Roku and Shopify Q2 2022 Earnings

Posted on July 29, 2022June 30, 2026 by io-fund

“It’s the Economy, Stupid,” is a famous line about focusing a political campaign on one central focus. It was used by Clinton during a recession when George Bush was out of touch on what Americans were experiencing during 1992.

Management teams over the last 24 hours are saying it’s the economy and it’s out of our control. I used that headline because there is one central focus right now and its probably time to set nuances and other explanations aside.

Today, it was announced that GDP declined for two quarters in a row, which technically puts us in a recession. This happened around the same time that three management teams said ad spend on their platforms was paused (Meta, Snap last week, Roku). Not only did ad spend halt suddenly in Q2 but it has not gotten better one month into the third quarter.

What do Roku, Snap and Shopify have in common? They are ad-tech and e-commerce related but otherwise there’s not much in common product-wise. Snap and Roku have little to no overlap in advertisers or audience being mobile vs CTV ads and Roku has zero effects from Apple’s iOS changes. In fact, one thing that bothers me about Roku’s report is we now know that Snap’s Q3 miss was not due to the Ukraine war or Apple’s IDFA changes. We also know that Shopify’s margins are not worsening due to the fulfillment center or something management did. We also now know that tough Q2 Covid comps are not the issue or else the guidance would have been strong.

The common thread across these management teams is that the economy is greatly affecting them and there’s no way to manage this except to cut headcount and muscle through it. What they are also saying is that a recovery is not on the horizon at this time.

Roku actually had surprising account growth of 1.8 million — higher than Q2 of last year. Snap also grew 18% despite tough audience growth comps. Shopify believes their Merchant growth in the second half will accelerate from the first half. Yet, this is not translating to more revenue, and in all cases, is translating to more losses on the bottom line.

This is because we are in a recession.

There’s no reason to discuss the nuances of the products, the management teams, or too many details if we are in the midst of a fierce, macro headwind that is not letting up. We know macro is challenging but the headlines want to make it about the actual company.

“Tiktok is taking too much market share.” Well, Snap had strong user growth of 18% and this will be the highest across all media by the time the reports come in. In a normal economy, dollars follow eyeballs. “Roku faces too much competition” – well, the company added 1.8 million active accounts in a quarter when juggernaut Netflix was negative roughly 1 million this quarter. Netflix’s guide next quarter is for 1 million, so Roku’s Q2 is two times Netflix’s Q3 guide right now. All around, the evidence is not there it’s a competitive issue.

I’m not going to elaborate on product because it’s in the rear seat right now and the economy is in the driver’s seat.

Here’s the question — will these three companies be the only ones to discuss broad economic headwinds that they’re not able to overcome evidenced by flat to negative revenue growth and worsening margins?

Our analysis on SHOP and ROKU is fairly similar which is that Q2 was a miss on the top line and management in both cases said Q3 is faring worse than Q2 in terms of revenue at this time. In addition to the top line issues, the losses on the bottom line are increasing.

I’ve pulled out quotes about what was said in terms of a potential recovery (it’s not going to be a Q3 rebound and Q4 is in question). It’s easy to fall into black and white thinking (one stock is bad because it’s down right now and another stock is good because it’s up right now), but I think something broader is going on.

The earnings calls over the past 24 hours have been nearly identical in tone and statements:

Here is Meta from Q2 call:

“That said, we seem to have entered an economic downturn that will have a broad impact on the digital advertising business. And it's always hard to predict how deep or how long these cycles will be, but I'd say that the situation seems worse than it did a quarter ago.”but I'd say that the situation seems worse than it did a quarter ago.”

Meta also said this:

“Now of course, the third challenge that we're facing here is the macro economy. And we can't control the timing of when things will bounce back, but I'll note that periods like this are when marketers reevaluate their budgets and are even more focused on finding the highest-performing advertising. And in the last recession, we invested in our ads business through the downturn and came out stronger on the other side, and I'm focused on making sure that we do the same today.”but I'll note that periods like this are when marketers reevaluate their budgets and are even more focused on finding the highest-performing advertising. And in the last recession, we invested in our ads business through the downturn and came out stronger on the other side, and I'm focused on making sure that we do the same today.”

I was encouraged by Big Tech’s earnings but now it’s looking like Google and Microsoft are simply more defensible.

With that said, we are likely to reconsider quite a few of our positions — not because a product is weak or a conviction of ours is gone for good. It’s because management teams across the board are saying that Q3 is worse than Q2 right now and as tech investors we’re not going to ignore that message.

Shopify:

I want to pull out only a few numbers for easy comparison:

This means Shopify’s revenue is essentially flat across a six-month period. There is year-over-year growth, but sequentially, it’s not moving much.

Here are the operating margins:

The adjusted operating loss for the second quarter of 2022 was $41.8 million, or 3% of revenue, compared with adjusted operating income of $236.8 million or 21% of revenue in the second quarter of 2021.

I was earnestly hoping for a bottom on these margins, but management said the opposite:

“Factoring in these expectations, we expect to generate an adjusted operating loss for the second half of 2022 with Q3 adjusted operating loss, excluding severance costs expected to materially increase over Q2.”we expect to generate an adjusted operating loss for the second half of 2022 with Q3 adjusted operating loss, excluding severance costs expected to materially increase over Q2.”

“As we significantly decelerate operating expense growth into Q4 and with Q4's higher seasonal GMV and revenue, we expect an adjusted operating loss in Q4 that is significantly smaller than in Q3, but larger than in Q2.”, we expect an adjusted operating loss in Q4 that is significantly smaller than in Q3, but larger than in Q2.”

Net margin is a bit of a mess for Shopify because they have investments in Affirm, Global-E and Slivergate. The unrealized losses are at $1.2 billion this quarter and were at $1.5 billion last quarter. However, adjusted net losses were at $38.5 million compared to income of $285 million last quarter. The company missed on EPS with expected adjusted EPS of $0.03 versus ($0.03) EPS reported.

Stock Based Compensation increased from $151 million in H1 2021 to $257 million in H1 2022. The company stated that SBC plus payroll taxes is at $750 million for the full year.

In the call, an analyst asked if the company was planning on exceeding the $1 billion investment that was already discussed in regard to Shopify Fulfillment Network and the CFO said there are no plans to expand that amount at this time.

Comments on the Economy:

“While the macro environment exited tough COVID year-over-year comps in mid-Q2, consumer spend on services and in-person shopping remained high and persistent inflation at 40-year highs dampened online sales globally. In the face of rapidly escalating prices for essential goods and energy, consumers have been favoring discount retailers and reducing their spend on other goods categories.”consumers have been favoring discount retailers and reducing their spend on other goods categories.”

“Consistent with this, we are taking actions to recalibrate our investment spending to build for long-term success. We are keenly aware of what's happening around us. We anticipate that inflation and the continued softness in consumer spending on goods will persist through the remainder of the year. Throughout the organization, our teams are mindful of the macro environment and have been rigorously evaluating and adjusting our spending priorities. And we have taken this time to also make adjustments to ensure we have an efficient, productive and highly motivated team.”We anticipate that inflation and the continued softness in consumer spending on goods will persist through the remainder of the year. Throughout the organization, our teams are mindful of the macro environment and have been rigorously evaluating and adjusting our spending priorities. And we have taken this time to also make adjustments to ensure we have an efficient, productive and highly motivated team.”

“We expect 2022 will be different, more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation.”more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation.”

“Our financial outlook for the rest of 2022, which includes the impact of Deliverr and our new compensation system, assumes that higher inflation will persist for the foreseeable future and, combined with rising interest rates, will pressure consumers' wallets for purchases of goods.”assumes that higher inflation will persist for the foreseeable future and, combined with rising interest rates, will pressure consumers' wallets for purchases of goods.”

Note: Microsoft said FX headwinds are expected to ease Jan-June of next year.

Roku:

Roku’s current quarter came in strong all things considered. The problem is the Q3 guide is a substantial miss of $200 million with management guiding for 3% growth to $700 million compared to $902 million expected.

This is surprising given the company had secured $500 million last year and secured $1 billion in the current upfront season in committed ad spend. What Roku calls the scatter market, or ad spend that can be turned on/off, is what is weighing on the current guide.

The company missed on gross profit for a guide of $395 million and reported gross profit of $355 million.

The company reported operating losses of ($110.5) million and net income losses of ($112) million.

Adjusted EBITDA also went negative to ($12.1) million so that’s weighing on the report. The guide is for ($190) million in net losses and Adjusted EBITDA of ($75) million.

So, not only has Roku firmly been in negative territory on their margins but these losses are increasing for Q3. The player gross margin weighs on this, which we knew would happen and this is not a deterrent as we want the audience growth that has come from keeping player prices low. However, the slowing revenue growth puts pressure on these margins and that’s not something management prepped investors for.

Roku also pulled full year guidance which I can’t recall has happened in the past.

The first analyst had the same question I have – where did this dramatic pullback in ad spend come from?

Cory CarpenterCory Carpenter

Hey, thanks for the question. Hoping you could expand a bit on what you're seeing in the ad market. It sounds like you saw a pretty dramatic, broad based pullback, but any color on when you started to see the market turn or what verticals perhaps were most impacted would be helpful. Thank you.It sounds like you saw a pretty dramatic, broad based pullback, but any color on when you started to see the market turn or what verticals perhaps were most impacted would be helpful. Thank you.

Anthony WoodAnthony Wood

Hey Cory. This is Anthony, I'll take that and then turn it over to Steve to add some more color. So, at a high level, of course we are seeing advertisers worried about a possible recession, and so we're seeing them reduce their spend in places that are easy for them to turn off and turn back on. So for example, the scatter market which is, an important source of ad revenue for Roku is an easy market for advertisers to turn off and turn back on, and so that's one of the big factors we're seeing from the macroeconomic environment and that's impacting the growth rate in the short term.So, at a high level, of course we are seeing advertisers worried about a possible recession, and so we're seeing them reduce their spend in places that are easy for them to turn off and turn back on. So for example, the scatter market which is, an important source of ad revenue for Roku is an easy market for advertisers to turn off and turn back on, and so that's one of the big factors we're seeing from the macroeconomic environment and that's impacting the growth rate in the short term.

Steven LoudenSteven Louden

Yeah. Just adding some color on the advertiser pullback in the scatter market overall. Certainly that was a significant factor in the quarter in progress as the quarter went on, but an advertiser perception survey noted that almost half of advertisers in Q2 made pauses on their ad TV spend on TV streaming, which was similar to the amount that passed on digital video and traditional TV.but an advertiser perception survey noted that almost half of advertisers in Q2 made pauses on their ad TV spend on TV streaming, which was similar to the amount that passed on digital video and traditional TV.

So this is definitely a broad scale, significant pullback that that happened within the quarter itself and one that's pretty similar to other historical times of a degree of uncertainty or advertisers worried about impending economic downturns. For example, at the start of the pandemic, this is very similar to when a lot of advertisers paused or greatly detailed their spend and then once they got a better handle on which way the world was going, they added those budgets back.So this is definitely a broad scale, significant pullback that that happened within the quarter itself and one that's pretty similar to other historical times of a degree of uncertainty or advertisers worried about impending economic downturns. For example, at the start of the pandemic, this is very similar to when a lot of advertisers paused or greatly detailed their spend and then once they got a better handle on which way the world was going, they added those budgets back.

Additional Comments on the Economy:

“In Q2, we saw a significant slowdown in TV advertising spend due to the macroeconomic environment, which is pressuring Roku's platform business growth in the short term.”

“The current economic state is causing TV advertisers to pause and reconsider spend, which is painful in the short term, but it also causes them to seek greater efficiency and ROI, which will benefit Roku in the mid and long term. This reminds us of when advertisers pause spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital.”The current economic state is causing TV advertisers to pause and reconsider spend, which is painful in the short term, but it also causes them to seek greater efficiency and ROI, which will benefit Roku in the mid and long term. This reminds us of when advertisers pause spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital.”

“Going forward, we expect reduced consumer discretionary spend to pressure Roku TV and player unit sets.”

“As we look ahead to the third quarter, we are facing an increasingly difficult and uncertain environment. Recessionary fear, inflationary pressures, rising interest rates and ongoing supply chain issues will continue to impact both consumers and advertisers. We believe consumers are going to continue to moderate discretionary spend and the ad scatter market will remain pressure.”We believe consumers are going to continue to moderate discretionary spend and the ad scatter market will remain pressure.”

“Our player margins will continue to be pressured as we insulate consumers from cost increases caused by ongoing headwinds from supply chain disruptions and inflationary pressures.”

“Given the volatility and uncertainty of the current macroeconomic environment, we are withdrawing our previous full year revenue growth outlook for 2022. Our outlook has always been based on our assessments of both our business and the broader macroeconomic environment and at this point we feel that there is too much macro uncertainty for us to provide a full year outlook.”

Here is a quote from Snap’s earnings report where the company said the same as Roku and also why digital ads can often be more forward-looking than other areas that are slower to respond to economic pressures:

“You alluded to this in your question in terms of it making — when it turns — it's easier to turn on. It's definitely easier to turn off. So as companies are reevaluating their priorities and their cost structure, they are looking at things like digital ad spend. It's easy to pause, reevaluate and move forward there. So those same tools and services that make it easy to ramp up, make it easy to ramp down. And we know that our advertising partners are facing significant uncertainty, and we talked about that a few times. So I'll focus on the others.”So as companies are reevaluating their priorities and their cost structure, they are looking at things like digital ad spend. It's easy to pause, reevaluate and move forward there. So those same tools and services that make it easy to ramp up, make it easy to ramp down. And we know that our advertising partners are facing significant uncertainty, and we talked about that a few times. So I'll focus on the others.”

This is a longer quote that has increasing importance in terms of when the slowdown occurred.

“And then beginning — later in Q4 and certainly through the first half of this year, we've seen macroeconomic challenges have built. While there have been lingering supply chain and labor supply issues impacting certain segments that began during the pandemic, more recently, we've seen the impact of persistently high inflation, then rising interest rates and rising geopolitical risks associated with the war in Ukraine. Those macro headwinds have disrupted many of the industry segments that have been most critical to the growing demand for advertising solutions over prior years.

We're seeing these various headwinds put pressure on the earnings of a wide variety of companies, and this is directly impacting the demand for advertising. Specifically, advertising spending, in particular, auction-driven direct response advertising is among the very few line items in a company's cost structure that they can reduce immediately in response to pressure on their top line or their input costs. As a result, as many industries and verticals have come under top line or input cost pressure, advertising spending has been amongst the first areas impacted.”We're seeing these various headwinds put pressure on the earnings of a wide variety of companies, and this is directly impacting the demand for advertising. Specifically, advertising spending, in particular, auction-driven direct response advertising is among the very few line items in a company's cost structure that they can reduce immediately in response to pressure on their top line or their input costs. As a result, as many industries and verticals have come under top line or input cost pressure, advertising spending has been amongst the first areas impacted.”

If you recall, Snap also reported a flat Q3 along with Meta and now Roku – with a specific mention of the slowdown happening in the last 90 days.

Conclusion:

I wanted to connect the dots here because two days ago, it looked like Snap was a turbulent product with a management team that had become hard to rely upon.

If you recall, analysts had slated a Q3 rebound and Q4 rebound for many ad-tech stocks while being wary of Snap’s ability to overcome Apple’s changes. Shopify was similar to ad-tech with consensus of 26% growth for Q3 and 29% growth for Q4. Those estimates have been lowered since this morning.

Some investors will want to make this a Snap problem, a Roku problem, a Shopify problem and a Meta problem (side note: Meta might have a product specific problem ….).

You can see what I’m getting at – how many companies does it take to have slowing growth before it stops being about the company and instead is seen as a problem with the economy? The issue with the current earnings reports is this was not slowing growth; it was halted growth. I very much want this to be an insulated case but there’s at least a 50/50 chance that the abrupt pause in digital ad spend will translate to more companies and industries as we move along.

Note from Knox: If we continue to receive broad confirmation of the developing thesis, expect us to strategically raise cash while in the current bounce. I’ve been providing daily levels and targets, which we will continue to use if we see a larger bear market rally as the most likely outcome over the coming weeks-months.

Positioning changes we are considering:

Reducing our Roku position to 3% range and we will buy back in when we see evidence of a rebound
It’s likely we close Twilio before earnings
It’s likely we close Asana before earnings
We may close Magnite as it’s tough to foresee this company doing well given the issues across ad spend
Across cloud, Snowflake has exposure to discretionary spending and we might reduce our position here. We would likely wait for Datadog to come in although SNOW had more exposure last quarter

We will put this money into the companies that show strength given tough macro and we will revisit our thesis on any closed or heavily trimmed positions once the economy bounces back. I’m aware it’s natural to want to make this about a company or a product or “Covid winners,” but we are not in consensus with this.

To complicate matters, the market is forward looking so Knox’s technicals are likely to front run fundamentals on a recovery. This means the market will start buying again before management teams provide strong earnings reports.

We want to be very careful with this decision and will wait for technical triggers to act. If we do get the signal to raise cash, we will buy/re-enter when a renewed uptrend begins, and our hedge signal is flashing all-clear.

Lam Research Q4 FY2022 Earnings Review

Posted on July 28, 2022June 30, 2026 by io-fund

Lam Research reported strong Q4 FY2022 results as revenue grew by 12% YoY and 14% QoQ to $4.64 billion. The company beat Wall Street analysts' estimates by $422 million (10% beat). It reported adjusted EPS of $8.83 and beat estimates by $1.50 (20% beat).

The Systems revenue which includes sales of new leading-edge equipment in deposition, etch, and clean markets grew by 8.8% YoY to $3.0 billion. Customer support business group revenue grew by 18% YoY to $1.6 billion.

The company is seeing increased demand in new advanced packaging architectures. Tim Archer, CEO of the company, said in the earnings call, “Our Kiyo plasma etch products with Hydro have a proven record of delivering the productivity and uniformity requirements needed for cost effective front-end device scaling. Leveraging this expertise in high-volume manufacturing, we have now achieved multiple new etch tool of record positions for advanced packaging at a leading foundry logic customer. As customers further develop these architectures in support of greater system performance, we see a growing opportunity for Lam’s etch and deposition solutions.”

The company’s gross margin was 45.3% compared to 44.7% in the Q3 FY2022 and 46.2% in the same period last year. The adjusted gross margin was 45.2% compared to 44.7% in the Q3 FY2022 and 46.5% in the same period the previous year. The gross margin was close to the higher end of the management’s guidance of 43.5% to 45.5%, as strong sales helped to overcome the rise in costs.

The gross margins could be under pressure in the near term due to inflation and increased expenses due to supply chain issues. The management expects it to improve in the long-term. The company is also moving closer to its customers in Asia by building facilities there, which is another point mentioned in the earnings call that could be a hedge for rising freight and logistics expenses.

The operating margin improved to 31.9% compared to 29.4% in Q3 FY2022 and 31.7% in the same period last year. The adjusted operating margin was 31.5%, which was up 210 bps helped by strong sales and was above the management’s guidance of 28.5% to 30.5%. The company’s adjusted net income rose 5.2% YoY to $1.2 billion. The adjusted EPS was $8.83 compared to $8.09 for the same period last year.

The company had cash and investments of $3.9 billion compared to $4.6 billion in the March quarter. The company repurchased shares of $868 million and paid dividends of $208 million in the recent quarter. The operating cash flow were $443.9 million in the recent quarter. It was down from the March quarter of $757.7 million as the company increased the level of inventory in the recent quarter. The company has a debt of $5.0 billion.

The company’s deferred revenue balance was $2.2 billion at the end of the quarter, up from $2.07 billion at the end of Q3 FY2022. The deferred revenue grew by $129 million in the recent quarter compared to $610 million in the previous quarter. It was higher in the last quarter due to part shortages which negatively impacted the recognized revenue in the last quarter.

WFE and guidance

The management has lowered the wafer fab equipment spending outlook for the calendar year 2022 to be in the range of low to mid-$90 billion range on the back of supply chain issues. This is lower than the management’s earlier forecasts of $100 billion. In the earnings call, Tim Archer CEO of the company said, “As suggested by our guidance today, we expect to see incremental improvement in supply chain conditions in the September quarter, but our view is that industry-wide output will continue to be constrained through the rest of this year. Consequently, we are lowering our outlook for calendar year 2022 wafer fab equipment spending to be in the low to mid-$90 billion range.”

In the last earnings call, Tim Archer said, “While continued supply-related delays could potentially limit how much wafer fabrication equipment investment can be executed in 2022, our current WFE view is still in the $100 billion range. We see unconstrained demand exceeding $100 billion in 2022 and any unmet demand should flow into next year.”

The management expects revenue of $4.9 billion at the mid-point of the guidance in the next quarter, representing a 14% YoY growth. It was above the Wall Street analysts’ estimate of $4.6 billion. The adjusted gross margin is expected to be in the range of 44% to 46% after taking into consideration the inflationary pressures due to supply chain issues, adjusted operating margin in the range of 30.5% to 32.5%, and adjusted EPS of $9.50 at the mid-point.

Recent analysts notes:

Wells Fargo analyst Joe Quatrochi raised the firm's price target to $475 from $460 and kept an Equal Weight rating on the shares. While Lam Research's better-than-expected Q4 results/Q1 guide reflect improving supply chain dynamics and execution, the analyst expects investors to focus on expanded China export restrictions and WFE commentary.

DA Davidson analyst Thomas Diffley lowered the firm's price target to $550 from $575 and kept a Neutral rating on the shares. The company posted a beat-and-raise Q4 results amid robust demand and improved operational execution, but the management also lowered its outlook for WFE spending to be in the low to mid $90B range – lower than initial expectations of $100B – due to ongoing supply constraints, the analyst tells investors in a research note. The risk-reward on Lam Research shares looks balanced, Diffley adds.

Conclusion

The company’s results were good as it beat both the top line and bottom-line Wall Street analysts' estimates by a wide margin. The guidance for the next quarter was also strong. The company’s management of rising costs and the slowdown in the WFE are two areas to watch in the coming quarters.

Netflix Stock Stronger Than It Seems Following Q2 Earnings

Posted on July 28, 2022June 30, 2026 by io-fund

This article was originally published on Forbes on Jul 22, 2022,01:44pm EDTForbes on Jul 22, 2022,01:44pm EDT

Netflix is trading at a 10-year historic low valuation, which means this is an opportune time to discuss the pros and cons of this stock should there be upside potential.

The lagging discussion on Netflix is that there was a subscriber decline in Q1 of 200,000, excluding Russia and a subscriber decline of 970,000 in Q2. While critics believe this is due to saturation, it’s much more likely the decline is coming from a pull forward due to Covid as all media stocks – both streaming and social media – demonstrated outsized audience growth through Q2 2021. Therefore, Netflix is lapping some tough quarters for audience growth comps.

Netflix management was clear that this quarter was “less bad” as they hinted the company is not exactly celebrating the results. The company technically returns to growth next quarter for subscribers with a guide of 1 million, yet this is a marked decline from the 4.4 million in the year ago quarter. As discussed, due to the overall impact across many media stocks from shelter-in-place, it would be hasty to believe there’s something inherently wrong with an individual company when the entire media industry was affected. It’s better to hold those conclusions until H2 2022 through H1 2023 after giving it a full year after tough Covid comps have cleared. Ultimately, media is very seasonal, and we should have a nice glimpse as to which companies emerge stronger by Q4 2022, as this is the strongest quarter seasonally.

With that said, there is already evidence that Netflix is taking more market share than its peers. In fact, Nielsen is raising Netflix’s market share for engagement to 7.7% from 6.6%, which puts Netflix in the lead over any other competing subscription service. This is due to high-quality content such as Stranger Things 4, which reported 1.3 billion hours streamed.

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Advertisers are likely to pay a high premium for Netflix’s Hollywood-level content. It’s not only the 100 million people sharing passwords that illustrates what the uptake could be for a lower-priced tier, it’s also the high level of engagement the company’s content garners that could make for a nice equation for industry-leading ARPU due to demand from exclusive advertisers coupled with the supply, or premium content, that Netflix offers.

Due to FX headwinds, Netflix missed on revenue in the most recent quarter at 9% revenue growth compared to 9.7% expected. However, on a constant currency basis, revenue growth was 13%. The same was true for Netflix’s guide, it was a miss due to FX headwind at 4.7% for the upcoming Q3 quarter, yet on a constant currency basis, it is a 12% guide on revenue and a beat in that regard.

Above: Portfolio Manager of I/O Fund, Knox Ridley, discusses Netflix earnings results.discusses Netflix earnings results.

Not surprisingly, the operating margin was also affected by the strong dollar at 20% in the current quarter and 16% for Q3. The strong dollar led to a slightly better EPS as Netflix saw a $305 million unrealized gain from F/X remeasurement on Euro debt.

The most important line item for Netflix is the company’s cash flow. Looking back, this has been troublesome for Netflix as the company lost $3.3 billion in cash in 2019 as it built up its original content pipeline. However, the company is on an entirely new trajectory with $1 billion in free cash flow expected this year and “substantial” free cash flow in 2023, per Netflix management.

The new and improved trajectory in free cash flow won’t change the company’s debt levels anytime soon. Netflix is firmly setting expectations for $10 to $15 billion in debt into the foreseeable future. This is necessary to continue to hold its place as the top media company in terms of revenue and engagement. Gross debt stands at $14.3 billion, when accounting for $5.8 billion in cash, net debt is at $8.5 billion. The company has been able to improve its cash content spend-to-content amortization ratio from 1.6X to 1.4X in 2021 and an expected 1.2-1.3X in 2022.

NETFLIX’S Q2 2022 INVESTOR LETTER

Forward-Looking Catalysts:

Netflix has a few new paths to monetization and to re-accelerate subscriber growth. The company is rolling out a new password-sharing plan and is also now partnered with Microsoft on ads to roll out in 2023. More time than not, cross-selling results in higher revenue where someone who would normally churn can now be monetized through ads. Likewise, viewers who can try out Netflix may decide to upgrade to remove ads. Ultimately, the move towards ads also helps Netflix to be more recession-proof in the event households decide to cut costs.

Risks:

We do not see the current soft subscriber numbers as a sign of saturation. Netflix has risen in market share over the past year. Instead, soft subscriber numbers are a result of the pull forward nearly all media companies experienced from Covid. We fully expect Netflix will return to normal subscriber growth due to the catalysts listed above.

Instead, the primary risk for Netflix is its debt in a rising rate environment. This may depress the company’s valuation more than its ad-tech peers who have strong cash flow and little to no debt during tougher macro conditions. Netflix cannot temper this debt if it intends to compete against other subscription streaming services and also the many broadcast networks that have migrated to streaming.

There is also execution risk with a pivot from subscription-only to also including the ad tier. We view the Netflix management team as perhaps the most capable in the industry of pulling off this pivot as they have consistently broken ground in areas much more challenging than introducing ads. In addition to this, CTV ads can monetize at $40 ARPU and we believe Netflix content will set a new record on ARPU. With that said, even if the execution risk is lower than it would be with other management teams, Netflix is likely to fetch a higher valuation after its proven the ad tier will be successful – ETA of H2 2023.

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What to Watch: Price Action for Netflix Stock

The big picture question to ask is – has NFLX put in THE bottom? There are 3 scenarios that could unfold from the current price range, that would help us manage risk around this question:

I/O FUND

Red: If NFLX breaks below $185, the odds favor one more low, which would be targeting the $147-$115 region. If this happens, it greatly reduces the odds that NFLX will see new highs in the next growth cycle.

Orange: The current swing up breaks above $250. If this happens, the odds favor a push into the $340-$405 region. If this scenario is playing out, we would see the uptrend stall in this region in a bear market rally. The same lower price targets would hold in this scenario.

Green: If any renewed uptrend can break above $405, the odds will shift towards a move to all-time highs.

Netflix bottomed in May while the rest of the market went on to make a new low. More times than not, stocks that bottom first, tend to lead into the next uptrend. This is a show of strength worth monitoring.

We only have 3 waves down from the 2021 high. This may not seem significant, but it is. If this 3-wave move down turns into 5 waves down (red scenario), the odds that we push deep into the orange range are low before the next leg down.

The Relative Strength Index (RSI) has reclaimed a significant level. Note the blue arrow on the RSI around 57. This was the spot where price topped just before the waterfall moment happened in this bear market. The fact that the recent push higher has reclaimed this level is a show of strength and an early sign that green/orange is likely playing out.

Conclusion: The odds favor a push into the $340-$405 region. As long as the next dip holds $185, the more aggressive play would be to buy into that dip. A safer play would be to wait for the breakout above $250.

Knox Ridley, Portfolio Manager at the I/O Fund, contributed to this article.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Alphabet Q2 2022 Earnings: Search’s Strength is Underrated

Posted on July 27, 2022June 30, 2026 by io-fund

Google and Microsoft both flexed their muscle in terms of margins with nearly no impact over the past few quarters due to the macro headwinds. The quarter was stable in terms of both revenue and margins.

There’s a chance the market is sniffing out that Q2 could be a bottom for financials. We need more information (this is not a statement written in stone) but there is evidence that some companies may have bottomed – Netflix’s return to (minimal sub growth), Tesla’s H2 deliveries guide, and Microsoft is a double-digit growth guide for FY2023 while predicting FX headwinds will ease between January-June.

I believe Google’s rally is due to the company’s category leading strength in ads, specifically Google Search, and the prospects of what it will look like when YouTube bounces back. Due to lack of guidance, we don’t have any hints on whether Google bottomed or not, but comparatively the company is stronger than expected.

You can watch my Bloomberg appearance here where I discussed this point Tuesday evening.

Alphabet Q2 2022 Earnings:

The company reported revenue of 13%, or 16% in constant currency, for a total of $69.7 billion. The operating margin was flat year-over-year, which is a win. Operating expenses grew 24% yet the operating margin was in line with previous quarters at 28% for $19.58 billion in operating income.

The net margin was a bit weaker than previous quarters in 2021 at $16 billion yet in line with last quarter. The company has free cash flow of $12.6 billion. The company has $125 billion in cash and marketable securities.

Search was stable given the current environment at 13.5% growth to $40 billion and this provided relief that not all ad spend has been paused. Search was strong last quarter at 24% growth to $40 billion, and was flat sequentially.

We covered the strength of search in our analysis: Alphabet is our Second FAANG.

“The strength in Search highlights the advantage that having first-party data provides. This is because Search is primarily done on a browser, allowing Google to capture valuable first party data from ownership of Google Chrome, Google Search and also from Android OS. Moreover, Google is releasing new products, such as Topics API, which enables behavioral targeting. This is a direct shot at Meta Platforms, who is known to be quite competitive on behavioral targeting through taxonomies.”

The effects of Google’s large R&D department and advances in AI cannot be overstated when it comes to the resiliency of Search in the current environment. We are getting a very slight glimpse of what’s to come for Google in terms of its advertising dominance.

On the call, an analyst asked what is the company’s north star, given their margins are very strong. Later, the CEO discussed that his focus is using their cash to drive more R&D in AI, which flows through to Google Search and YouTube, which then generates more cash to drive more R&D, etc.

“So, for example, we are obviously investing deeply in AI. We do everything from pure research to applied research to research, which is now things AI work, which is actually happening very close or within the areas like Search and YouTube, et cetera.

And so, you can imagine a scenario in which we are prioritizing and on the margin moving resources to making sure we are driving product improvements, which flow through a moment like that. That would be an example of sharpening focus for me.

And when I think about the opportunities out of AI, just coming out of I/O this year, looking at the progress we have made, how much we have made progress with multisearch, how multimodal things are getting and the fact that people are now actually doing voice searches a lot, visual searches a lot, all that is a good example of how we are driving value in our core products.”

The expectations were that YouTube would weigh on the report yet YouTube provided a bit of growth at 5% year-over-year. The company was adamant that YouTube growth is low because of the tough comps. The tough comps was touched on many times, such as this: “the modest year-on-year growth rate primarily reflects lapping the uniquely strong performance in the second quarter of 2021.”

The other issue is that just like hiring is seeing a reversion to 2019 levels, so is ad spend. The levels of ad spend seen in 2020-2021 are not sustainable which is why we are reverting back to 2019 in many of these growth rates. Regardless, the overall tone was positive about YouTube especially as YouTube shorts alone now has 1.5 billion signed-in users per month and 30 billion daily views.

Retail was discussed on the call. Although the management team declined to be granular with analysts, they did feel their products are better positioned to serve retail, as evidenced by the current growth rates compared to competitors, due to Omnichannel. Retailers prefer to drive both offline and online sales through multiple channels for in-store, online, curbside pickup which Google helps with across Search both mobile and browser, YouTube, and location-based searches/maps. Google introduced a new way to buy ads across all of Google’s channels called Performance Max with a single campaign to help more retailers tap into omnichannel.

We discussed in our recent Q3 webinar the importance of Big Tech capex, especially for semiconductor investors. This will be something to closely monitor in Q1 reports of next year in terms of expected capex.

So far, so good for this quarter. We got the following from Ruth Porat, CFO:

“Turning to CapEx. The largest investments in the second quarter were in servers followed by data centers and office facilities. After several large transactions closed in the first quarter, investment in office facilities was once again focused on fit-outs and ground-up construction on existing projects. We continue to expect an increase in CapEx in 2022 versus last year. For the balance of 2022, the increase will be particularly reflected in investments in technical infrastructure globally with servers as the largest component.”

Google Cloud slowed to 35.6% growth down from 43.8% growth last quarter. This means Google Cloud is growing slower than Azure on a lower revenue base. This is something to monitor in the future.

The company announced $70 billion in buybacks last quarter which is up from $50 billion in the previous year. This is also a marked increase from 2019 which saw $25 billion in buybacks.

Conclusion:

We had said this the following in our last write-up which pulls the pieces together to answer why Google has demonstrated stability in the face of ad-tech headwinds:

“Google also reiterated this point during their Q1 Conference Call when CBO Philipp Schindler explained that being able to fully measure what users do after they click on an ad is critical to measuring ROI. He added that “Measurement is also obviously a key component to success [in CTV], and we want to make sure that advertisers can fully measure their YouTube CTV video investments across YouTube and YouTube TV for an accurate view of true incremental reach and frequency and so on.”

CBO Schindler’s comments highlight the importance of measurement, a key aspect of digital advertising that has been challenged following the changes to iOS cookies. If advertisers cannot measure ROI, they tend to limit their ad expenditures, so it's critical that ad platforms find solutions to measure ROI in order to sustain growth.”

Ultimately, in addition to Google’s many channels, Google is resilient right now due to AI driving stronger ROI for advertisers. For example, AI-powered Performance Max has grown 5X year-to-date with case studies driving 60% more revenue.

The company is also more defensible following Apple’s attribution and measurement changes as the Google can provide this on their OS and browser while offering an omnichannel strategy.

Microsoft Earnings Review Q4 FY2022

Posted on July 27, 2022June 30, 2026 by io-fund

Microsoft released its Q4 FY2022 results for the period ending June 30th. Revenue grew by 12% YoY to $51.9 billion (missed Wall Street analysts' estimates by 0.94%) and EPS came at $2.23 (missed estimates by 2.9%). The strong US dollar negatively impacted the revenue by $595 million and EPS by $0.04. Net income grew by 2% YoY to $16.7 billion. Microsoft Cloud revenue grew by 28% YoY to $25 billion. The company’s results are good considering the various macro uncertainties, China lockdown, and the strong US dollar. FY2022 revenue grew by 18% YoY to $198.3 billion and net income increased by 19% YoY to $72.7 billion.

The company’s CEO Satya Nadella sounded more confident about the company’s prospects. He said, “In this environment, we are focused on 3 things: first, no company is better positioned than Microsoft to help organizations deliver on their digital imperative so that they can do more with less. From infrastructure and data to business applications and hybrid work, we provide unique differentiated value to our customers. Second, we will invest to take share and build new businesses in categories where we have long-term structural advantage. Lastly, we will manage through this period with an intense focus on prioritization and executional excellence in our own operations to drive operational leverage.”

The company’s gross income increased 10% YoY to $35.4 billion. The gross margin was 68.3% when compared to 69.7% in the same period last year. Excluding the impact from the change in the accounting estimate, the gross margin was relatively unchanged.

The operating income increased by 8% YoY to $20.5 billion. The operating margin was 39.6% compared to 41.4% in the same period last year. Excluding the impact from the change in the accounting estimate and FX, the operating margin would be relatively unchanged.

The company’s cash flows continued to be strong in the recent quarter. Cash from operations grew by 8% YoY to $24.6 billion (47% of revenue) and free cash flow increased by 9% YoY to $17.8 billion (34% of revenue). The company has cash and investments of $104.8 billion and debt of $49.8 billion.

Segment results:

The Productivity and Business Processes revenue grew by 13% YoY to $16.6 billion. This was in line with the midpoint of the management’s guidance given in June. The Office Commercial revenue grew by 9% and Office 365 commercial revenue grew by 15%. Dynamics revenue grew by 19%, which was helped by Dynamics 365 growth of 31%. It was slightly below the management’s growth expectation. LinkedIn revenue increased by 26%, which was lower than the management’s expectation due to the slowdown in advertising revenues.

The operating income of this segment increased by 12% YoY to $7.2 billion. The segment accounts for 32% of the total revenue and 35% of the group’s total operating income. The management expects the Productivity and Business Processes segment revenue to be $16.1 billion at the mid-point of the guidance in the next quarter.

The Intelligent Cloud segment revenue grew by 20% YoY to $20.9 billion. The management’s guidance was $21.05 billion, the negative impact from the strong dollar led to the slight miss in this segment. The server products and cloud services revenue grew by 22% helped by Azure & other cloud services growth of 40%. On a constant currency basis, Azure grew by 46% and the management is guiding for a growth of 43% in the next quarter. Google Cloud revenue in the recent quarter grew by 36% YoY to $6.3 billion.

Some of the key wins in the recent quarter include American Airlines that chose the company’s cloud platform to run its operations. Telecommunications company, Telstra will use Microsoft Azure for its internal IT workloads. The operating income increased by 11% YoY to $8.7 billion. The segment accounts for 40% of the group’s total revenue and 42% of the total operating income. Intelligent Cloud revenue is expected to be $20.45 billion in the next quarter.

The More Personal Computing revenue grew by 2% YoY to $14.4 billion. It was below the management’s guidance of $14.69 billion. The slowdown in this segment was expected since there is weakness in the PC business. Windows OEM revenue fell 2% and despite the deteriorating PC market the company witnessed some share gains. Surface revenue grew by 10%, which was helped by commercial sales. The gaming revenue declined 7% and was in line with the management’s expectations. The operating income fell by 5% to $4.6 billion. The segment accounts for 28% of the total revenue and 22% of the operating income. The management expects More Personal Computing revenue to be $13.2 billion.

Guidance

The management expects Q1 FY2023 revenue to grow 9.8% YoY at the mid-point of the guidance to $49.75 billion. The strong dollar and PC weakness might be the reason for the company to give a cautious guidance for the next quarter that was lower than the analysts' initial estimates. They expect FX headwinds to be higher in the first half of the fiscal year when compared to the second half.

They sound more optimistic on the full year guidance as they expect revenue to grow double digits for the full year. Amy Hood, CFO of the company said in the earnings call, “We continue to expect double-digit revenue and operating income growth in both constant currency and U.S. dollars.” The management guidance does not take into consideration the impact from the acquisition of Activision Blizzard which they expect to complete by the end of the fiscal year 2023.

The company also made an accounting change in the useful life for server and network equipment assets from four to six years which will extend the depreciation expenses for the company. Amy Hood said in the earnings call, “First, effective at the start of FY '23, we are extending the depreciable useful life for server and network equipment assets in our cloud infrastructure from 4 to 6 years, which will apply to the asset balances on our balance sheet as of June 30, 2022, as well as future asset purchases.

As a result, based on the outstanding balances as of June 30, we expect fiscal year '23 operating income to be favorably impacted by approximately $3.7 billion for the full fiscal year and approximately $1.1 billion in the first quarter.”

Conclusion

Microsoft is in a better position to withstand the macro challenges with stable revenue, consistent margins and the company’s strength in Microsoft Cloud. The company’s forward guidance for the next fiscal year looks positive. Despite PC’s weakness, the company’s other segments continue to grow. Notably, Microsoft Azure’s growth is very solid and outpaced Google Cloud.

Ad Tech Stock Valuations Historically Low – Q3 2022 Earnings

Posted on July 26, 2022June 30, 2026 by io-fund

Last week, the team of I/O Fund analysts kicked off Q3’s earning season with a member-only webinar to discuss how they will position their portfolio for Q3 2022 and beyond. In this clip from the premium webinar, Beth Kindig examines ad tech stock valuations and answers important questions for investors searching for ad tech growth opportunities. Watch the clip to find out the answer to three important ad valuation questions:

3 Questions Beth Kindig Answers in this video:

Beth Kindig looks back at Facebook ($META), the ultimate ad-tech stock between 2012-2018, to answer the following questions:

What valuations do ad tech stocks usually trade at?
Are ad tech stocks cash-efficient?
What is a reasonable valuation for ad-tech stocks right now and how much upside room do ad-tech stocks have?

The unanswered question: When will ad-tech rebound?

Subscribe for Premium to learn when ad tech stocks will start to rebound. Find out what quarters the I/O Fund predicts these stocks will move again!

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About Beth Kindig

Beth has ten years of experience in competitive analysis and product analysis in the tech industry dating back to 2011. Considering tech growth stocks took off after the financial crisis, she is an experienced professional in every sense of the word. Her tech conference appearances date back to 2014 and her analysis began garnering press in the same year. She is known for making bold calls on tech stocks and offers a weekly free analysis that leverages her ten years of experience in the private markets. It is not only the big gains she has achieved with individual stocks but also the quality and consistency of her analysis.

Disclaimers:

I/O Fund blends fundamental and technical analysis to help retail investors get the best out of growth tech stocks. I/O Funds research does not qualify as financial advice, please consult your financial advisor.

Closing Snap, Looking for Entry into Netflix

Posted on July 22, 2022June 30, 2026 by io-fund

We saw with Shopify that this environment is not going to allow management slide by and not provide formal guidance. Shopify has not provided guidance for some time yet was penalized last quarter (23%) for continuing this pattern.

Snap did provide this in their investment letter:

“As we look toward Q3, we are pleased with the momentum we have observed in our community, and we estimate that DAU will be approximately 360 million in Q3. Thus far in Q3, revenue is approximately flat on a year-over-year basis.”

The story has changed since we first entered the stock, and that’s the #1 reason to close a position. You may recall, Snap was free cash flow positive last year +$223 million FCF in FY2021 and had provided 50% revenue guidance for the next few years during their Analyst Day. Q4 earnings was a blowout in terms of positive surprise to the upside – the stock gained 58% in one day. But Q1 was a slight disappointment with some complicated earnings call discussions over ads being paused during the Ukraine situation. You can read my write-up here. That Q1 earnings report caused us to cut the position in half from 6% to 3%. Due to Snap losing 50% of its value since Q1 earnings, that puts our position at roughly 1.5% when we close it tomorrow.

If this was due to tough Q2 comps, then it could have been forgiven if the company provided a strong guide. The guide was anything but strong. When Snap opens tomorrow, it will join other ad-tech companies such as Unity with its YTD losses. The goal is to find which one of these ad-tech stocks will lead us out of this rout and it’s not going to be Snap anytime soon. Unity now looks comparatively better, which is why earnings season requires flexibility as new information comes in daily.

The more important topic discussed on the call was that Snap stated they lack visibility because advertisers can turn on/off ads with very little friction. This affected other ad-tech stocks because investors are concerned it means Q3 will be weaker than expected on ad spend.

The other negative to Snap’s report included more losses on the bottom line. Free cash flow is at ($147) million in the most recent quarter. Adjusted EBITDA fell from +$117 million to +$7 million. GAAP net losses went from ($152) million to ($422) million.

The positive was Snap’s audience growth. The company is likely to report the highest audience growth this quarter across all media – including streaming media and social media — with 18% growth in DAUs to 347 million. The guide for Q3 on DAUs was also strong at 17.6% growth from 306M to 360M DAUs.

We are laser focused on finding the ad-tech stocks that can emerge as leaders right now and our plan is to move quickly to build those positions and consequently cut any that under perform. You can expect to see Knox’s Sell Alert come through sometime soon.

Eyeing Netflix: Q2 Earnings

Netflix is trading at a 10-year historic low valuation, which means this is an opportune time to discuss the pros and cons of this stock should there be upside potential.

Advertising is not a 1:1 on users, rather Netflix’s revenue growth following the ad tier will be determined by engagement. Today, Netflix has more engagement with 220 million users than YouTube with 2 billion users. That’s key to the equation here.

Advertisers are also likely to pay a high premium for Netflix’s Hollywood-level content. It’s not only the 100 million people sharing passwords that illustrates what the uptake could be for a lower-priced tier, it’s also the high level of engagement the company’s content garners that could make for a nice equation for industry-leading ARPU due to demand from exclusive advertisers coupled with the supply, or premium content, that Netflix offers.

View Knox’s TD Ameritrade Appearance here discussing Netflix’s earnings.

Source: Netflix’s Q2 2022 Investor Letter Netflix’s Q2 2022 Investor Letter

Forward-Looking Catalysts:

Risks:

What to Watch: Price Action for Netflix Stock

By: Knox Ridley

The big picture question to ask is – has NFLX put in THE bottom? There are 3 scenarios that could unfold from the current price range, that would help us manage risk around this question:

Green: If any renewed uptrend can break above $405, the odds will shift towards a move to all-time highs.

Please Note: We have not forgotten about Unity as perhaps a better choice to re-allocate Snap’s position. The stock needs to breakout first.

I/O Fund in the Media: Semiconductor Stocks, CHIPS Act, and Why We are Bullish on Bitcoin

Posted on July 19, 2022June 30, 2026 by io-fund

Lead Tech Analyst Beth Kindig joins Charles Payne of Fox Business news to discuss the $52B CHIPS Act, FABS Act, opportunities in tech that may be overlooked, and why I/O Fund is bullish on Bitcoin right now.

CHIPS Act – What Semiconductor Stocks Will Benefit The Most?

While it’s a big week for tech earnings, we’re also keeping an eye on activity on Capitol Hill as we wait for a decision on the CHIPS Act which could bring $52B in subsidies and investment tax credits to boost US manufacturing. Beth and Charles discuss the question on every investor's mind: “Who can benefit from this?”

“The CHIPS Act as it’s written will only benefit manufacturers,” Beth says. “Those manufacturers that only focus on design aren’t happy about this – rightfully so – because, again, it’s slanted in favor of manufacturers.” Beth goes on to explain the FABS Act which offers a manufacturing credit and a credit for chip design activities and that, according to the bigger chip companies, is more fair.

Ultimately this is a positive thing. We could potentially bring chip manufacturing over to American soil. Chips are becoming the way forward in tech, so outsourcing the manufacturing where another country controls has become a source of tension. With that said, ideally it would be more evenly split between manufacturers and design activities, as the goal is to make sure the government doesn’t get in the way of innovation by weakening our strongest design companies.

As the Acts are written and if they’re passed, they stand to benefit Intel, Micron, Texas Instruments and Lam Research – which are all FABS on American soil. As Charles points out, it also will help Applied Materials in the long run.

Opportunities in Tech that may be Overlooked

Every time there’s a bump in the market we see the mega-cap names that do pretty well. Charles asks Beth about the second-tier, non-profitable tech names that seem to be doing well, but are potentially being overlooked.

“What we saw is there were a couple of cloud stocks and cybersecurity stocks that bottomed in May,” Beth explains. “That means as the broader market made a new low, these companies did not make a new low. From the FAANGs – Google was the one that didn’t make a new low, that’s always very encouraging to see.”

Beth’s Favorite Name in Tech Right Now

Bitcoin – Despite crypto being out of favor, we’ve been buying in the crypto space lately. The way we will know if Bitcoin is in a larger uptrend (bulls in control) is the price has to stay above $14,000 to $15,000. This is a line in the sand. Due to sentiment, we could see one more minor pullback, and if this pullback holds the $19,000 region, then that’s a strong buy signal.

“Fundamentally, Bitcoin is in a much better position than when it traded around this price previously,” Beth stated. She notes that Bitcoin wallets have gone exponentially up, and companies such as Tesla, Square and others hold it on their balance sheets – meaning Bitcoin is certainly fundamentally stronger today.

Want to see more from Beth? Follow her on Twitter, and subscribe to her FREE newsletter where she delivers deep-dive analysis to your inbox every week.

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Apple Vs. The FAANGs (Technical Analysis)

Posted on July 18, 2022June 30, 2026 by io-fund

Apple Inc. (NASDAQ:AAPL) became the most valuable company in the world through creating and dominating the smart phone/mobile microtrend. As the majority of the global community went from zero smart phones to it becoming a necessity in their lives, Apple became the most valuable company in the world. However, like all trends, eventually it reaches the point of saturation. Instead of hypergrowth, we see competitors fight over existing customers on lower cost goods as revenue growth moves into a more consistent yet slower rate of change.

Apple epitomizes what it means to be both a good value stock and a good tech stock with its strong margins, outsized cash flows, stable balance sheet, and a loyal base of customers supporting the brand.

Apple has been very consistent with its margins and cash flows. The company's operating margin of 30.82% and the net profit margin of 25.71% are excellent, while most tech companies are currently struggling with the bottom line. It also has an outstanding free cash flow margin of 26.37%. The company has also been shareholder-friendly since it consistently repurchases shares.

We have not owned Apple because it is simply not involved in any of the new tech microtrends that will likely give us the next Google (GOOG, GOOGL), Apple, or Amazon (AMZN). However, this does not mean that Apple does not deserve a place within a portfolio.

Apple is an outsized beneficiary to passive investing. For those that do not want to pick stocks, and instead just own the index, Apple takes up the largest portion of this money. For example, if you don't want to own tech companies and instead want simply exposure through Technology Select Sector SPDR ETF (XLK), 23.47% of that money goes to Apple.

In regards to the S&P 500, which is the most passively owned index through various mutual funds and ETFs, Apple currently takes up 6.85% of the weighting in the S&P 500, and therefore gets 6.85% of funds going into the S&P 500. This is more than UnitedHealth Group, Berkshire Hathaway (BRK.A, BRK.B), Johnson & Johnson (JNJ), Nvidia (NVDA), and Exxon (XOM) combined!

Because of how its history of share buybacks, healthy Free Cash Flow, and its very large market cap, it remains a darling within institutional funds that are managing billions. In fact, as of June 30th, 16.07 billion shares outstanding are owned by institutions. This means that roughly 98% of all shares outstanding are owned by institutions.

Even though it is not in the forefront of AI, Machine Learning, Cloud or Big Data, it is uniquely setup to capture an outsized portion of passive investors' funds as well as institutional funds. Therefore, it is difficult to imagine the broad markets making new highs without Apple.

Technically, Apple has exhibited a level of relative strength in this bounce that is what you want to see in confirming a broad market trend reversal. It has reclaimed the $145 resistance level, which is a key supply zone to take back. Whether it will hold it is the question?

The fact that Apple has reclaimed the $145 level is a show of strength, regardless of the weakness in the momentum. If the other FAANGs were showing the level of strength APPL is right now by reclaiming key resistance levels, that would be encouraging that a meaningful low is underway. However, we are just not seeing that right now.

Google

We recently wrote about how Google (Alphabet) is our second favorite FAANG. In a cookie-less world due to Apple's notable change to its IDFA, owners of 1st party data, like Google, are setting themselves up to further dominate. This catalyst, coupled with its positioning within the AI microtrend, is the reason why it reserves a position within our portfolio.

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This also lines up with the technical chart on a long-term basis. Google is the healthiest chart amongst the FAANGs, as it is comfortably above its critical support zone at $1800. As long as any additional weakness is seen here, above this critical support suggests that GOOGL is one of the FAANGs that is likely to make a new high.

However, over the next month, it appears that Google is tracing a bear flag pattern. This is a common pattern that we see in 4th waves, which suggests we need one more wave to complete the 5 wave pattern in Google's drawdown.

Netflix

NFLX is another FAANG that we believe has a higher probability of making a new high in the next growth cycle than most believe. While market was focused on NFLX reporting a subscriber miss of 200,000, it failed to recognize that NFLX is on track to monetize around 100 million new subscribers who are sneaking onto the platform through shared passwords. We wrote about this extensively in a recently report, and as a result has entered into our matrix of potential positions to own going into the next growth cycle.

We believe NFLX is undervalued based on where this monetization will take its revenue in the coming quarters, and this is showing up in the chart on a long-term basis. However, over the next month, Netflix looks to be tracing a bear pennant pattern/triangle pattern. These are common in 4th waves, suggesting one more push lower to complete the drawdown.

Microsoft

Microsoft (MSFT) is one of the FAAMGs that we believe will continue to exhibit dominance into future tech trends. It is one of the leaders in the on-going cloud trend, and is also setting itself up to lead in edge computing and machine learning. We believe Microsoft has multiple catalysts to maintain its growth, which is why we own it within our portfolio.

We think Microsoft is the best risk/reward mega-cap tech stock due to its firm foundation in the cloud and its diversified cloud products. It's also positioned for outsized growth due to its exposure to secular tailwinds such as Artificial Intelligence (AI), Machine Learning (ML), and the build out of the 5G network edge. We think Microsoft will take a substantial share of these markets at the infrastructure level due to its relationships with the Fortune 500 and Global Fortune 2000.

The company's business relationships with Fortune 500 companies, brand image, and wide user base are the moats that will help the company drive revenues in the hybrid cloud, machine learning, and artificial intelligence segments. Microsoft Azure is used by more than 95% of the Fortune 500 companies, which shows the company's dominance across enterprises.

This is also present within the long-term chart of Microsoft, as it is another FAANG that has a high probability of making a new high in the next growth cycle. As long as it critical support holds at $215, this will remain our primary outlook. However, like the rest of the FAANGs, it looks like it is setting up for one more push lower before we can start looking up.

Amazon

Amazon also looks ready to break the $101.50 support zone in what looks like a 4th wave top. The RSI continues to fail under the key bear market resistance at 57. We also have a confirmed Negative RSI Reversal Signal, which is when the RSI makes a higher high while price makes a lower high. This is happening well underneath the bear market resistance of 57 on the RSI. The odds favor one more push lower.

Nvidia: A Leader in AI Hardware and AI Software

Posted on July 15, 2022June 30, 2026 by io-fund

If you were to guess, when do you think we wrote the following paragraph?

“When a thesis is not reflected in the revenue segments yet, there are typically lower entry points and ongoing volatility. You’ll see in the technical analysis that although I could not be more bullish on this stock long-term, there is weakness in the semiconductor sector and we hope this translates to a lower entry point for our readers.

The market is also in a fierce debate between AMD, Intel, and Nvidia and is also distracted by other chips, such as Micron and NXP. In my analysis, I look for growth. How big is the market relative to how big the company is now?

You can ignore Nvidia’s gaming revenue and other segments for the main trajectory that we are focused on. Gaming is great for stability and earnings reports, but the growth will not be from gaming (a market where Nvidia is already a mature, market leader). I’m also not focused on PC sales or the CPU-powered cloud, as the first is not a growth market and the second is not the piece in the cloud stack that will accelerate future technologies.”

That was written in 2019 yet the far majority of those concerns could be stated verbatim right now. Do we care about PC sales or gaming consoles? No, although our stance is that we have to expect these concerns will affect our semiconductor positions at times. The good news for Nvidia and AMD investors is that as time goes on, the less consumer-related hardware will have an impact. The 2022 Nvidia Investors Presentation provided numbers which show in detail how consumer exposure will become less of a concern in the future for these AI heavyweights.

When do you think we wrote this analysis?

“Over the past few weeks, I have read many lagging explanations on the chip shortage – too many fabless semiconductor companies, too few foundries, automobile manufacturers paused ordering in March and didn’t prepare for the sharp rebound, tensions with China, and even a fire at the Asahi Kasei plant that specifically manufactures sensing devices for the automobile industry.

While all of these are true, the overarching issue is that the role of semiconductors has changed from a commodity to the primary accelerant of future technologies. This is because connectivity, automation, and ultimately AI, will disrupt every corner of every industry.

We saw this happen with data and cloud but now we must accelerate this to the next level for AI/ML and the common denominator is semiconductors. Automotive is only the beginning. We can add renewables to the list and even e-commerce as AR/VR and AI/ML attempt to prop up the leaders who are competitive enough to add these features first.

As a tech stock analyst, I don’t have the luxury of lagging analysis of any kind. My subscribers require (and deserve) forward-looking, and with my intense focus on semiconductor chips, I don’t think my readers are surprised that semis are under pressure due to an increasingly important role.

I have repeated (perhaps too many times) that there is no way forward without the semis. We are seeing this manifest in automotive right now, but as investors, we should get used to hearing about semiconductor shortages.

You and I can debate Palantir, Snowflake or C3.AI, for example, and the valuations or the right angle for AI/ML-driven software, but the common denominator to these companies is the need for semiconductors to drive forward AI and 5G.

Now, we add the enormous push for auto manufacturers to compete with Tesla, Apple, Lucid Motors and what we have is a bottle neck where the automotive industry filters into semiconductors.

My guess is the demand won’t be letting up for many years as we are no longer in the cyclical pattern that semis are notorious for. Instead, demand will outpace supply for years to come.

Is this a bad thing or a good thing for our stocks? As investors, we can either listen to the news or listen to management. In this case, they are not aligned. Machines trade off news and natural language processing (NLP) but as human investors, we have the advantage of looking deeper into the issues.

I have written volumes of analysis leading up to the triple-digit growth we are seeing now in the data center from AI accelerator chips. Most of this was written when data center growth was negative. For instance, my Nvidia thesis was set end of 2018 — and in 2019 Nvidia reported negative data center revenue year-over-year for four quarters in a row.reported negative data center revenue year-over-year for four quarters in a row.

I mention this because following a trend’s trajectory is more important than immediate gratification from the market. The trend will always win out over time.

I have maintained that chips will eventually lead the AI market and are the best angle for investing in edge computing. I have also defended our stocks against custom silicon. Now we have the first of what I predict will be many semiconductor shortages and bullish to me.

The shortage is that there are hundreds (thousands really) of companies that rely on semiconductors. This will come to a head with AI and 5G as those who go-to-market soon with these features will have an enormous competitive advantage.”

That was written at the height of the bull market in February of 2021. My goal is to illustrate there has always been headlines to worry about for the semiconductors. We’ve firmly held these stocks and bought during dips. In the past, from 2018-2019, I focused on the GPU-powered cloud and the CUDA moat here and here. Our 2020 coverage centered on the A100 GPU which we discussed at time of launch for premium here and continued coverage on the A100 about a year later on the free side.

Here is background on the A100:

“Nvidia released the Ampere architecture and A100 GPU as an upgrade from the Volta architecture. The A100 GPUs are able to unify training and inference on a single chip, whereas in the past Nvidia’s GPUs were mainly used for training. This allows Nvidia a competitive advantage by offering both training and inferencing. The result is a 20x performance boost from a multi-instance GPU that allows many GPUs to look like one GPU. The A100 offers the largest leap in performance to date over the past 8 generations.”

Nvidia's AI Dominance Will be Propelled Forward by Software:

I wanted to go back through a bit of Nvidia’s history – what was the thesis and how did the thesis evolve? – before I go into how Nvidia will continue to dominate. In my opinion, I believe this is the most important analysis I have ever written on Nvidia because the company is changing rapidly into a software company.

The shift that Nvidia is going through has gone unnoticed and that’s to our benefit. Because we have been hell bent on finding what companies will dominate AI hardware, I’ve been asked frequently who do I think will dominate AI software (Palantir? Snowflake? Google?)

I’m prepared to give you that answer today: I believe Nvidia will be one of the biggest or perhaps the biggest AI software stack company in the world.the biggest AI software stack company in the world. The analysis below kickstarts our in-depth coverage on this new thesis — and I fully believe I will be quoting this analysis in five years from now when we check back on how the AI software thesis played out.

Before I go into semiconductor jargon where I risk losing your attention, I want to make sure our Members are fully aware that the segment where Nvidia will dominate with AI software is automotive. I am not talking about a few OEMs that trickle into a little bump in revenue. I am saying that Automotive is scheduled to become Nvidia’s number one segment – even over data centers – and to the tune of it being 3X larger than its gaming segment.

Don’t take my word for it because the CFO said exactly that (more on this below) and there is ample evidence that this is happening, which I also detail for you. Wall Street won’t be giving this the credit it deserves until 2023 at the earliest but you will hear non-stop “Nvidia Automotive” coverage by 2024-2026 as this segment ramps. I go over why those are the target dates below.

But first, let’s talk about the H100 and how this new GPU architecture will also help Nvidia lead on AI software at the enterprise level. There is plenty going on outside of Automotive that we need to cover so I kept automotive for last.

GTC Highlights: The Hopper H100 GPU

In March at GTC 2022, Nvidia announced the Hopper H100 GPU with 80 billion transistors and will be released in Q3 of this year. For reference, the A100 has 54 billion transistors. This is Nvidia’s solid attempt to keep their stake in the ground in leading high-performance computing over AMD’s Instinct MI250/250X and the newly announced MI210.

It’s easy to focus on hardware with Nvidia (and AMD) yet these companies are becoming more software-driven each year. By owning the majority of the market for AI accelerators, these two companies are afforded an opportunity to also own the software layer as a means to lower the barrier to entry for training models, deploying inference across various frameworks, and other workloads related to deep learning, conversational AI, video conferencing algorithms, and more. By supplying the hardware, these companies have natural inroads to machine learning operations (MLOps).

The H100 is the New Artificial Intelligence Infrastructure

DGX, DGX Pods and DGX SuperPods:

The H100 will power all AI and high-performance computing systems including the PCI express accelerator for mainstream servers and many H100 GPUs can be combined to power advanced AI through the following systems: DGX, DGX Pod and DGX SuperPod.

The difference between the A100 and H100 is the performance will be two to three times faster. The H100 GPUs and the DGX H100 server pods and super pods offer Nvidia the next leg-up as the company has solved an important bandwidth issue.

Hopper tackles some of the bigger issues around previous generations like speeding up algorithms by offering dynamic programming on GPUs to break down problems to simpler subproblems, boosting bandwidth by 3X with SHARP in-networking computing and Infiniband Switches, and the H100 can leverage NVLink to connect eight H100s into one giant GPU for 640 billion transistors, 32 petaflops, 640GB of HBM3, and 24 terabytes per second of memory bandwidth.

The chip is custom built by Taiwan Semiconductors with a 4nm design making it the world’s fastest 4nm GPU. The H100 has about 50% more memory and interface bandwidth than the A100. That’s 1.5X more bandwidth with the NVLink connection and PCIe 5.0 doubling the bandwidth of PCIe 4.0. The H100 will ship with support for 80GB of HBM3 memory at 3 TB/s speed.

The NVLink is now able to link together server nodes to build a data center-sized GPU. NVLink was originally designed to bypass the PCIe slot and has become an important tool for chip-to-chip connectivity, especially for high-speed operations. There is a dedicated chip called the NVSwitch which has increased the NVLink’s bandwidth. The ultimate goal is to run 32 servers with their own operating systems to run a single job. NVLink will complement the InfiniBand networking for high-performance computing and NVLink will be default for all of Nvidia’s chips, including GPUs, CPUs, DPUs and SoCs.

Where the H100 really stands apart is the leap in performance with about 3X more performance than the A100 and the H100 is up to 6X faster. The leap in performance is measured by H100’s ability to deliver up to 4,000 TFLOPS of FP8 compute, 2,000 TFLOPS of FP16 compute and 1,000 TFLOPS of TF32 compute and 60 TLOPS of general purpose FP64 compute. The A100 lacked support for FP8 compute at default whereas the H100 will leverage a transformer engine to switch between FP8 and FP16, depending on the workload.

According to Nvidia, the H100 delivers 9X more throughput in AI training, and 16X to 30X more inference performance. The company also states in HPC application-specific workloads, the H100 is 7X faster. The goal of the H100 was not only to add more transistors and make the H100 faster, but to also offer function-specific optimizations. This is achieved through the transformer engine.

The architecture aims to answer one of the bigger challenges facing superfast compute, which is that moving data into traditional servers overloads the CPU and system memory and becomes bottlenecked by PCI-Express.

By improving the bandwidth issue, Nvidia’s goal is to create more demand for their DGX Pod and SuperPod Systems, which in turn, will create more demand for their software.

The H100 DGX Pod is a 32-node, 256-GPU system. The H100 DGX Pod connects 32 DGX systems using the NVLink Switch System to scale into a super-GPU capable of 768 terabytes per second. To compare, the entire internet requires 100 terabytes per second. This results in 1 exaflop of AI computing.

From there, multiple H100 DGX Pods can connect through the Infiniband Switch to scale DGX Superpods with thousands of H100 GPUs. DGX SuperPods are turnkey systems that power enterprise AI. DGX SuperPods were also available with the A100 yet the H100 will have 6X better performance with 1 exaflop of FP8 AI performance to run trillions of parameters (more on this below).

Spectrum-4 Ethernet Platform

Perhaps one of Nvidia’s most important advancements for the H100 is the ability to attach the network directly to the GPU to avoid bottlenecks at the CPU. This is accomplished by sending data with direct memory access at 50 gigabytes per second. Hopper HGX and DGX are networking and interconnects that facilitate moving data with an advanced networking processor called the CX7. The result is the H100 CNX that avoids bandwidth bottlenecks and frees the CPU and system memory to process other parts of the application.

The Spectrum Ethernet platform, which consists of a Spectrum-4 Switch, CX7 SmartNIC and Bluefield-3 DPU will be used for several of Nvidia’s AI platforms, such as Riva, Merlin and Omniverse. These workloads include natural language processing, recommenders, and digital twins and will be supported by a networking system that helps exchange large databases between nodes. Whereas traditional workloads required many connections exchanging small amounts of data, the workloads of the future will require data to be shared quickly between GPUs and storage. This is accomplished by bypassing the CPU and sending data directly to the GPU while using the network hardware to move the data.

This is ideal for enterprise use cases where people are more likely to use Ethernet while AI and HPC workloads continue to use the Quantum-2 based off Mellanox’s InfiniBand. Quantum-2 allows for in-network computing to do data reductions in the network. It’s also more likely that Ethernet is used for 5G and sensors.

Eos: The First Hopper AI Factory

Nvidia is building AI factories to compete with AI supercomputers, which are blueprints for AI infrastructure that can be adopted by cloud partners and enterprises.

Eos is built with 18 H100 SuperPods, with 576 DGX H100 systems and 360 NVLink Switches. Nvidia states EOS is 1.4X faster than the fastest supercomputer and offers 4X the AI processing of the world’s fastest supercomputer. This will deliver 18 EFLOPS of FP8 AI compute or 9 EFLOPS of FP16 compute.

Previously, FP16 was the standard for AI whereas FP8 is gaining more support to become the industry standard. Depending on what AI compute you use, benchmarks will not be apples-to-apples if FP8 is compared to FP64 performance. Right now, AMD’s Frontier supercomputer is #1 with 1.1 exaflops of FP64 performance compared to the upcoming Venado supercomputer’s 10 exaflops of FP8 performance.

The difference is that the smaller bit size allows for an economical way to achieve more speed when giving up a small amount of accuracy doesn’t make a critical difference. This also helps in the face of a slowing Moore’s Law. FP8 is most commonly used for inference yet may be used for training in the future due to boosting throughput. Following the release of the Hopper H100, Intel released Gaudi2 which supports FP8. Chip makers Graphcore, AMD and Qualcomm have recently pushed for an industry-standard for the low precision floating point format FP8 rather than integer formats.

Here is what Nvidia said in the GTC keynote:

But the trend in AI computing has been toward developing neural nets that lean on the lowest precision that will still yield an accurate result. The smaller formats compute faster and more efficiently, and they require less memory and memory bandwidth. The addition of 8-bit floating-point units in the H100 leads to a significant speedup—double the throughput compared to its 16-bit units”

DPX Instructions (ISA):

The H100 improves dynamic programming with DPX Instructions that will help specific AI Algorithms to perform up to 7X faster than previous GPUs and 40X faster than CPU-based algorithms. As algorithms require more complexity, the new set of DPX instructions will help break the complex problems down into simpler subproblems using GPUs instead of CPUs or FPGAs.

The DPX ISA are expected to be broadly available with the CUDA 12.0 release. Examples of where this will be useful include disease research and drug discovery where the process can be sped up 35X for real-time processing to match the rate of DNA sequencing. Route optimization and finding the shortest distance between destinations for use in factories and autonomous driving systems, or Floyd-Warshall acceleration, is boosted up to 40X compared to CPU-only servers. These instructions will also be used for quantum computing and SQL queries as dynamic programming can help find the optimal order for joining a set of tables.

GPU Confidential Computing:

Data is encrypted at-rest and in-transit yet is often unprotected during use. Meanwhile, the data used to train AI models is worth millions in investments and is trained from domain knowledge and company-proprietary data. The new H100 offers confidential computing whereas previously only CPUs offered the protection of both data and applications during use.

Nvidia is Becoming a Leading AI Software Company

It would be easy to read the information above and to assume Nvidia is improving its hardware. However, the company’s future resides in software which will remove some of the cyclicality of hardware revenue. I believe once Nvidia’s software revenue begins to reveal itself in earnings reports, the market will finally piece together the true potential of this AI powerhouse.

It’s both the hardware and the software stack that led me to say Nvidia will surpass Apple in 5 years. You know this story well: the relationship between a hardware company leveraging their position to capture the lion’s share of the software — because that’s exactly what Apple did.

There are four layers to Nvidia’s full-stack accelerated computing: hardware, system software, platform software and applications. Below, I discuss a few ways that Nvidia is capturing more of the software stack due to vendor lock-in effects from their dominance in hardware.

As stated, in the past, our focus was the GPU-powered data center. This was a four-year thesis from 2018 and we doubled up on the thesis in June of 2020 for the A100 release. I want to make sure and emphasize that Nvidia’s lesser-known catalyst is actually the software.

The H100 is helpful in maintaining a lead in GPUs, which is critical turf to protect with GPUs being the most popular AI accelerator, however — the AI/ML catalyst will be further fueled by the Nvidia’s lead in software. This is why the majority of who will remain the AI leader will be up to developers and not the C-suite partnerships on hardware that characterized Intel’s lead over the past few decades. The developers choose the frameworks, the SDKs, libraries and the other parts of the software stack, and because of this, they also choose the GPUs they build on rather than IT departments.

Transformers

The transformer engine is one of the key aspects of the H100. Transformers are becoming one of the most popular neural-network models by applying self-attention to detect how data elements in a series influence and depend on one another.

Sequential text, images and video data are used for self-supervised learning and pattern recognition, which results in more data being used to create better models. Prior to transformer models, labeled datasets had to be used to train neural networks. Transformer models eliminate this need by finding patterns between elements mathematically, which substantially opens up what datasets can be used and how quickly. Transformers are partial to the parallel processing that GPUs offer.

Google first introduced transformer models in 2017 and transformers are used in Google and Bing Search. Transformers also led to BERT models, which stands for Bidirectional Encoder Representations from Transformers, and is commonly used for text sequences. Transformers are also used in GPT-3 (it’s the T in GPT) which improved from 1.5 billion parameters to 175 billion parameters. GPT-3 has the ability to report on queries it has not been specifically trained on.

Nvidia and Microsoft recently worked on a Mega transformer model with 530 billion parameters and the future for AI engineers is trillion-parameter transformers and applications. The H100 is already prepping for this. According to Nvidia, the training needs for transformer models will increase 275-fold every two years compared to 8-fold for other models. The H100 GPU with its Transformer Engine supports the FP8 format to speed up training to support trillion-parameter models. This leads to transformer models that go from taking 5 days to train to becoming 6X faster to only taking 19 hours to train.

The transformer engine is software combined with the new hardware in the H100’s tensor cores. As discussed, the A100 was designed for floating-point numbers to 16 bits while the H100 is designed for 8 bits. This is helpful because AI models are moving toward neural nets that lean on the lowest precision and yet still yields an accurate result. In this case, 8 bits double the throughput of 16-bit units, compute faster and more efficiently, and they require less memory and memory bandwidth.

The main feature from the Transformer Engine is the ability to choose what precision is needed for each layer in the neural network at each step, transitioning between 8-bits, 16-bits, 32-bits, plus the H100 is able to do matrix math with two forms of 8-bit numbers with either 5-bits as the exponent or 4-bits as the exponent: E5M2 and E4M3. This is important because the E4M3 may be favored for back propagation while E5M2 may be favored for inferencing.

Pictured above: Nvidia is prepped to support model sizes growing up to 275X every two years

Triton Inference Server:

Nvidia offers AI frameworks to reduce time for developers throughout the AI workflow from data processing and ETL to deep learning model training and large-scale inferencing. These libraries include Dali, Rapids, Triton and Magnum I/O. The library supports all popular frameworks and offers pre-trained models and data pipelines.

Triton is open-source inference software that helps developers deploy models across GPUs and CPUs, it supports Tensor Flow and PyTorch, any query type and any model – such as Transformers or CNNs (used for image recognition) and RNNs (used in speech recognition). The inference engine helps developers take AI development from experimentation to production by removing the need for multiple inference servers and simplifying machine learning infrastructure on the backend.

MLOps (machine learning operations) helps developers with less ML expertise to train and deploy models yet there were limited use cases with little help in deploying custom models. Triton offers high performance inference and scalability with Dockers and Kubernetes while serving up to hundreds of models with the model control API. By supporting all popular frameworks, Triton helps developers avoid framework lock-in due to the consistent interface regardless of training framework or hardware.

Nvidia will Power the Lion’s Share of Automotive – and that means software licensing

Nvidia’s lead in automotive across dozens of OEMs requires its own deep dive. The reason I haven’t prioritized this is because Hyperion 8 is shipping in 2024 and Hyperion 9 will ship in 2026. However, as long-term investors, we should touch base now on the long-term vision for yet another large and sweeping revenue segment. In fact, automotive promises to be Nvidia’s largest segment by 2030 – so on that alone, imagine what Nvidia investors have in front of us.

Nvidia’s Orin SoC (system-on-a-chip) is designed for the neural networks that run robots and AVs at the edge. This is the central computer for the car. The Orin SoC is capable of 254 trillion operations per second by combining Nvidia GPUs with Arm CPU cores and TensorRT APIs. The goal is to help OEMs move from Level 2 autonomous systems to the elusive Level 5 and it stiffens the competition with Tesla’s FSD. Notably, at the release two years ago, Tesla pointed towards Orin’s power consumption as a potential issue for EV batteries but this has not stopped many competing EVs from adopting Nvidia’s in-vehicle hardware and DRIVE software stack.

The EV manufacturers that have already moved forward with Nvidia DRIVE Orin include: Nio, Xpeng, BYD, Lucid Group, Mercedes and Land Rover, GM Cruise — you name it, it’s probably in production with Nvidia at this moment. The company’s current automotive pipeline exceeds $11 billion over the next six years – expect this small blip of pipeline to grow exponentially.

Nvidia recently announced an upgrade to Orin called Atlan with 1,000 TOPS on one chip, or more than then Level 5 compute in AVs today. This chip will catapult forward the computing performance of AVs and is expected to be released in 2023.

Nvidia DRIVE is the operating system and software stack for vehicles that offers an execution environment and includes both security and over-the-air updates. DriveWorks is an SDK that enables self-driving applications. Drive AV offers key ingredients to an autonomous system, such as perception, mapping and planning modules. Regarding mapping, Nvidia DRIVE Map is a multi-modal drive engine that can map independently and has two map engines. Drive IX is open-source software that offers vision, voice and graphics for the user experience. (I will do a separate deep dive on Nvidia Automotive in 2023).

The entire autonomous platform is called Hyperion, which includes the compute and sensor toolkit. This includes the hardware plus a 360-degree camera, radar, lidar and ultrasonic sensor suite. As stated, Hyperion 8 ships in 2024 with Hyperion 9 shipping in 2026, which will double the processing speed and offer an increase in sensors. Nvidia offers open-source developer kits to help increase its compatibility across various projects.

Rather than train the vehicles on the road, Nvidia trains in simulation and can create virtual world obstacles for the vehicles to learn from. This is a different approach from companies like Tesla who have millions of cars on the road collecting data which they then augment for unusual events with a photorealistic simulator.

Tesla has the most data of any car manufacturer which helps the company competitively as more data equals better performing models especially in terms of object detection. More data from millions of cars on the roads also helps with prediction as Tesla collects data from incorrect predictions that can be added to the training set. By leveraging a prediction neural network, Tesla does not need to use human labeling or annotation and can instead use what’s called a temporal sequence of events — in other words, Tesla rewinds events and labels objects automatically with the use of a supercomputer.

The advantage here is that training neural networks correlates with the miles (which again, are substantial due to size of fleet on the road compared to competitors) rather than correlating with the need for human labeling. The result of automatic labeling is that Tesla is able to predict rare situations with more accuracy.

Where Nvidia delivers a strong advantage is the company has decades of history with graphics and simulation due to its gaming roots. As stated, Tesla also uses imitation learning and has a photorealistic simulator which uses vector space for labels and functions like a game engine. However, Nvidia has been quietly working on their simulation platform for many years internally despite only recently marketing Omniverse to the public. In this case, Nvidia has such a high-level of confidence in their simulation skills that they forego the real-life fleet to primarily train virtual 3D models. The company is also packaging the simulation platform for many other uses cases, such as AI factories, 5G networks, power plants and climate research. Developers can work with 3D tools through Python-based development.

Here’s a 10-minute demonstration with the simulation platform here around minute 7:00.

To keep it simple, Tesla’s primary advantage is the data they have collected as no other EV/AV has collected this level of data from real drivers. To contrast, Nvidia has arguably the best simulation platform due to decades of graphics work. These digital twins are only now being widely marketed despite being in development for over 5 years. The license costs $9,000 and Nvidia has estimated its current addressable market is 20 million engineers. Notably, Nvidia’s Hyperion will also be deployed in millions of vehicles over time, offering similar levels of data as Tesla’s fleet.

The Tesla VS Nvidia debates have not formally begun but they are certainly in our future … so brace yourself. Ultimately, the way Nvidia stands apart is the company does not directly compete on manufacturing vehicles. This is something anyone can agree on. That means many OEMs will use Nvidia’s DRIVE system whereas Tesla is less likely to commercialize their software as they’re viewed as a main competitor.

As long as Nvidia continues to innovate and maintain a lead, the popularity of its DRIVE system is likely to remain due to the company’s strategic advantages in AI and supercomputing. The company did an excellent job of tackling the edge computing use case of autonomous vehicles first.

Hardware is only part of the equation. The long-term plan is for Nvidia to license software for autonomous vehicles, which will create a recurring revenue stream. The licensing fees will go well beyond Omniverse to include the actual owner of the vehicle paying a subscription fee to Nvidia for its software. Tesla does this with their AutoPilot software which has grown from $5,000 to $12,000 per vehicle.

The breakdown according to the 2022 Investor Presentation looks like this:

$100 billion from gaming
$300 billion from chips and systems
$150 billion from AI Enterprise software
$150 billion from Omniverse software – fees are charged to both users and robots/digital twins
$300 billion from Automotive – primarily software

What Nvidia is communicating is that software revenue will surpass hardware revenue long-term.

Here is what Kress stated: "Our software content per vehicle can be in the thousands of dollars over the lifetime of the vehicle compared to the hundreds of dollars for the hardware. And second, software scales with the installed base of vehicles, not annual production.”

Note on CUDA:

The software discussion on Nvidia is not complete without a mention of CUDA. We called this Nvidia’s moat back in 2018 and we continue to believe it provides an important moat. The CUDA-related libraries include frameworks that span quantum computing, robotics, 5G networks, cybersecurity and drug discovery. The universal skills taught around CUDA and Nvidia’s SDKs help to drive more business for Nvidia’s GPUs.

Note: I’ve covered Omniverse in-depth here.

Risk: Valuation

The primary risk right now is valuation as Nvidia trades 2X higher than its peers on both the top line sales valuations and on the bottom line with earnings and cash-based valuations. There’s probably equal risk in waiting for Nvidia to drop another 50% as there is in buying Nvidia at the 2X valuation. One reason Nvidia may be valued here is because it’s slowly becoming a software company. Regardless, Knox’s technicals help immensely in determining if the market will continue to award Nvidia it’s gold medal valuation or if the market will discount Nvidia based on sentiment-driven headlines. This is a position we plan to keep on building so you can keep an eye out for those trade alerts over the next few years.

Conclusion:

Finding great companies is only half the battle, fighting negative sentiment is the other half – and semis have no shortage of this in any market – hence our beginning quotes from 2019 and also 2021.

Nvidia is the strongest company in terms of product on the market today. That doesn’t mean semis won’t be a roller coaster – we should fully expect that semis will undulate in sentiment and price while we hold our stocks over many years. We can’t change the way Wall Street works — which is a pendulum that swings between value stocks and growth stocks — but we can describe in great detail why concerns around gaming and consumer electronics slowing down is not going to change our position. We do not care to perfectly time entries or to find a perfect bottom – you’ll be hard pressed to find any legendary investor recommend that this be an investor’s goal. What we care about is finding quality companies and building those positions over time. Nvidia fits this description.