Motley Fool Hidden Gems Investing - Nvidia Booms

Episode Date: May 25, 2023

The graphics processing maker became $200 billion more valuable in a single day. (00:21) Jim Gillies and Ricky Mulvey discuss:  - Nvidia’s blockbuster quarter and valuation questions to consider.  - The history of tech cycles and lessons for investors.  - If Best Buy needs sales growth to reward shareholders. Plus, (16:21) Tim Beyers and Meilin Quinn interview Digital Ocean CEO Yancey Spruill about how the cloud service provider differentiates itself from competitors like Microsoft and Amazon. Companies discussed: NVDA, BBY, QCOM, CSCO, INTC, MSFT, DOCN, AMZN Host: Ricky Mulvey Guests: Jim Gillies, Yancey Spruill, Meilin Quinn, Tim Beyers Engineers: Dan Boyd, Heather Horton Stock Advisor Roundtable podcast: https://open.spotify.com/episode/0RhY5qYNv1l2AyS4g8LV1d?si=ded6d6d1cdda46cb Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. NVIDIA grows by more than $200 billion, all in a day's work. You're listening to Motley Fool Money. I'm Ricky Mulvey. Joining us now is former NVIDIA shareholder, Jim Gillies. Good to see you on this day of all days. You're going to stick the knife in right to start, are you, Ricky? Okay. I think you got some knives to stab back. This morning, investors cheered NVIDIA's place in the AI race. NVIDIA builds graphic processors, and the company made $7 billion this quarter. But analysts really liked the guidance. NVIDIA expects an extra $4 billion in sales next quarter.

Jim, what went through your mind when you saw that the stock gained a full McDonald's today? Yeah, I should clarify a couple of things. One, I think I sold my shares in 2010, so it's been a while. And they were part of an option strategy that doesn't look too good now, but I did lack a crystal ball at the time and still lack one today. And also, too, is it NVIDIA or NVIDIA? Maybe it's a Canadian thing. I've always called it NVIDIA. But anyway. NVIDIA. I've heard both. I'm kind of curious. But yes, what went through my head? It's a fantastic quarter, really was. I am not much of a tech investor, as I think a lot of people know. I think most tech,

there's facets of a lot of business models that make it difficult to pick long-term winners. I sound kind of Berkshire-esque, I think, on that one. It's not that I'm opposed to owning some, but I think that there's also some valuation concerns that sometimes come to play, and I would suggest sometimes is with us with Nvidia today, I don't think I've ever seen a guidance revision or guidance update like they gave for their Q2, where I think analysts were broadly expecting the mid-$7 billion in revenue. And as you say, they were saying, oh, no, we're going to do $11 billion, we're going to add $4 billion to that. And of course, the stock is up about 30%, I think, this morning. And that's great. It really is great. But my take on that is, look,

Nvidia, fantastic quarter, fantastic company. I think the Longs, people who own it, should rejoice today. I think it's really great. But just be cognizant of what today's price, and I did this work before the market opened, so it might be slightly different, but it's roughly right. Before last night's meet or beat and raise, NVIDIA was already trading at 39 times sales and about 20 times EBITDA. Incorporating in last night's results for cash generation, it's trading for about 190 times the last four quarters, including last night, the last four quarters free cash flow. What that means is, if Nvidia started today, with this little thought experiment, started today to pay out, say, we are going to have a dividend policy of paying out 100% of free

cash flow. Remember, free cash flow is the money that's left over after the company has paid all of its bills, made all of its capital expenditure choices. This is money that it has, in theory, to pay out as dividends, buy back stock, make acquisitions, pay down debt, make additional growth-oriented CapEx things. There's not many more things you can do with free cash flow. But assume that Nvidia wanted to pay out 100% of its free cash flow, it would take you two centuries, basically, to get your money back. I don't like your chances of making it to the end. Now, of course, the big glaring thing that I'm omitting there is the potential for growth, and that is why people are willing to pay 190X free cash flow for this one. I very much think

two things are true. One, Nvidia is not about to start paying out 100% of its free cash flow, that's just as a construct. The second thing is, I'm reasonably sure there will be some growth here. I think the open question is, how much growth? Because the way that investors are pricing this thing, they are pricing it to be a multi-trillion dollar company in the not-too-distant future. It could get to a trillion this week, frankly, on market cap basis. Do you want me to go down? I could go down a little bit of a history lesson here. Let's go down the history lesson of tech adoption cycles. I'm rocking with NVIDIA, I do think we can occasionally learn a couple of lessons from history, and especially maybe

the boom of the early .com and internet cycles for a lot of those tech companies. Right. I've looked at the last couple of years of COVID, COVID craziness, the rise of SaaS, the rise of AI, the rise of a lot of these tech things. I've said, history doesn't repeat, but it does rhyme kind of thing. I thought the last few years have been not dissimilar to the tech bubble and the tech wreck of, say, circa 1997 through 2002, which I had the fortune or misfortune, depending on your point of view, to invest through. I was a young investor, so I think I learned a few things. I hope I learned a few things through that experience. My framework today is, I've looked at these things as, I call it the tech

bubble stocks, there's four categories. The garbage, that went to zero, ignore it. The stuff that was fine, it was fine. But a lot of the stuff that was fine, because it was only mediocre and fine, it got to such ridiculous valuations. Today, it's down 80% from all-time peaks, or it took so long to climb back. The third category is my most interesting, why I spent the most time, it's called the generals, the guys that were setting the tone for that era. The companies that you couldn't miss, fantastic companies, and they're all by and large good companies. But it was a valuation thing. The four I like to call the Four Horsemen are Intel, Cisco, Microsoft, and Qualcomm. Intel and Microsoft basically owned PCs,

which was the hot tech trend of the day. I suppose you could throw Dell in there as well, but let's talk Intel and Microsoft. In everyone, Intel today is down 60% from its all-time high, set 23 years ago, and that is after bringing out a dividend, raising it every year, buying back about 40% of their stock, never recovered. Cisco, which was the router king with some new thing called the internet, is going to take over all facets of our lives. Cisco, down about 40% from its all-time high, never recovered. Again, same drill, raise the dividend annually, buy back 40% of the stock, the long-term shareholder from there is still down. Microsoft was dead money for 16, 15, 16 years, really only has recovered because of Satya Nadella taking the reins

of the company and going in a different direction. They're the gold standard of the big four generals that I talk about, whereas they have returned about 7.4% annualized before dividends since their peak in 2000, which is fine, but you could have got that with less risk by buying an index fund. And the fourth one is Qualcomm, who had a royalty on every new mobile phone sold at that time. Qualcomm has given a non-dividend adjusted return of about 15% since 2000. Not 15% annually, Ricky, 15% total. So, that's category three, the general. So, the garbage, the fine, the generals. And then the fourth category, I call it, is Amazon, which has, of course, been its own thing. I think it's very safe to say NVIDIA is not

bucket one or two. It's not garbage, obviously. It's not fine, obviously. I hold that they are a general. Then the question becomes, where in this cycle are we buying Nvidia today? Because I lack the ability to go back and buy it at last week's prices. Maybe there are some time travelers out there at which point call me, but I don't have it. I think it's a bucket three. I think it's a general. Where are we buying it? If we're buying the general in, say, early 98, late 97, that's much better. But are we buying it at the $99,000-$2,000 peak? That is problematic. I think we're buying a general earlier in the cycle, but that valuation, just be aware, fools, if you're going to be buying NVIDIA today after

what was a really, really spectacular quarter, be prepared to put it away for five years. don't look at it, don't put 20% of your portfolio into it. Take the time to say, okay, I am buying this high-quality company for the long-term, and I'm not going to get spooked if margin compression, say, takes us down 50% in a year or two. I'm here for additional gains. And also recognize the limitations of large-number investing. As I said, Ricky, this is probably going to be about a trillion-dollar company or trillion-dollar market cap by the end of the week. It looks like if it triples from here, it's the largest company in the world. I don't like those odds very much, but others' mileage may vary.

Yeah. I think this is also, for me at least, a somewhat difficult company to understand. NVIDIA expects a lot of their growth to come from data center usage with those large language models and generative AI. Those are the words. I still think that a lot of the business is incredibly technically complex, at least for me. This makes me put it in the too hard bucket, at least for me, Jim. Let's move on to the complete opposite end of the spectrum to a more, I would say, Jim Gillies company, and that is Best Buy, a retail electronics store where shoppers are slowing down on big-ticket purchases. We've seen this at Walmart, Home Depot, Target as well this quarter. For Best Buy, comparable sales growth is down 10% from

last year, but management affirmed full-year sales guidance of about $44-ish billion. What were your big takeaways from Best Buy's quarter? I'm a little hurt. I'm going to point out, I did own NVIDIA at one point. I've never owned, to my knowledge, Best Buy. It was a Jim Gillies company. But no, I think the through line I would give you from NVIDIA to Best Buy here today is this idea that companies should know what they are, and investors should kind of buy into knowing what companies are. And so, the Best Buy quarter, it was perfectly decent given what this company is. They beat expectations, which were low, because of course, the world's slowest-moving recession has been giving so much fear to people for at least

the last, what, four to six quarters now. There's, of course, also the long-standing general fear of Best Buy being Amazon's showroom and unnecessary in the present era of retail. They did affirm their outlook for the year, but they also mentioned that they are seeing inflation hitting household budgets by, as you mentioned, buying less electronics and what have you. Here's the thing about Best Buy that I look at, though. They bottomed about a decade ago. They bottomed about $12 coming into 2013, meaning they have been about a six-bagger since they bottomed a decade ago. That's before dividends, if you assume dividend adjustments, closer to an eight-bagger. It bottomed because of the perceptions that we have today, that is,

Amazon showroom, unnecessary, they sell commodity goods that we can buy practically anywhere. And yet, Ricky, over the past decade, Best Buy has produced just over $17 billion in cumulative free cash flow. They spent about $4.6 billion of that on their annual dividend, which they have tripled the cumulative payout over the decade. Dividend per share has gone from $0.68 a year to $3.68 a year, that's a 5.2% yield today. They spent $10.3 billion in buybacks over the last decade, shrinking the share count by 36%. They spent another $1.4 billion in acquisitions. We'll assume those have been intelligent acquisitions, may or may not be reasonable. The rest of the cash is piled up on the balance sheet such that you have a balance sheet with nearly $1 billion

in net cash today versus a balance sheet a decade ago with net debt of about half $1 billion. dollars. And what debt they do carry is relatively long-term and low-cost. So, what I talk about, know what companies are, understand what they are, I look at Best Buy as basically a no-growth perpetuity-like cash cow. Revenue last year was about $46 and change billion. Revenue a decade ago was just under $42 billion. That's about 1% growth, so I think my low growth assertion is fairly valid. But management teams have recognized that the value for this business is as a cash cow and not as a growth engine, so they've managed it as a cash cow, and that's how you've gotten market-smashing superior returns from Best Buy over the past decade out of all companies.

Can that continue? I believe management will probably try. Again, they've done about $17 billion over the past decade in free cash flow, call that averaging $1.7 billion a year. If they could do $1.5 billion a year, the current valuation is 10X that cash flow. You're going to get your 5%, 5.2% dividend yield. With the combination of increasing dividends, because again, they've raised it every year practically and done a good job. They've grown it 18% annualized, the dividend that is, over the past decade, plus maybe taking down 3% or 4% of the shares per year, which is, again, what they've been doing for the past decade. I think that probably gets you north of a 10% total return annualized from here. Now, is that good enough,

or is it just easier to go indexing? That's for investors to decide. But I will point out, I followed the Best Buy story for a while, in spite of never owning it. And look, if you were taking bets a decade ago that Best Buy would be a six-bagger before dividends over the next decade, I'm reasonably certain you would not have gotten many takers. Because again, the story was, Amazon showroom, it's unnecessary, fails the snap test, as David Gardner would say. And I hold that that can still be a beautiful setup if you understand what you're buying. And with Best Buy too, I think Corey Berry pointed out in the quarter, which I found, which I appreciated, is that the demand drivers are still there. Yes, people are spending less

on big ticket items, but all of those laptops and TVs that people purchased over the pandemic, those get replaced every three to seven years and your Best Buy showroom will be there for you. Exactly. Jim Gillies, always appreciate it. Thank you for your time and your insight. Thank you for the invite, Ricky. Before our next segment, got a heads up for Stock Advisor members, a new episode of our premium podcast, Stock Advisor Roundtable, just dropped on Spotify. Tom Gardner and the team talk about managing risk and some mid-cap companies that they believe

have a bright future. Check out the show description for a link. Next up on this show, we've got some more tech talk. DigitalOcean is a cloud services provider that focuses on developers and small to mid-sized businesses. But is it doing anything differently than Microsoft Azure or Amazon Web Services? Motley Fool analysts Tim Byers and Malin Quinn caught up with DigitalOcean CEO Yancy Sproul to find out how it's retaining larger customers and standing out in a hyper-competitive landscape. Yancy Sproul Here's what I want to get to, because you're certainly known for simplicity, And that is interesting. I want to get to some of the things you're doing as you scale up. But

before we get there, can we talk about how you get those larger customers? I'm just looking at the release here. And what you said, let me make sure I have this right. But the percentage of customers who are spending at least $50 a month. Is that now 43%? Yes, 43% of what you call builders and scalers, customers spending more than $50 per month. That increased 43% from the first quarter of 2022, and their revenue is up 32% year over year. What are you doing to get people to stick with DigitalOcean instead of getting to a certain size and then say, I'm ready to graduate to AWS? So it's really important that we were built day one to serve the idea generator who wants to launch that into a business. And what we've learned over time is adding features and

functionalities, layering support, supports customers on their journey. We've also learned some things about product. You know, one size fits all, as you said, with the container does start to run out as customers grow beyond $50, $250, $500 with the scalers. And the reason we launched a premium dedicated droplet is precisely that reason. We learned that for bandwidth intensive use cases like media or streaming businesses, they need a different configuration than a standard amount of compute network and storage to the relationship that we have conventionally. And so we tailored that for that business. So how we've been able to scale with customers over time is we're tailoring the capabilities. We've added load balancers. We've

added other bandwidth products. We've added other variants of Droplet that does flex to a scaling need. We've added databases. Once you go from X number of customers to Y, you can't use a whiteboard anymore as a startup to talk about your customers. You need a sophisticated tool to use digital tools. And so you need a managed database. Once you go from one or two engineers writing all the code to 10, 20, 30, you need different software deployment models. Kubernetes, serverless are helping with that. So we've added capabilities over time so that as a two-person startup goes to a 10 or 20 or 50 or 100 or in some cases hundreds of employees we have on our platform you know as your number of employees grows your workflow increase gets more complex

software helps to make that less complex so we have more tools that i just cited we also have a marketplace and then it in the same with your customers as your customers grow you need other tools on the compute side, on the infrastructure side. So we've been able to scale that. So we've made it such that if you looked at our largest customer today, started as a handful of people around a computer terminal in 2014, spending $10, $12 a month. And now that's nearly a $200 million revenue business with hundreds of employees. Cloudways, who we bought last year was a customer started in 2014 at 10 bucks a month and uh you know grew to spending with us a million bucks a month when we their last invoice when we acquired them last summer so

so we we've created this flexible model and we have support and this i can't uh overstate this enough in that support and documentation our tutorials our community they help people who don't have, you know, they can't call IT on the eighth floor or call DevOps on the fifth floor and say, come up here and help me with this problem. The product has to stand on its own. And when it doesn't, the documentation, the investment we've made there and support, every customer gets support, regardless of price point, is critically important to help them on the journey. Because we have lots of customers who come to us from one of the larger players or even smaller competitors who don't have that commitment to support,

and it's a differentiator for them because it's like a force multiplier because they'd rather invest their marginal dollar in some sales and marketing or their product, their customer relationship. They don't want to invest it in core team when they can get it embedded in the product experience with us. Those are all the ingredients for how we're able to get people liftoff when their idea is ready for liftoff. and support them through large levels of scale on their journey to realize their aspirations as to be entrepreneurs.

One thing that's always impressed me about DigitalOcean is its high net dollar retention rate. Just seeing that customers are spending more and more on the platform, I think, really speaks to the value that DigitalOcean provides. And I'd love to chat about new customer growth with so many companies like, you know, Microsoft, AWS, just continuing to lower the prices of their services. I'd love to chat a little bit about, you know, the competitive landscape. Where does DigitalOcean sort of fit into this and how does it differentiate itself from other cloud services providers that also target small to medium sized businesses? You've already kind of touched on this, but I would love if you could share. First, the market for what we call SMB cloud, and this is per IDC, is $100 billion a year today. So it's a massive market.

It's not as big as the enterprise cloud market, which is several times that. But this market's very big. It's very fragmented because there's 100 million small, medium-sized businesses in the world. There's 30 million developers. Collectively, those two groups spend the $100 million in cloud spend today. is very fragmented so how we attract people to the platform is through our tutorials we have tens of thousands of documents online that generates 10 million or so visitors to our website a month and we offer that for free and

whether it's how do I do this on AWS you can come to our site and get insight into that let alone how to do things on digital oceans cloud many people come to to our cloud to read our tutorials and learn how to program. I've met a number of people who are running businesses on our platform today who first came to us because we had a tutorial that helped them learn how to program in a certain language. And then they played with that for a few years and ultimately launched the business. So we germinate people early on, foster their learning and their growth, and then we support them. That's very differentiated, the fact that we have the documentation to support. We're an open platform. You don't have to customize your software app to

our proprietary platform. We're simple, easy to use. In the time we've been here, frankly, the first five minutes that we've been on this call, you could have signed up and been coding on our platform. In the time we've been on here now, you could have read a tutorial and then signed up. So it's very simple, easy to use. And then it's cheap. You know, it's really value priced, which we're proud of that. And we intend to maintain that differentiation. And so what that does is it allows us to attract people who don't yet know what they're going to do. We call them learners. They come to the platform and they just stay here. And they may stay here, I think, on average for four plus years before they may or may not launch a business. We like to, that's fine

for us because it's super low acquisition cost to get them here. We write their tutorials once and they're read millions of times. So it's really low acquisition costs. They don't consume the use case in the early stage ideation stage. You don't consume a lot of compute. So it doesn't cost us a lot to serve them. And we're going to have that compute anyway to serve the builders and scalers, which are 86% of our revenue. So it's a really low cost acquisition. I said it on the call the other day it's the world's best lead generation tool because they pay us to be leads and then we're using we're getting smarter and smarter at identifying earlier and earlier who's a high potential user who has high intent and then we're helping them with um you know get get there sooner

so that they can get above 50 as a builder or 500 bucks as a scaler we use 50 as a marker because you know above 50 you you you are doing more than just a hobbyist or figuring things out you actually are converging on running a business building a business and so that's how we differentiate is we're here for the journey we're not here for the million dollar only customer a month we're here for come here the average customer starts at 18 or 19 a month through self-serve we're about identifying, creating this place for them to figure things out. That's what we call community, huge commitment of ours. And then we help customers along the journey so that they can reach their aspirations faster and get into that builder and scaler. And that's why we're feeding

the builders and scalers. Why we've been tailoring our disclosure over the last several quarters to talk only about them or principally, because that's what's fueling the business. but it but we need the learners we need that large pool of people who come here don't spend a lot not sure what they're going to use how they're going to use it and create incubate them and foster them so that they when they're ready to explode and launch we're there to serve them and then the the application scale to you know you could build a billion dollar business on this platform. And that's very unique. That's how we're differentiated from everybody else in this large end of the market that's S&P 500.

As always, people on the program may have interests 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. I'm Ricky Mulvey. We'll see you next time. We'll be right back.