Motley Fool Hidden Gems Investing - Nvidia Rolls On

Episode Date: May 23, 2024

The tech giant continues to crush analysts’ lofty expectations. (00:20) Asit Sharma joins Ricky Mulvey to discuss the boom of Nvidia’s data center business, future growth stories for the company, and some questions about its valuation. Then, (13:08) Matt Frankel and Mary Long continue their conversation about David and Goliath business match-ups. Companies discussed: NVDA, META, CAVA, SG, CMG, MKL, KNSL Host:Ricky Mulvey Guests: Asit Sharma, Mary Long, Matt Frankel Engineers: Tim Sparks, Desiree Jones Public.com disclosure: A High-Yield Cash Account is a secondary brokerage account with Public Investing, member FINRA/SIPC. Funds from this account are automatically deposited into partner banks where they earn a variable interest and are eligible for FDIC insurance. Neither Public Investing nor any of its affiliates is a bank. US only. Learn more at public.com/disclosures/high-yield-account Learn more about your ad choices. Visit megaphone.fm/adchoices

nvidia once again knocks the cover off the ball you're listening to motley fool money i'm ricky mulvey joined today by asit sharma asit good we've been talking for 20 minutes but it's still good to see you good to see you ricky all right there's there's one story on the platter for the a segment and that is nvidia they reported yesterday high expectations in the business asset is still crushing it revenue was 26 billion which is a billion more than the analysts were expecting they got a 10 for 1 stock split and they also announced the new chip platform the blackwell is in full production do you have any big takeaways before we get to the meat of the business ricky yeah i've got one takeaway i think there must be some return on investment here

for all the companies the hyperscalers the enterprise businesses the internet businesses that are buying products from nvidia this is one thing analysts have worried about for a while what if we get to the end of the road and people find out that generative ai doesn't really change much well it's changing a lot and we saw that in the fact that nvidia which had such a blout quarter as you mentioned is up 10 today because in the fourth quarter is when they think blackwell will really start to sell it's out of production and they only put their estimates for one quarter at a time so it's leaving the whole investment community guessing how much more revenue can grow sequentially year over year two quarters from now there's a lot of exciting things going on

with NVIDIA. This is a data center business though. It's how NVIDIA makes most of its money and just an eye-popping figure where I'm going to the decimal, I'm sorry. 427% year over year growth for the data center business. I want to know who are the customers buying? What are they buying? How do they grow that much? It's so fascinating, Ricky. This has made the other segments that NVIDIA report just look like afterthoughts, because they're a couple billion in the hundreds of millions. The customers primarily are the big cloud providers. I say primarily, that's not really the whole story, but yesterday in the call management said that 40% of customers were coming from this data center cloud business. You can think of the big cloud titans, Microsoft,

Amazon, Oracle, etc. This is the group that's pushing the growth, but enterprise businesses are buying it. Academic institutions are buying NVIDIA products. As we saw, this is a theme now in the last three calls, sovereign governments, which are trying to develop their own strategy. Whole country-specific avenues of revenue are being opened up by NVIDIA. All this comes together, but the real meat and potatoes of their business right now are the big familiar cloud titans. They're driving the acceleration. Let's talk about sovereign AI for a minute, because this is throughout the call, they're trying to paint the picture of the next growth stories, the next growth waves for NVIDIA products. And this is something that Jensen

Wong has talked a lot about, which is sovereign AI or a nation's basically capability to produce artificial intelligence using its own infrastructure, data, workforce, business networks, basically all of the data produced in a country, the government should be able to control that and then create intelligence out of it using NVIDIA products, of course, Asit. Is this something that you think, are you as bullish on this as Jensen Wang is, or there's the cynical take of if there's a gold rush, you want to sell picks and shovels to everyone? I'm medium bullish on it, Ricky, for one detail. And that is that NVIDIA has been building their own data centers and playing around

with these for a long time. So they have the capability to configure data centers, they say, almost instantaneously. And what that means is that if you are a country like France, which is a customer of NVIDIA's, if you are a Middle Eastern oil-rich company that wants to diversify your country's GDP base, you want to be able to do that very quickly if you're going to take a chunk of that GDP in a year and put it in NVIDIA's coffers. They're able to deliver on that. Their systems are highly configurable. If you show NVIDIA, this is our data infrastructure, they've got products which are supercomputers, which are backwards compatible. They've got

the Blackwell, for example, which can be air-cooled, it can also be liquid-cooled. This configurability, idea that they can help you build data centers in a really rapid fashion gives some legs to their predictions. I think they said that this is going to be a high single-digit billion dollar business in the very near future. I don't disbelieve them on that. Now, I'm not quite as bullish as Jensen Huang is on this. I think every proposition out in the business world has to be tested, even if it's coming from Nvidia. We'll see. But, medium-bullish, sure. Okay. And the other, I would say the other growth story that's getting tested right now is autonomous driving. We have a new update from Tesla and their full self-driving cars,

which NVIDIA discussed on the call. But Austin, when we were watching this morning, we were watching a full self-driving video of a Tesla with the latest update, but it seems they're not quite there yet. Essentially, it was a car in Chicago where a car stops in front of it, the hazards turn on, but the Tesla is still maybe not able to pick up the fact that the hazards are on, the car is stuck in traffic and it needs to go into the right lane in order to get around the traffic. So I'm not going to give you my personal answer on this, Ricky. I'm going to give you the answer that I think NVIDIA's management would give to investors. And that is to say that in the past, Tesla has, yes, relied on NVIDIA hardware and software to train their

supercomputer. They've also used a lot of data straight from vehicles. Everyone is aware of this. If you drive a Tesla that's contributing to their machine learning, but there's been a shift since I would say the beginning of the generative AI explosion in that NVIDIA, which has really great core competencies in physics, the optics of physics is pushing this vision of, and I'm punning here, of autonomous driving being trained on video models. Instead of gathering data from cars, now NVIDIA is working with Tesla and other manufacturers to have their artificial intelligence machines watch a ton of video. Because as Jensen Huang will tell you, the best way for an AI to learn if you are looking at autonomous driving isn't really to gather data from vehicles, but

it's to understand the physics of the world. The best way for the AI to do that is by sitting in front of a screen, watching a bunch of videos like the one you and I were watching and laughing at this morning. And to that extent, they mentioned supporting Tesla's expansion of its AI supercomputer via 35,000 H100 GPUs. That's quite a big number and quite a huge capital investment. But this is the way of the future now for autonomous driving, its inference and its training being generated through video. Well, and the other part of whatever growth story NVIDIA tells you is, you may not know what the next one is. This is a company that started building GPUs for gaming computers that have turned out to work well for cryptocurrency mining operations, and then

an artificial intelligence. NVIDIA is very much selling during the earnings call, and one it was selling is how valuable the customer relationships are. The one they featured was with Meta, which is now using its Llama 3 AI system with NVIDIA hardware. NVIDIA is saying that Meta will get $7 in revenue for every $1 they spend in server cost. Let's translate this into English. Does this just mean that Meta is making really good ads from the information they're getting through this or what, Asit? Yeah, actually some of this gets pretty confusing. So here NVIDIA was really talking about the open source large language model called Lama. Lama 3 is the latest version. And they were referring to companies that will use Lama 3. Think of a small AI startup that

has an LLM you want to use. They're saying if these startups and larger companies as well are going to charge for the tokens for that usage when you talk to a large language model, they can drive $7 of revenue for every dollar that they're paying out on someone else's server. Now, obviously, Meta itself is making money off of both Lama and the computational power. And you're right that they are making some money using this. But really, what they're referring to there is they're pitching to startups use our technology use technology it's based on nvidia let's talk about the value of the company for a little bit this is one where the bulls the bulls are out in forest asset and one that i'm

honestly kicking myself for for not owning since i started looking at it as i'm sure some listeners are as well this is now a two and a half trillion dollar company at about let's say 38 38 40 times forward earnings at this point what are your thoughts on nvidia's valuation i think it's it's a hard company to value you have a company that has this incredible demand and they're already telegraphing to the market that we're a bit now supply constrained we're working with suppliers like tsmc and other partners in our ecosystem to get products as fast we can to customers on the other hand they're also saying that we're innovating at this incredible pace If you've heard, our roadmap has a re-up every year, which is super fast in this industry.

It's also about the innovation in data centers, the fact that now they're providing so much of a data center, from the switches to the other networking equipment to the software. They're working on their own InfiniBand technology, but now they play well with Ethernet. This is a company that's innovating in so many directions that it's not far-fetched to think that they could keep up from here a pretty decent run rate going further. I don't think we're going to see, again, this 400% year-over-year growth. But to be a $2.5 trillion company that could grow at a decent double-digit rate, you would not really blink that much to pay 38x forward earnings for that.

It's a premium company with a lock on its marketplace right now. Some of that isn't just about the expected earnings growth, it's about the stability of the perceived cash flow. I don't think it's that expensive at 38X, Ricky. Maybe you can buy just a little bit here. I know for me, when I've watched companies run up and it's painful if I didn't buy them, I found it sort of easy to reduce that pain. Just take a little bit and watch that bit from there.

NVIDIA is a company that gives you cyclical opportunities to buy. However, I think this is not truly an exception. At some point, the steam will evaporate a bit, so there'll be more buying opportunities. But right now, for people who want to hold this company for a long term, it's still not too expensive. And I'm glad you pointed out that multiple. It's not a crazy multiple. And as you and I were chatting before the show, there's a few companies that are also

big tech that are much more expensive. It's basically the same if we're using forward earnings. It's basically where Amazon is right now. and it's below Tesla. So those are your sticks in the wind, Asit. Management would give you points for putting that PE ratio into context. They're all about context and how that plays into inferencing and everything they're doing with artificial intelligence. If Michael Nobison ever listens to this show, which I will not assume he does, I'm sure he would want to kick me from afar. I think he moves on to another podcast when

both you and I are conversing in particular. Let's end it there. Asit Sharma, as always, thank you for your time. Thank you for your insight. Thanks for breaking this down. Thanks a lot, Ricky. It's a lot of fun. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region. In seconds, you'll see exactly what's behind your quota risk and fix it before it's missed. Question answered, action taken, crisis averted.

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complex actions across your entire organization. That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today, rippling.ai slash fool. All right, up next, Mary Long and Matt Frankel look at two more David and Goliath matchups. You can hear the first two on yesterday's episode, but this time it's in food and insurance. Next up, we'll go to Kava and Chipotle. Last summer, Sweetgreen and Kava both IPO'd. And the question kind of heard around the investing world at the time was, is X, X being Sweetgreen or Kava, the next Chipotle?

As a consumer, I love Chipotle and I feel like we glorify Chipotle stock a lot, But maybe for someone who's less familiar with investing or new to investing and less familiar with Chipotle stock, what is it that makes Chipotle stock so great? It's such a great restaurant business. I'm saying this from someone who ran restaurants. That was my first career way back when. I'm aging myself, but the very early 2000s. It's a hard business to make money in.

A good restaurant might make a 5% net margin if things are going well. People don't realize how little money good restaurants actually make. Chipotle has a 13% net margin. They're a highly profitable business. They essentially invented that fast-casual concept. Fresh food, fast. That was really a Chipotle thing. They really scaled that beyond anybody's dreams.

It's high-quality food at fast food times and fast food prices. That's what made the business great. A lot of companies like Kava have essentially tried to replicate the model, but none have been able to do it with the scale and profitability of Chipotle yet. Yeah, yet is maybe the key piece there. Kava would sure like to think that the rest of that sentence ends in yet. Because as you said, Kava in many ways seems like a Mediterranean-themed Chipotle. It's the same kind of concept of fast casual. That said, it's at a far earlier growth stage.

So, theoretically, you could take that idea and say, oh, now's my chance to get in on the new Chipotle. I'm using air quotes early. What, if anything, is stopping Kava from becoming the next Chipotle? I mean, I can personally, this is just anecdotal, but I can tell you that three Kavas have opened up within a 10-mile radius of me within the past year. So, you're right, they're in rapid growth mode. And none of them replaced a Chipotle, by the way.

So, Chipotle is still doing fine. So, you're right, they're in an earlier stage of growth. They're growing faster. They're expecting to grow revenue by about 20% next year. Chipotle's is about 15% is their consensus. So, faster growth rate than Chipotle. Both businesses actually have identical gross margins, it was interesting to find when I was doing some research for this. They both have 33% gross margins. As you would expect, Kava is not nearly as profitable yet because they're in growth mode

more so than Chipotle. Chipotle has, I'm not sure the exact number off the top of my head, but thousands of stores that are able to turn it into a compounding machine, whereas Kava, they have fewer resources and faster growth. So, they're not making a ton of money right now. Do not look at the P.E. on this stock. That doesn't tell you the story. They both trade for similar multiples of sales. Really interesting businesses. I don't want to say the next Chipotle. That's like saying the next Berkshire Hathaway. But Kava's in that conversation. Yet we still try to make that comparison, the next Berkshire Hathaway, a mini-Berkshire Hathaway.

And that's maybe a perfect segue into our final matchup where we've got two specialty insurers which are duking it out. So first in one corner, founded in 1930 and today boasting a market cap of $21.7 billion. We've got Markel, a stock that's up over 13,000%, bold that, underline that, since its 1980 IPO and is up 55% in the past five years. Other corner with a market cap just shy of $9 billion. We have Kinsale Capital Group. That was founded in 1990. So it's not exactly a newbie, but it went public in 2016 and is the younger of the two companies here. Since then, Kinsale stock is up over 2000%. That's since 2016. And in the past five years, that stock is up 356% last I checked. So I'm going to go ahead with all that information. I'm going to go ahead and say that

Markel is our Goliath. But if that's the case, why has Kinsale seen better returns in the past five years. There's so much to unpack there. I own both of these stocks, and I know both companies really well. We'll start with the insurance businesses. Both of these are insurance companies, at their core, at least. But they do things a little differently. They're both specialty insurers. Markel actually has two big businesses. They have specialty insurance and they have reinsurance. Their reinsurance business, think of it like insurance for insurance companies. If, say, what's a good homeowner's insurance company, State Farm, wants to limit their

losses or exposure to hurricanes or something like that, they might purchase a reinsurance policy that limits their exposure and would pay off in the event that a bad natural disaster hits. So, they're not going out of business. That's a much more inconsistent business in insurance than property casualty insurance. Markel's reinsurance business has actually been unprofitable in the past few years. Both of them are specialty insurers. Kinsale focuses on smaller accounts. While it sounds like it has a smaller market share, customer account-wise, they're more similar than you might think.

Markel is not just an insurance company, though. We said the next Berkshire Hathaway. That was the big segue into this. They take a Berkshire-like approach. All insurers invest their money. That's how most insurers make most of their money, from investing the money that they've taken in before they pay it out for claims. Markel invests in a big stock portfolio like Berkshire Hathaway does. Berkshire is actually its largest investment. They also have Markel Ventures, which is a venture capital division. Unlike Berkshire, they can make small investments like that and have them move the needle if

they do well. Kinsale makes their money on insurance. Markel has a standard profit margin when it comes to their insurance business. Their underwriting margin is in the 4% to 5% range, which most insurers would be very happy with that, and just to make more money off on their investment portfolio, which Markel does. Kinsale, on the other hand, and stop me if I ramble too much. Ramble. Kinsale, on the other hand, their investment portfolio is boring, for lack of a better term.

They invest in high-quality corporate bonds and Treasury bonds, mostly fixed income stuff. They have a small amount of common stocks, but nothing that is worth mentioning in the investment thesis. Their insurance business, on the other hand, is wildly profitable. I mentioned that Markel's underwriting margin is usually in the 4-5% range, meaning that after they pay all their claims and pay their business expenses, they have a 4-5% margin of the premiums left over. Kinsale's is over 20%. About five times as profitable. That's also why Kinsale is more highly valued on a price-to-sales basis. Highly profitable insurance business.

If they ever get to the point where they're actually building a stock portfolio and making real money on investments, watch out. That's a lot of potential. But totally different insurance business dynamics. That focus on small companies, a very overlooked area of specialty insurance that allows Kinsale to be that profitable. When we talk about can sales profitability, is it just able to outcharge its competitors with its insurance offerings? When I think about insurance, and maybe stop me if this veers off into a different type

of insurance and doesn't maybe apply to the specialty insurance area. But when I think about home insurance and natural disaster, I feel like there have been so many news stories of late about insurance companies that are stopping insuring certain car manufacturers that are stopping to insure houses in certain states? Is the insurance business getting harder? And if so, does that impact positively or negatively Kinsale and, with it, Markel's ability to price? Great question. And I thought that too. I actually talked to Kinsale's CEO, Mike Kehoe, a couple of weeks ago, and he pointed this out to me because I had a misconception about this. It's not that their underwriting is as profitable as

we make it out to be. It's that their costs are much better. There's two components to underwriting margin. There's the money that you're paying out for claims. That's called your loss ratio. There's the money that you're paying for the rest of your business, to pay your employees, to pay your offices, and things like that. That's your expense ratio. Put them together, it's called your combined ratio. Kinsale has a very low combined ratio, but it's more because of that expense ratio side of it than it is the underwriting side of it. Their expenses are roughly 10% points lower than their peer group. They're very price competitive, is really the point that their CEO wanted to make to me. They're price

competitive. It's not that no one else is underwriting these policies for small companies. They can undercut everyone else because they have a low-cost structure. They automate most of their underwriting process. They have a proprietary technology platform that they view as their core competency. It allows them to be more efficient on an expense basis than their peers. You mentioned early on that the market share in the specialty insurance business doesn't quite tell the whole story here. I'll throw out some numbers just in case they were missed. Last I checked, Kinsale has about 1.5% of the excess and surplus market, which is what we're talking about often when we say specialty insurance, that basically means think of a

weird or obscure business, an ax throwing business, a marijuana dispensary, that kind of thing. And that fits into the excess and surplus category. So Conceal has one and a half percent of that market. Markel has closer to 5.6%. That sounds like a small number, but that makes it, I think, the third largest insurer in the industry. So, okay, that in mind, how do we think about these to as competitors? Is it a growth story? If we're trying to pick the better company here, is it only one that we should be betting on? Or is it more about growth story? How do you think about this? It's a very fragmented business. As you mentioned, the number three has a 5% market share. I think the numbers one and two are Lloyds and AIG that are in specialty insurance.

And you're right, it is the same kind of insurance that you would buy for your home or for your car. But in situations where most insurers wouldn't want to touch it, like the axe throwing business, or if you're a Hollywood stuntman, you want life insurance, MetLife might say, no, we don't really want to touch that. But that's where a specialty insurer comes in. When it comes to smaller accounts, there's less competition. It's not really an apples-to-apples thing. But at the same time, another thing that Kinsale's CEO, Mike Kehoe, pointed out to me, There's a lot more small accounts than you would think. It was like 80% of the ENS market. I do think of them as competitors. But at the same time, I think there's enough room

for everybody, for more than one big winner here, to disrupt. The traditional players are the Lloyds, the AIG. Berkshire has a big specialty insurance business. Those are what I think of as their traditional players, and there's room for both Kinsale and Markel to disrupt them. 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 anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow. Thank you.