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Big tech stocks have driven the market to record highs, but with concerns about whether the rally can continue, what are we hearing from companies? Evan Chen, Portfolio Research Associate at TD Asset Management, speaks with Money Talk's Greg Bonnell.
Transcript
Greg Bonnell – Big technology companies are driving the market to new highs, but there's a lot of concern about whether this rally will last. What are we actually hearing from these technology companies? Evan Chen, associate of portfolio research at TD Asset Management, will be joining us now. Thanks again to the show, Evan.
Evan Chen – Thank you. I feel like I'm a regular now.
Greg Bonnell – Have you here regularly. Of course, technology is a hot topic for investors. We're a little wary. I know there's a big stake in Nvidia (NVDA). But the earnings to date, we're hearing from other big tech companies. What are they telling us?
Evan Chen – Well, have you ever had a boss that was so demanding that you just couldn't get along with them? A boss that you could never please and never get along with. Now imagine this: A colleague turns in a report a day early. And your boss says why not do it two days early? Another colleague says we automated this task that takes up an hour of our time.
And your boss says, why didn't you do this sooner? But you're not. You're the best employee they've ever hired. You work hard and you get everything done. So I liken the first two employees to Google (GOOGL, GOOG) and Microsoft (MSFT, MSFT:CA). And you're Meta (META, META:CA).
Now, let's look at revenue. Google revenue was good. It beat expectations on all fronts except YouTube. Margins were near all-time highs, and they successfully cut headcount for the second consecutive quarter. So what do we get? Negative 6% due to concerns about YouTube and margin compression in the second half of the year.
Microsoft's earnings were also strong. They beat expectations everywhere except for their core segment, Azure, their cloud platform. That meant growth was 30% instead of the expected 31.5%. So what did we get out of that? They were down 7%, but then almost recovered the next day. But that just shows how volatile the market was.
Now, finally, Meta. Meta's revenue was very good. It beat expectations on all fronts. This was driven by upside and ad pricing as advertisers expected better return on spend. On the call, Mark mostly outlined the AI strategy with some concrete examples. The next day, the stock price rose 8% and has continued to rise since then.
Let's take a look at the financials. All three companies are growing earnings by about 15%, 50% higher than the S&P 500. Margins are strong and we continue to see operating leverage. However, margin expansion is probably nearing an end as capital expenditure charges hit the income statement. So all of this translates into double-digit earnings growth around market multiples, which are still pretty attractive.
Greg Bonnell – When you were talking about Meta and Mark Zuckerberg was talking about AI, one word that stood out to me was “tangible benefits.” As we go around these companies, everybody loves to use that phrase, but is the key now to figure out how to specifically leverage this opportunity?
Evan Chen – Well, I think a big theme this quarter was the discussion around AI-related spending and capital expenditures. Last time we were on the show, we were hearing hyperscaler capital expenditures are up 30% to 40% this year, and early projections for next year are about the same. That's a lot of money, maybe $200 billion. That's going to buy you a lot of stuff. So what does that actually buy you?
Google, Meta, and even Microsoft have said that the risks of underinvesting in AI are greater than the risks of overinvesting. Investors were spooked and interpreted that as “too much investment for us to make money.” That's pretty scary.
I take the other side of this argument. I think we're starting to see AI-related revenue in the hyperscaler clouds and Meta efforts. That means the capital infusion, capex to revenue cycle will take at least 18-24 months. These data centers are not going to appear overnight. It's going to take a long time.
They're physically capped. So you have to build them. You have to put everything into them. You have to test them. You need all of that to go live. So you're not going to see a lot of benefit yet because you're still building the things that are going to give you a benefit.
Greg Bonnell – So, some people will say that maybe this surge that we've seen in the market and in the tech industry is a missed opportunity, and it sounds like you're making the argument that it's still an interesting time to explore this space because it's still early days.
Evan Chen – Yeah, I have a couple of examples of how AI is relevant to these companies. First, a lot of what we're seeing in terms of AI for consumer and B2B is summarization and improved search. That's not super exciting, but it's a start. And I think it will expand over time.
Just to give you some numbers, Microsoft's run rate for AI-related benefits in Azure is probably $3.9 billion. That's not a small amount. Amazon has said they have billions of dollars in cloud AI-related benefits. Google has said the same, billions of dollars in AI-related benefits in their cloud platform. And Copilot has a run rate of $1.2 billion. It's still early days, but billions of dollars are starting to move in some of these spends.
Second, even if a consumer product isn't obviously “wow, it does everything for me,”
Greg Bonnell – It's a killer app, right?
Evan Chen – Yes, the killer app.
Greg Bonnell – Search has been around for a long time. We want to make search even better, but where is the killer app?
Evan Chen – Where is the killer app? But I think we're making progress bit by bit. Many of the Fortune 500 companies said on conference calls that they're seeing tangible benefits from AI. For example, Amazon (AMZN, AMZN:CA) said that AI has saved them 4,500 years of developer time. That's a lot of years, and that equates to $260 million annualized.
Microsoft says it has saved hundreds of millions of dollars in customer support by using AI, and bank Goldman Sachs (GS) says its developers are at least 20% more efficient by using Microsoft Copilot. These are benefits that are already here, and we're just getting started. I think this technology will only get better.
Greg Bonnell – When you think about this stage, you think about data centers. These processors are doing the heavy lifting and the heavy thinking. There's a lot of interest in this space. What's the current situation?
Evan Chen – Yeah, that trade has kind of dipped since the last time we were in. It's interesting. We probably joined at its peak and it's come down a little bit. We have Nvidia tomorrow. Let's see what they say. But I think these stocks are taking a breather.
Some are up over 100% and we're down 20%. I'm not too worried. I think the long-term trend is still there. And I think we're going to see more data center construction because, as these companies are saying, the risk of underinvestment is greater than the risk of overinvestment. So I don't see us exiting anytime soon.
Greg Bonnell – I think you spoke last time about the fact that while there's been a lot of attention on the hardware, the data centers, the brains that run AI, some of the software is being overlooked. What's the status of that space?
Evan Chen: Well, software stocks have been struggling, up just 6.5% year to date, which is lower than the overall market. But are these businesses really losing money? I don't think so. I think it's an interesting time to look at some of the software.
It's not that there has been a sudden drop in growth. So, there has certainly been a slowdown in growth. In 2021, we were growing revenues by over 30%. Now, maybe one or two companies are doing that, but we're not in negative growth. We're still growing at double-digit rates.
The first quarter was a bit disappointing after the strong numbers at the end of last year. However, many stocks with unique stories performed better than expected and performed reasonably well. So, while there is some uncertainty in the market, it is clear that there is still demand for certain attractive stocks. Companies like ServiceNow, SAP, etc. have unique value propositions. And they are still doing well.
Greg Bonnell – So when you put all this together, investors are thinking about the technology sector. They've seen some strong performance. They're thinking about the path forward. What do they need to keep in mind?
Evan Chen – I think valuation is something to keep in mind. It's a boring story. But what I'll say right now is that for a lot of these internet giants, the valuations are reasonable. You don't have to pay too much more than the market average for some of these stocks that are growing 50%. So, to me, they look pretty attractive.
But of course, you have to be aware that you're riding the AI trend, and you can overinvest and eat up all your gains. So it's a question of balance. But I think we're positioned for pretty good future returns.
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