tooling. So customers are going to go shopping into those environments. Some of them will make big commitments to one of those platforms. I think that's going to be the rarity though, Mary, I think price feature set, you know, um, familiarity with the environment are going to have a much bigger, uh, set of determining factors of which you use. So, um, yeah, I don't think it's, I don't think it's a huge, um, determinant having said that, boy, could we just take a second to give a golf clap to Google Cloud. My goodness, man, you are right. I mean, spending makes a huge difference. And in this

particular case, Google Cloud was nowhere. I mean, they really were nowhere just a few years ago. But today, GCP is up in the double digits in terms of market share. That's extraordinary. Not only that, I mean, you mentioned earlier, Mary, that operating margins were up. I give some credit to Google Cloud for helping push those operating margins because the operating margin for Google Cloud in the quarter was 17%. That's up for 3% year over year. That's pretty good. That's pretty good. And on that, I want to pivot to a totally separate story that you wanted to be sure to hit on today. Bit of a different tone than what we've discussed with with google's news uh we've got super micro computer which makes storage solutions for

data centers this is a stock that has been on a wild ride over the past year uh the company joined the s&p 500 in march and shares have surged nearly 250 percent in 2023 alone that said in late august hindenburg research revealed a short position in the company yeah they alleged accounting manipulation. Today, the stock is down over 30% last I checked on the news that its auditor, Ernst & Young, resigned from the job. Why is EI out, Tim? Because they have said, and I can't really quote this here. I'll see if I can pull it up. But the resignation letter essentially says we can't trust what we are hearing. Specifically, they said we are no longer able to rely on management's and the audit committee's representations of these financial statements.

And they are unwilling to be associated with these results. In other words, what they are saying, Mary, in so many words is, yeah, Hindenburg is right. I mean, they're not saying that explicitly, but they are saying it implicitly that these numbers are not trustworthy. And key to Hindenburg's thesis is that these numbers are not trustworthy. And EY has just kind of confirmed that. That is horrible. That is absolutely horrible. um can we just please give a warning here if you are one of those daredevil investors think who

you know down 30 this must be an amazing buying opportunity no no no this is not the fire that you run into this is the fire you run away and you warn every neighbor in the neighborhood to stay away from this thing and you start a bucket brigade or you call the fire department and you get out of here like no this is stay as far away from this one as you possibly can i i just i hate this for people who who speculated on this stock on the belief that it had some real ai tailwinds we could talk about that but it was a company that did have some ai tailwinds yeah so i mean we've talked about how so many massive companies are pouring so much money into AI. That is obviously a buzzword. That's a huge growing industry that many, many folks are incredibly

bullish about. Supermicro had an AI business. I'm going to intentionally use the past tense there to just underline the dumpster fire point that you already made. Had an AI business. It's one thing to now see and hear this news of EY and to see the short report, but at the time, if you were an investor that was thinking of this as an AI company that maybe some people early on were paying less attention to than bigger names like NVIDIA, you could be forgiven for saying, oh, an AI company, great, shiny, awesome. What does this kind of teach us about how you discern between companies that are riding popular tailwinds? It's a hard one. I want to give credit to Tom Gardner. I mean, huge credit to Tom Gardner because in April, he and the team at AI Playbook put

out an alert, not something that we typically do, but Tom decided to do it because it is a company that was so embedded with AI and said, here's why this company that you would think belongs in this portfolio on this scorecard is not going to be part of this scorecard. And one of the things he noted and the team noted in their report was governance issues. And so you asked, how do you sort of suss this out? Or when do you start looking for things like warning signs? I will tell you that when Kirsten and I put this into Interconnected Opportunities, which is now Trends, it was on the Trends scorecard. And it was just a massive winner for six months. And then we sold it because the valuation had just gone, it had gone parabolic

and it made no sense anymore. There was no reason to keep it, so we decided to sell out of it. We didn't have any hints, none whatsoever, as to what's happening now. What Tom said, though, was like, hey, you know what? There's a board member that looks at it as a member of the audit committee who looks like is stepping down. That's a yellow flag. Then there were other things that noted in this report and when the yellow flags start to add up a little bit they start you know turning from yellow to orange and fairly quickly into red and you want to be careful and i think that's why i want to give tom so much credit here is like you have to look at the kind of the spectrum of signals you can get because you can't know about this mary you know

David Meyer in one of our internal chats made this point, and he's right about this. There's no way to know about this unless you're an insider at the company, and none of us are insiders. So all you can do is look at the signal. So a board member steps down, particularly a member of, say, like the audit committee, which is overseeing governance of the company. Maybe there's a delay in financial filings, or some numbers don't look quite right, or you see an unusual amount of growth that just came out of nowhere, be thoughtful and willing to ask very tough questions about every position you hold. In this particular case, big credit to Tom for looking at a company, asking some questions and saying,

I don't have answers here. I'm not willing to buy. I think that is a very good lesson for fools. Unfortunately, a pretty heartbreaking one here. Hard questions often lead to pretty good answers. Tim Byers, thanks so much for the time and the insight on this one. Always appreciate having you on the show. Thanks, Mary. What does a clothing company have in common with Costco? Up next, Bill Mann joins Ricky Mulvey for a look at Fast Retailing, a Japanese company that owns the clothing brand Uniqlo.

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basically looking to sell good quality basic stuff at reasonable prices. You can get a decent graphic t-shirt for like 25 bucks, down winter coats for 160 bucks. And this was interesting to me because I go to the Nike store right across the street. That place is significantly less crowded, less busy. I know this is the beginning of the journey and a lot of people get stock ideas this way. But after an experience like this, what should I do before whether or not I decide to buy any stock in this fast retailing things what are the next steps in my lynchian journey uh well done ricky discovering a business that's been uh that's existed since 1972 first of all thank you you did it this is part of your lynching journey is to find a business that's 52 years old have i told

you about this song called boogie on reggae woman i heard it a few weeks ago it's pretty sweet man so uh yeah uniclo is run by a guy was founded by a guy named tadashi yanai who took over his father's basically uh tailoring shop and had a you know and decided that he was going to turn this into a thing i guess i mean maybe that's the that's the the technical term he just saw an opportunity to produce high quality, low cost goods. And so he did it throughout Japan. It is one of the largest businesses in Japan, and came over to the US and has gone to Europe, you know, late 90s, early 2000s. And yeah, they have brought a type of business and a business model and a back end that's really differentiated from almost every other type of business. And it really has to

do with the incredibly unique nature of Tadashi and I as a manager and as a founder. You got to my second step, which is that I realized I might be about 15 years too late to this party. I go through and I'm amazed by... You go into a Uniqlo now, the way they do a checkout is you just put all of your things in this basket and it automatically scans. No person, no scanner, no nothing. And I'm like, this place is absolutely the future. And then I look at the stock chart. And I think that a lot of investors have have thought this before me. I know you've been following you've been following this company for a while. What originally got you interested in fast retailing? So, you know, obviously, I've taken a very long interest in Japan. And one of

my favorite things is to find play a game basically called one of these things is not like the other. So you had a 30-year period of time in which Japan really wasn't doing very much. The market wasn't growing. The economy wasn't growing. And you had this clothing store called Fast Retailing in Uniqlo that was growing like wildfire, both out on the street and in the stock market. So, you know, instantly I said, huh. And Tadashi and I, a very, very unique CEO, he has a book, his autobiography from 2003 is titled One Win and Nine Losses. He is someone who is absolutely geared towards taking risks and having failures and moving on. So that to me was an incredibly interesting thing to come out of a Japan at the time that almost seemed terrified of failure. So really, I was betting the jockey. Yeah, I was watching some YouTube videos of him before we started recording. One thing I appreciated about him, so this company is often lumped in with H&M and Zara, which is fast fashion. And I think he makes a really good distinction about what they do differently, which is they're not introducing a ton of new styles. And also, he basically said, we put sustainability before scaling. And the way we actually do that is we make our clothing. And we're not only just offshoring our production facilities or production, we're making our own stuff. And sustainability is important versus saying sustainability is important. And we look at our manufacturers a little bit.

Yeah, and it's a really interesting point. One of the ways in which they are differentiating themselves is not just sustainability, because that's a really important thing. And I feel like we're kind of talking down to H&M and to Zara and their process. The Zara parent company is called Inditex. it's a choice that they're making but in the case of in the case of uniclo he saw those much more high input materials as being something that you know in some ways he was giving to society doing it as cheaply as possible but things that aren't going to end up in a landfill after three or four uses i know you've been following this company for a while i want to look at fast retailing's latest year? Because I just started looking at it, Bill. It's a new company. That's fine. It's a new company to me. The warm discovery of Peter Lynch investing, sometimes people find out about this stuff before. I'm seeing a mature company that's growing a little bit and getting

a lot a bit more efficient. So what's growing a little bit? Revenue is up about 12%, increasing store count by about 3%. Same store sales getting a little better with that. But then you see something like the operating profit, which is up more than 30% in just one year, revenue up a little, efficiency up a lot. What are you seeing in fast retailing in 2024? Well, I'm seeing exactly what you saw in New York. And basically, I feel like this segment was all just about a flex for you being able to say that you've been hanging out in Manhattan. Let me just say that. For a day? Look, man, you get the flex. You don't take any weekend. I took a weekend trip. You get the flexes where you can. That's all I'm saying.

Okay. I've taken weekend trips to Cincinnati. Yeah. Well, think about this, though. You've just talked about exactly what attracted you to Uniqlo was that process for the checkout. I mean, just because they use high-end materials doesn't mean that they aren't rabid about pulling unnecessary costs out of their system. This company, if you want me to describe a company that I think is actually the best proxy for fast retailing, it's Costco. This is Costco because Tadashi and I years ago said, you know what? One of the problems in Japan is that we have a moribund economy and we are impacting our workers by not paying them very much. And so Uniqlo raised salaries by 40% for all of its employees.

What do you think happens when you pay your employees more than they can make elsewhere? They stay. They're loyal. They do their best. These things are – you would think it would be otherwise, right, that you pay as little as possible. But companies like Costco and companies like Fast Retailing make more money because of the happy fingers of their employees. I firmly believe that. And they're also not losing people to attrition.

You know, I need like a hand signal when you're doing a rhetorical question, Bill. That way I know not to jump in. You should just go ahead and jump in. They're all rhetorical, Ricky. I got some weirdness. So here's some weirdness. Fast Retailing trades on the Nikkei. And earlier this year, there's something like, it's almost like the stock has done too well.

So earlier this year, the Nikkei said that it was going to apply what they called a capping ratio to the company. This sounds technical. Maybe there's something interesting here. What does this mean? What's going on between the Nikkei and fast retailing? What you have to keep in mind is sitting here in the United States, we happen to have the most diverse economy in the world, which, you know, so you've got the S&P 500, which does a reasonable job of measuring an incredibly diverse set of companies. Most countries, even huge economies like Japan, don't necessarily have this same level of diversity. So they want to make sure that one company doesn't make the index move too much. So they put a cap on how much

it is valued in the market. So for the Nikkei 225, no company could be more than 10% of the market cap. And so fast retailing has done very well. So they put a cap on it. Maybe the best example of this, Ricky, and I know you didn't ask me this question, is in the early 2000s when uh nokia was about 75 of the market cap of the finnish stock market because it was valued so much versus every other company in the country so i like hearing that it's the costco of fashion that sounds great but one thing that sort of uh off put me was almost the the past price appreciation for a company like this because it is a fashion company and you know maybe it's even though it's selling basics, maybe it's a cyclical. And I'm going to throw a quote to you from one up

on Wall Street, quote, you can lose more than 50% of your investment very quickly if you buy cyclicals in the wrong part of the cycle. And it may be years before you see another upswing. Cyclicals are the most misunderstood of all of the types of stocks. It is here that the unwary stock picker is most easily parted from his money and in stocks that he considers safe. End quote. Are we counting fast retailing is is a cyclical here does it matter we should but i guess this is where we talk about my huge mistake with fast retailing which is i owned it a long time ago and sold it after fat uniclo came into the u.s and they opened first in new jersey and they had a couple of stores and they failed and i failed to think about what yanai had said which is we're going to take

risks and and a lot of them are going to fail and then we're going to take additional risks you don't have to if you like a company and you think that they are unique and i would say that this company is definitely that you don't have to put all of your money in at once right if you're worried about a cycle fast retailing is trading at a pe of more than 40 right now and for a retailer especially one the size that they are that's a lot but if you want to talk about any company in this space that could surprise you on the upside like doing something that you did not expect that makes that multiple seem cheap. I think it's this company and it's this manager. A company that's not really a direct competitor, but plays in the same space. It was the store I

went to right after I went to Uniqlo was Nike. And this is a cyclical company. And right now, it's definitely in a down part of the cycle with a CEO change. You have a veteran coming in, Elliot Hill, who is telling investors the sweet stories that they want to hear. This company is going to repair relationships with retail partners. We're going to get a little more focused. And I like to think that a comeback story makes a lot of sense. And this is one, Bill, where I actually am. I don't own shares right now, but I am considering playing a cyclical game here. And I think a lot of investors are who are following the story. What do you think about that? How about you on that? I think the great thing about Nike

right now is that they have done minimal damage to their brand right like everything that's happened at nike seems to be happening upstream they've had problems with suppliers they've had problems with you know not not necessarily any products like tanking just failing to to take off they have a lot of little screws that they could turn i would be much more worried if they had damaged their brand than you know and then where they sit right now so i think it's a reasonable uh it's a reasonable bet that elliot hill will be able to turn it around i guess the flip side of that though is that all of these relationships these things will take a lot of time you're not talking about hey i'm going to turn red into blue and suddenly it's going to

work awesome. So Nike's got a lot of work in front of it. But the good news is that the Nike brand and that swoosh still retains a huge amount of value. Oh, man, appreciate you being here. Thanks for your time and your insight. Thanks. 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 are not approved by advertisers.

We only pick products that we personally recommend to friends like you. I'm Mary Long. Thanks for listening. We'll see you tomorrow.