We issued a press release yesterday in Business Wire with our full audited returns entitled “I/O Fund Catapults to 131% Cumulative Returns Due to Leading AI Allocation,” which you can find here.
The I/O Fund portfolio posted returns of 56.9% in 2023. If we were a hedge fund, our ranking would be #4 in the Wall Street’s Journal Winners’ Circle ranking of 1,191 funds. For those who don’t have access to the article since it’s behind a paywall, the average fund returned 19.7% in 2023 and the top three funds returned 65.2%, 59.1%, 57.2%, with the fourth returning 55.6%.
Source: Wall Street Journal
Our cumulative returns of 131% also exceeds other tech peers. When compared to the most popular tech ETF on the market, we are ahead by as much as 157%.
If you had invested $10,000 with the I/O Fund’s picks versus other all-tech portfolio at inception, the difference would be a portfolio value of $23,052 with IOF versus $8,982 with popular tech ETFs. The difference in value is 157%.
Our high allocation to AI of 45% in 2023 was timely as it allowed us to beat Wall Street to the explosive trend of AI. Nvidia was a strong call by our firm and was our largest position at the time of its knockout report. Most importantly, our track record places us as a front runner within this trend, and we are confident we will find additional winners. We exited the year with an AI allocation of 52%.
A Few Important Stats About our Performance:
The I/O Fund’s cumulative returns of 131% outperformed the Nasdaq-100 by 49%
The I/O Fund cumulative returns of 131% outperformed the S&P 500 by 68%.
The I/O Fund’s cumulative returns since inception of 131% compared to popular tech ETFs at (-10%) with a relative outperformance of 141% in less than four years.
Since inception, the I/O Fund has a lead over institutional technology portfolios by as much as 157%.
Our 2023 returns of 56.9% would rank us as the #4 performing hedge fund in the United States, according to the Wall Street Journal.
We had seven positions beat the Nasdaq-100. These positions were Nvidia +237%, Bitcoin +158%, Chainlink +168%, AMD +123%, Ethereum +92%, CrowdStrike 58%, and Microsoft 54.6%.
In 2021-2022, we issued 9 buy alerts under $200 for Nvidia with the lowest at $108.51 on October 13, 2022 for gains of up to 775% in eighteen months.
During the same time period, we issued 11 buy alerts on AMD under $110.
2023 Winning Positions Overview
Nvidia:
On average, a 15% allocation, which was our top position for most of 2022 and 2023. The returns for 2023 were 237% for 2023.
Bitcoin:
Once we confirmed a new uptrend in Bitcoin, we began to accumulate heavily throughout 2023. It is now one of our top 3 positions, and returned 158% in 2023.
Chainlink:
Chainlink has been a staple in our portfolio. It once held a 7% allocation in late 2020, and we reduced it to 2% in 2021. Now that we have a new confirmed bull cycle, we have been accumulating this alt coin in 2023. It returned 168% in 2023.
AMD:
AMD has been a top 3 position for most of 2022 – 2023. We heavily accumulated throughout most of 2023. The position was up 123% in 2023.
Ethereum:
Ethereum was up 92% in 2023 and has been a solid holding for us in 2024, so far.
CrowdStrike:
We began accumulating CrowdStrike in the $160 range. It returned 58% in 2023. We have since been taking significant gains in the $280 – $320 range, and it still remains a 6% position.
Microsoft:
Microsoft was up 54.6% in 2023. We began taking gains in 2023 and have continued into 2024. We plan to begin accumulate when the valuations become more favorable.
Performance Review:
Below is the engagement letter from the firm that reviews and verifies our performance. Our terms and conditions with the accounting firm state that this engagement letter is to only be shared with paying customers. For that reason, our performance letter resides behind our paywall.
With that said, any paying customer can access the engagement letter which is posted on io-fund.com for this purpose. The I/O Fund owns the performance review and we do not authorize our customers or any person on our site to share a confidential engagement letter or performance review outside of our paywall. As the owner of the report, we will at times market our performance number outside of the paywall. The terms and conditions can be found here.
The I/O Fund Mission:
The I/O Fund began as an experiment to see if a team of retail investors can beat Wall Street. We are setting out to answer the million-dollar or billion-dollar question, which is how to safely participate in tech while limiting the downside. We do not believe this question has been truly answered. Hedge fund managers often pick one tech stock or a few tech stocks and place them alongside a diversified portfolio as a means of limiting the downside. However, tech is the world’s most valuable industry – no other industry offers you the opportunity for life-changing gains repeatedly, year after year. Therefore, diversifying away from tech certainly helps protect the downside but it greatly limits the upside, as well.
That leads to our mission, which is to offer an all-tech portfolio that participates in the upside yet aims to limit the downside. That’s how we hope to set our portfolio apart. Our comparison chart proves we are off to a great start in answering this problem.
When it comes to research sites, our edge is the accountability and transparency we offer. By tracking every trade in real-time, we are forced daily into instant accountability on every action we take. What results is rapid self-improvement, similar to athletes who track every mile they run, or every swing of the bat. By measuring every single daily action, our accountability has shot through the roof as has our drive to improve.
Real-time trade alerts and an audited performance are extremely uncomfortable when you’re not performing well. However, it was this very thing that forced us to become better over the past four years. We made the case in our free newsletter that this is partly why retail performs so poorly. There are simply too few resources available that mirror what real money managers do. Transparency is integral to outperformance; money managers have to answer to their daily actions and this forces them to become better.
With that said, most professional money managers resemble what Knox does on the I/O Fund site, which is actively managing positions, with lots of activity, pivots and course corrections. This is the reality even if Retail is sold on the utopian idea that you can buy one stock and hold into eternity. In some cases, this is the correct thing to do, but it’s rare.
Risk Management:
What’s important to remember when viewing our returns is that Ark had strong returns in 2023, primarily due to Coinbase’s phenomenal performance of 400%+ which was their top position — yet our returns on a cumulative basis are 157% higher than Ark’s because of our emphasis on risk management. Retail investors are often hyper focused on the upside, which is a grave mistake because losses are geometric in nature. For example, if you are down 50%, you must go up 100% to break even. If you are down 80%, you have to go up 400% to breakeven. The impact is visible when you view our cumulative returns compared to others who had steeper losses in 2022. What separates smart money from retail is an emphasis on limiting the downside.
Conclusion:
The I/O Fund's mission since inception is to help retail investors beat Wall Street in the competitive and complex tech sector. Our experiment in providing institutional-level research and tools to retail investors has been successful since we first launched in 2019. This includes having a cloud-focused portfolio in 2020, beating our other all-tech portfolios in the tough years of 2021 and 2022, and pivoting to a high AI allocation well ahead of 2023, which helped us triple our performance on a cumulative basis.
In the arena of investing, 2023 was a strong win for us. We easily rank in the top 90th percentile according to publicly available information on the annual returns and our cumulative returns. What I hope our members see when they review our performance is a team that has strived to deliver quality and value. The only way to truly beat Wall Street is by remaining humble while working hard at producing original analysis. The value of original analysis cannot be underestimated when working in an environment where ideas are recycled, an investment edge becomes quickly eroded, and competition is high. What we intend to deliver is the opposite, which is original and actionable analysis that helps our members get ahead of Wall Street.
We want to thank you for your business and your vote of confidence in our abilities. We love our jobs, and we are honored to tackle 2024 with you.
Last year was a stellar year for investors – in 2023, the Nasdaq 100 rose 54% for its best annual return since 1999, while the S&P 500 gained 24%. The Magnificent 7 were the de facto leaders of this market rally, with the group’s returns averaging 111% for 2023 and accounting for more than 60% of the S&P 500’s annual gain.
This was the opposite of 2022, the only year in history in which Treasury bonds and the S&P 500 both lost 10%. It was a year so rough that it marked the greatest destruction of wealth in modern history with an estimated $57.8 trillion lost across all asset classes combined.
And while 2023’s Big Tech-driven rally looks superb in headlines, a deeper glance shows this was not always the case – especially when accounting for 2022’s steep losses. In fact, on a 3-year cumulative basis, the indexes’ performances make a strong case for investing in indexes over ETFs.
Simply put, allocating only to a leading sector, such as cloud in 2020 and 2021, would lead to significant underperformance through 2022 and 2023, when multiples were cut dramatically as budgets were slashed. Semiconductors underperformed in mid to late 2022, but outperformed significantly in mid to late 2023. It’s these disparities in between different sectors of tech that prove the value of active investing versus passive investing.
Our firm believes that having an actively managed portfolio is where you get the best of both world’s – performance that far exceeds the indexes and ETFs by paying close attention to allocation, (quickly) cutting stocks that do not meet specific criteria, and choosing stocks that have strong, fundamental strength.
The I/O Fund is releasing our official 2023 returns plus our updated cumulative returns next week — so stay tuned to your inbox. Our returns help to prove an actively managed portfolio can exceed all indexes and major ETFs on a cumulative basis (that we are aware of).
However, before we release our returns, we think it’s prudent to discuss the importance of verified returns for retail investors. The I/O Fund goes to great lengths to deliver a rare level of transparency for our Members. This is not about a victory lap; it’s about raising the bar. We do not know of another research site that publishes every single trade in real-time, and then takes this further to have their performance independently verified. We do this because it’s the right thing to do, but there are other reasons putting our best foot forward with verified returns is important for retail investors.
The New Norm of Quant Trading Puts Retail at a Disadvantage
Algorithms account for up to three-quarters of equity trading volume, as hedge funds and investment banks are increasingly turning to algorithms and quant trading systems to outperform benchmarks. Algorithmic trading is one of the primary culprits to the extreme volatility seen in recent years, most notably with the flash crashes and rallies of 2020.
This creates a serious disadvantage for retail investors and those who do not have a team of Python developers to leverage quant systems that trade in the blink of an eye. Ray Dalio, the fund manager for Bridgestone, has openly discussed that the best approach to the modern-day stock market is what he calls “the man and machine.” His firm has 1,500-employees that use computer models to test hypotheses; which is just one of the many advantages hedge funds and institutions have over retailers.
According to Dalio, the ideal is to have an algorithm work alongside a portfolio manager for a customized approach to predicting the markets. Although the I/O Fund does not have a team of Python developers, we partnered with Vincent Duchaine of WealthUmbrella in 2022 to close the gap between human-driven actions and emotionless machines.
This marked an important turnaround for our firm as we gave up what I would call “retail idealism” which centers around the idea that holding a stock for a long period of time is retail’s only defense. This works during times of economic expansion, but where this can go (horribly) wrong is when a new, more challenging macro changes the outlook for any given company.
For example, in 2022, hundreds of tech stocks finished down 70%, and nearly every tech stock finished down 50%. This includes the indestructible FAANGs, with many falling to trade at historic low valuations. An investor would have to be in denial to focus on the poor performance of an individual company rather than acknowledge something much bigger was going on. 2022 highlighted a crucial yet overlooked point (that we encourage our readers to do): let go of the idea that picking good stocks alone can save a portfolio in the tech industry and to instead fully embrace risk management tools.
2023 reiterated this point very well – although numerous stocks saw face-ripping rallies, such as Nvidia’s 239% rally and Meta’s 156% gain, only a handful outperformed and ended with positive returns on a 2-year basis from 2022 through 2023. Looking at Meta, despite that 156% rally, it ended just 5.2% higher since the start of 2022. Tesla rallied nearly 102% in 2023, but since the start of 2022, returns were (-29.5%). Alphabet’s 2-year return was (-2.6%), even with its 59% rally in 2023.
Risk Management Tools
In April 2022, the I/O Fund stopped relying on stock picks as the primary, offensive measure because this approach simply wasn’t working with the new macro. After partnering with Wealth Umbrella on an automated hedge, the I/O Fund began to boldly hedge up to 100% of our portfolio, at times, and we still continue this approach today.
We pivoted to playing defense rather than offense. Those who watch team sports will understand this transition well, as the strategy changes from attempting to make money (or make a goal) to a strategy that prevents losses (or prevents a goal).
Unlike many other all-tech portfolios and ETFs, we believe a more active stance is necessary for long-term tech investing. We also believe that the easy years of buy and hold are over, marked by the narrow leadership we saw in 2023 where a small number of stocks drove the rally last year. As a result, we rotate our portfolio frequently, raise cash and actively hedge our portfolio with an automated signal.
Real-time trade alerts are sent to our members the minute we decide to buy, sell, trim or add to a stock. For those who may not be aware, this is extremely challengingextremely challenging to do as it combines the two most advanced forms of portfolio management.
One of the most advanced forms of portfolio management is real-time trade alerts. This places immense pressure on a portfolio manager as the stakes are high to record what you do every second in real-time. To voluntarily choose to have the highest level of accountability in retail is nearly unheard of, yet registered fund managers are required to do this and file their stock trades.
Secondly, hedging up to 100% of a portfolio is also a large psychological hurdle, and traditionally a risky one. Markets spend the vast majority of their history in uptrends, for one. Secondly, the amount you can lose on a short is literally infinite, to where one’s downside risk is capped at 0 on the long side. To overcome these hurdles, we have spent considerable resources developing a “man and machine” signal with the help of Wealth Umbrella that is truly state of the art.
It’s only natural for retail services to want to ease the pressure of having to report in real-time. The stakes are much higher when what you do is recorded the minute the action is taken, but overall, having the highest level of accountability possible has made the I/O Fund much sharper investors.
Logging trades in real-time also places immense pressure on the analysts at the I/O Fund, as well, who are not allowed to simply choose a stock but must also determine the allocation for the stock. After recommending a stock, the analysts must help the portfolio manager actively manage the position, which can change at any time.
There is a reason most services do not provide this level of transparency and activity. The more granularity that is offered, the more skill is required. Also, compare this to social media, where some investors will casually claim trades that were not logged in real-time.
Verified Returns
In addition to a lack of risk management tools, I believe a lack of verified returns in the retail space contributes to the losses this investor type experiences. Smart money is careful about who they consider a good investor — they do not take someone’s word they are a good investor; they make the investors or firms they follow prove it. Every single hedge fund must report their returns, which reduces the chances of posturing.
Retail is not offered these checks and balances, and instead, this investor type follows many influencers and research sites who verbally state their performance without proper verification. Across the board, retail is offered a very low amount of accountability – this includes unverified month-end reviews, a list of stock tickers, unchecked screenshots, or other methods that are easy to manipulate. This widespread acceptance of loosely stating a stock performance is odd, to say the least, considering the finance industry is more inclined than any other industry toward deceptive practices.
How the I/O Fund Sets a High Bar for Accountability
Over the past three years, the I/O Fund has invested over $165,000 into accountability and transparency for our members. When we launched in July of 2019, for the first year or so, we used a forum hosted by Tribe for our trade alerts, but by January of 2021, we had migrated to SMS and email tools that were the least likely to experience an outage for our real-time trade alerts. This costs us $30,000 to $40,000 per year, depending on our trading frequency.
In addition to this, we use an auditor from a large firm in San Francisco to mathematically review and verify the performance of our I/O Fund portfolio trading account and crypto account. The process is quite extensive and it takes up to four months to complete. This costs $4,500 per audit and we’ve completed five audits for a total of $22,500 spent on this process. Accountability is expensive but we feel it’s worth it.
Conclusion
I believe real investors take necessary steps to prove their returns, that they accept the pressure that comes with registering trades in real-time and that they do not expect anyone, under any circumstances, to lower their standards and accept an unverified number regarding portfolio performance. Due diligence on stocks requires scrutiny, and this same level of scrutiny should be applied to the company you keep in the finance industry.
To put it simply, the I/O Fund was founded to bring the standards that smart money insists on to the retail investment class. We think retail will be empowered to outperform when their standards are higher on who they follow and what research they read, and when they refuse to accept a lower standard on transparency.
The I/O Fund is wrapping up our annual audit for 2023 this week (you can access our previous audits including here, here, here and here). We look forward to adhering to the high standards that retail investors deserve. You can look forward to our 2023 performance being published shortly.
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.
This article was originally published on Forbes on Mar 21, 2024,01:49 pm EDTForbes on Mar 21, 2024,01:49 pm EDT
Arm Holdings is positioned to capitalize on the growing adoption of artificial intelligence (AI) technologies, leveraging its established licensing model and extensive ecosystem to drive future growth. Arm's established licensing model offers a recurring and relatively stable income source, and the stock is seeing favorable price action due to the growing tailwinds from its higher-royalty v9 design supporting next-generation AI chips from Nvidia, Microsoft, Amazon and others.
Yet, despite Arm dominating the smartphone market with 99% share, the company has made very little on licensing compared to its partners. For example, mobile handsets created a $200+ billion segment for Apple, which relies on Arm technology for the iPhone, yet only resulted in (roughly) $3 billion for Arm. In this case, it was far better to own Apple.
The market is excited about the fact that AI will drive double the licensing fees for Arm. My contention is that, similar to mobile, it’s better to own the AI leaders who license Arm’s technology rather than Arm. Analyst estimates have Arm growing to $6.5 billion by 2028. For our purposes, this isn’t high enough growth to ensure insiders, aka SoftBank, won’t take their exit following the IPO lock-up expiration. Frankly, the valuation on Arm is absurdly expensive, at more than double the most-expensive chip stocks, including Nvidia. This is why we’ve stated in the past that Arm makes a better acquisition target. For public investors’ purposes, there is no riskier proposition than an IPO that is richly valued.
Background on Arm
Arm offers the most popular CPU architecture in the world with 250 billion chips shipped since inception, of which 30.6 billion were shipped in FY2023. It’s most dominant in mobile CPUs with 99% market share, and 40.8% in automotive, for an overall share of 48% in Arm’s related markets. This dominant market share is achieved through its developer ecosystem.
For mobile (and how it came to reach 99% share), Arm’s design known as “heterogenous compute” has helped facilitate lower power requirements as the architecture allows different CPU parts to work together for improved efficiency. This enables workloads to work across both high-performance and low-performance CPU cores to lower energy by balancing performance.
Arm’s different licensing models are the following:
Arm Total Access Agreements: It is a type of licensing model wherein the company provides a package of CPU designs and related technologies for an annual fee. The agreement has a fixed term and Arm reserves the right to modify the package by adding or removing specific products.
Arm Flexible Access Agreements: This model provides a selection of CPU designs and related technologies for an annual fee. However, the latest products are not included. In comparison, the total access agreement is a comprehensive package. Another key difference is that the customers need to pay a single-use license fee for specific products if they are included in the final chip design. Like total access agreements, the company reserves the right to modify the package.
Technology Licensing Agreements: It involves licensing a specific CPU design or technology to the customer for a fixed fee. The license can be used for a fixed term or the number of uses.
Architecture License Agreements: Under this agreement the customers design their own customized CPU designs using the Arm’s Instruction Set Architecture (ISA).
Arm’s v9 Architecture
The latest Arm v9 architecture offers significant improvements in performance and efficiency, particularly for artificial intelligence (AI) applications. This has led to increased adoption by its partners, particularly in the premium smartphone segment and with hyperscalers developing their own custom silicon for data center use.
CEO Rene Haas explained that the “premium smartphone is almost exclusively now v9, and virtually every high-end data centre chip is v9. When you look at Grace Hopper, when you look at Graviton, when you look at Microsoft Cobalt, these are all v9-based designs.” However, CFO Jason Child emphasized that Arm is “overweighted towards smartphones on v9, primarily because it’s an annual refresh cycle.”
Compared to the previous v8 architecture, v9 chips command double the royalty rate. This means Arm receives a higher percentage of the chip's selling price when a manufacturer uses v9 designs.
The rapid growth in v9 adoption and its higher royalty rates have already contributed to a significant increase in Arm's royalty revenue. v9 constituted 10% of royalty revenue in the September quarter and accelerated to 15% in the recent quarter. By doing the math, v9 revenue grew 69% QoQ to $70.5 million. As adoption continues to rise, the v9 architecture is expected to be a major driver of future royalty income growth for Arm.
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Addressable Market
The company’s total addressable market was $203 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 6.8% to $247 billion in CY2025. The company has maintained a market share of over 99% in the mobile applications processor market. It expects this market to grow at a CAGR of 6.4%, from $29.9 billion in 2022 to about $36 billion in 2025. The company estimates that the aggregate value of chips that contain Arm technology was $98.9 billion (48.9% market share) for the CY ending December 2022, up from 38.7% in 2014. Notably, the 6.8% CAGR is a low CAGR for an AI trend with AI chips expected to grow at a 38.2% CAGR.
Arm also has strong market share of 40.8% in the automotive chip market. Management expects the automotive chip market to grow from $18.8 billion in 2022 to $29.1 billion in 2025, growing at a CAGR of 15.7%.
The cloud compute chip market is expected to grow at a CAGR of 16.6% from $17.9 billion in CY2022 to $28.4 billion in CY2025. Arm’s market share in the cloud computing chip market has increased from 7.2% in CY2020 to 10.1% in CY2022. Since Arm-based chips are increasingly used in data centers, its market share is expected to increase significantly in the future.
Per the prospectus, “Arm-based chips have been gaining market share as CSPs, such as Amazon AWS and Alibaba, have started to deploy Arm products in their own in-house designed chips used in their data centers, and as other CSPs, such as Microsoft and Oracle, start to deploy chips designed by Arm licensees, such as Ampere. As a result, we expect our market share of cloud compute to grow significantly faster than the overall cloud compute market.”
Financials
Arm’s recent Q3 FY2024 revenue ending December grew by 13.8% YoY to $824 million, helped by the recovery in the smartphone market and demand for AI technology. This marks the second consecutive quarter of positive revenue growth, following declines of (2.5%) in the June quarter and (3.7%) in the March quarter, due to the cyclical downturn from smartphones.
License and other revenue grew 18% YoY to $354 million. The company has seen strong growth in license revenue as they are signing long-term and high value agreements with its customers due to demand for Arm’s advanced CPUs to run AI workloads. The trend was strongest in the Sept quarter as license revenue grew by 106%.
CEO Rene Haas said in the earnings call, “And that has seen growth in not only the smartphone sector but also in infrastructure and other markets, which drives growth. We are also seeing strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”
They expect another record quarter for the licensing revenue. CFO Jason Child said Arm is “expecting another strong quarter for licensing with revenue up sequentially to near record levels. As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”
Arm reported record royalty revenue, thanks to its higher value v9 technology and market share gains in cloud server and automotive markets. Royalty revenue rebounded to 11% YoY growth to $470 million from a decline of (5%) and (8%) in the previous two quarters.
Management’s guide for the next quarter is to grow over 30% YoY, due to a weak comp against the “bottom of the industry wide inventory correction that occurred in prior year Q4.” On a sequential basis, royalty revenue was guided to increase by the mid-single digits.
Source: ARM
CFO Jason Child explained that the “sequential growth is mainly coming from increasing penetration of Arm v9, where royalty rates are on average, at least double the rates on equivalent Arm v8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”increasing penetration of Arm v9, where royalty rates are on average, at least double the rates on equivalent Arm v8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”
Management increased its revenue guidance for the next quarter by $95 million to a range of $850 million to $900 million, representing YoY growth of 38.2% at the midpoint. This strong upward revision was due to the points discussed earlier, including the rebound in royalty revenue and the higher revenue opportunity from AI. Analysts expect revenue to grow 37.4% YoY to $869.88 million in the next quarter and 27.9% in the June quarter.
Source: Seeking Alpha
FY2023 revenue ending March declined by (0.9%) YoY to $2.679 billion. Analysts expect FY2024 revenue to grow 18.7% YoY to $3.18 billion and 23.9% YoY to $3.94 billion for FY2025.
RPO
Remaining performance obligations (RPO) grew by 38% YoY to $2.43 billion, helped primarily by high-value license agreements and renewal of long-term customer agreement. As per the shareholder letter, “We expect to recognize approximately 28% of RPO as revenue over the next 12 months, 26% over the subsequent 13-to-24-month period, and the remainder thereafter.”
Source: ARM
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Margins
Gross margin was 95.6% in the recent quarter compared to 96% in the same quarter last year. Adjusted gross margin improved 50 basis points YoY to 96.8%.
Operating margin was 16.3% compared to 33.7% in the same period last year. The operating margin was lower due to the increase of R&D expenses from an increase in engineering headcount and SG&A expenses from increase of non-engineering headcount.
In the Sept quarter, the operating margin was low at (19.4%) due to increased R&D expenses, stock-based compensation, and IPO-related expenses. SBC was higher than it is expected to be in future quarters as the IPO triggered a one-time expense for previously granted shares. SBC in the September quarter was “$509 million with $19 million in cost of sales, $343 million in R&D and $147 million in SG&A.” The future SBC run rate “will depend on a number of factors, including the share price, but is currently expected to be between $150 million to $200 million per quarter.” At the midpoint, this will be about 20% of revenue.
Adjusted operating margin was 43.8% compared to 39.9% in the same period last year and 47.6% in the Sept quarter.
Source: ARM
Net margin was 10.6% compared to 25.1% in the same period last year and (13.7%) in the Sept quarter. The adjusted net margin was 39.3% compared to 31.1% in the same period last year and 46.9% in the Sept quarter.
Valuation and Risks
Arm’s IPO lock-up period expired on March 12th, so there is risk of volatility in the coming months. Arm is wildly expensive, and it’s this ultra-premium valuation that leads to elevated downside risk for investors, especially now that SoftBank’s IPO lock-up has expired.
Arm was previously listed from 1998 to 2016 when it was taken private by SoftBank Group, and it holds about 90% of the outstanding shares. Arm’s current valuation of $133 billion (90% of that is ~$120 billion) is significantly higher than SoftBank’s current market valuation of $86 billion. The lockup expiration frees up SoftBank’s 90.6% (~930 million shares) stake, allowing SoftBank to lock in gains on Arm after acquiring the company in 2016, should the holding company decide to do so.
Arm’s shares have doubled since its IPO in September 2023, and it is currently trading at a forward P/S ratio of 43x, far higher than AI semiconductor companies that have much higher growth. For as much as Nvidia is being called a ‘bubble’, Arm is trading at more than double its forward P/S multiple of 20x. Meanwhile, AMD and Broadcom, also followed closely for AI potential, are trading in the 11x P/S range, or one-quarter of Arm’s multiple.
Though Arm’s licensing and royalty model allows it to have a superior gross margin profile relative to its GPU customers, it does not have the same hypergrowth profile that will allow it to command such a multiple, let alone expand on such a multiple to provide gains for investors at these levels.
Nvidia is expected to see 81% revenue growth in FY25 (Q1 beginning in February) to more than $110 billion, with similar earnings power, whereas Arm is expected to record just 24% revenue growth to $3.95 billion. Despite tens of billions in revenue growth next year for Nvidia, not to mention other AI chipmakers underpinned by Arm’s designs, Arm is expected to only see $800 million in revenue growth. Even with a beat above the $800 million, this is not nearly enough to support the $60 billion gained in valuation since Arm’s earnings report.
On the bottom line, Arm still trades at a significant premium to peers. Arm is currently trading above a 113x forward PE, more than double AMD’s 50x multiple and triple Nvidia’s 37x multiple. Looking ahead to Arm’s fiscal 2025, Arm is trading at an 86x forward PE with estimated earnings growth of just 27%, compared to 91% for Nvidia.
The rich valuation combined with lockup expiration is the predominant risk, however, the longer-term risk is RISC-V.
Arm is based on lower power instruction sets and hardware, which is also known as a RISC architecture (Reduced Instruction Set Computing). As stated, this contributes to Arm’s approach to power efficiency by reducing the number of instruction sets required. Intel and AMD’s x86 CISC, or Complex Instruction Set Computing, offers more complex instructions that execute multiple operations. This leads to better performance but more power consumption due to the need to decode the complex instructions.
There is a third competitor to Arm and x86 which belongs in the RISC architecture category, called RISC-V. The instruction sets for RISC-V are similar to Arm’s yet RISC-V is open source and is also very new with an official launch in 2019. Compare this to Arm, which was founded forty years ago. RISC-V emphasizes register access over direct memory access, which may be more suitable for parallel processing.
It’s unlikely that RISC-V overtakes Arm in the near-term but it could become a serious contender in future years – some of Arm’s customers support RISC-V, which could limit Arm’s ability to raise prices.
Conclusion
Strong tailwinds for growth exist in Arm’s core markets, notably in AI, automotive and cloud compute chips, while royalty revenue is accelerating on the backs of increased royalties from the v9 design. Despite accelerating key metrics, including revenue, RPO and average contract value, Arm’s valuation poses significant risks, given that it is trading at exuberant levels even relative to the hottest AI chip stocks. In the event the valuation comes down drastically, we’ve done a thorough analysis on Arm as it’s a central player to edge AI and is key to the next phase for AI.
I/O Fund Equity Analyst Damien Robbins contributed to this report.
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.
The rise of AI marks a transformative technological, economic, and societal inflection point — one with extreme implications for how we live and invest. So, how can investors take advantage of the trend? Jordi Visser, CIO and Chairman of Weiss Multi-Strategy Advisers, spoke to Beth Kindig, our Lead Tech Analyst on the Real Vision podcast on March 20th, to dive deep into AI’s potential for explosive economic growth, how to find winners in this theme, sectors that benefit from AI, the potential for crypto to decentralize AI, and more.
Timestamps:
00:00 – Introduction
03:35 – Artificial Intelligence
07:44 – The Impact of AI
12:18 – AI compared to Mobile
16:48 – How long will it last?
22:14 – Tech sectors that will benefit from AI
30:14 – Sectors AI will disrupt
35:26 – AI, DeepMind and other industries
40:16 – Crypto and AI
43:28 – Q&A
Note: The I/O Fund owns Broadcom as of March 21st per our real-time trade alert sent to Premium members.
The rise of AI marks a transformative technological, economic, and societal inflection point — one with extreme implications for how we live and invest. So, how can investors take advantage of the trend? Jordi Visser, CIO and Chairman of Weiss Multi-Strategy Advisers, spoke to Beth Kindig, our Lead Tech Analyst on the Real Vision podcast on March 20th, to dive deep into AI’s potential for explosive economic growth, how to find winners in this theme, sectors that benefit from AI, the potential for crypto to decentralize AI, and more. Click here to watch.
Timestamps:
00:00 – Introduction
03:35 – Artificial Intelligence
07:44 – The Impact of AI
12:18 – AI compared to Mobile
16:48 – How long will it last?
22:14 – Tech sectors that will benefit from AI
30:14 – Sectors AI will disrupt
35:26 – AI, DeepMind and other industries
40:16 – Crypto and AI
43:28 – Q&A
Note: The I/O Fund owns Broadcom as of March 21st per our real-time trade alert sent to Premium members.
Every quarter, we provide an overview of the cloud sector including hyperscalers and best-of-breed companies. We had discussed in our last analysis that the hyperscalers are showing signs of stabilization. In a further positive development, the hyperscalers growth accelerated in the recent quarter, helped by a much-needed boost from AI.
Below, we look at best-of-breed companies that are expected to decline sequentially by 4 points, the same deceleration we noticed in Q3 to Q4. This is an improvement from an 11 point decline in Q1-Q2 of last year. We also discuss various financial metrics that can help determine which cloud companies will continue to lead.
Tracking the Cloud ETFs YTD performance, SKYY beat the QQQ (tracks the Nasdaq-100 Index) by one percentage point and other ETFs are trailing with WCLD with (1.37%) return and CLOU with (4.06%) YTD returns.
Big Tech is the Best Proxy for Cloud
Big Tech Companies are more insulated than Best-of-Breed cloud and offer a 360-degree view of how the cloud industry is faring. The Big 3 cloud providers are the best proxy since they account for 67% of the cloud market. They also represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services.
Microsoft Azure had the fastest growth of 30% among the Big 3 and all the three companies showed an acceleration that was helped by AI revenue. Microsoft Azure Q4 growth rate and AWS accelerated by 1%, while Google Cloud accelerated by 4%. This is an improvement from the trend in the previous quarter when we noted, “Microsoft Azure’s Q3 growth rate was the outlier among the Big 3 as its growth rate accelerated by 3%, while AWS remained steady albeit at a slower growth rate, and Google Cloud decelerated by 6%. The steep deceleration in Google Cloud was a negative surprise as analysts were expecting it to grow 26% compared to the actual 22%.”
According to Synergy Research Group the combined Q4 YoY growth of the Big 3 cloud providers marked the highest growth compared to the previous three quarters and also the largest sequential increase ever. “The year-on-year growth rate was 20% in Q4, markedly higher than the previous three quarters. Notably, the market grew by $5.6 billion from Q3. That is by far the largest quarter-on-quarter increase ever achieved.”
Microsoft
Microsoft Azure grew 30% YoY and 28% in constant currency, including a 6% incremental contribution from AI.
Growth accelerated from 29% in the previous quarter and was slightly down from 31% in the same period last year.
The company’s CFO, Amy Hood, said Azure growth will remain stable in the next quarter. “In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI.”Growth will be driven by our Azure consumption business with continued strong contribution from AI.”
AI’s impact on Azure was notable: Microsoft said that Azure’s 30% growth stemmed from “strong demand for our consumption-based services including 6 points from our AI services.” This 6-point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4. While that may seem small, it is significant considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate.
Microsoft’s earnings call reflected growing AI optimism, with strong key metrics for its AI offerings across its product suite. Satya Nadella also signaled in the earnings call Q&A that optimization is over for now on traditional workloads, which is positive. “I'll call it, optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycle by customers, both whether it comes to AI or whether it comes to the traditional workloads.”
AWS
AWS revenue grew by 13% YoY to $24.2 billion and is now approaching a $100 billion annualized run rate.
Growth accelerated by one percentage point from 12% in the last quarter yet was lower than the 20% in the same period last year.
The company’s CEO, Andy Jassy, sounded very optimistic in the earnings call on the prospects of AI. “Gen AI is and will continue to be an area of pervasive focus and investment across Amazon, primarily because there are a few initiatives, if any, that give us the chance to reinvent so many of our customer experiences and processes, and we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”
The company’s CFO pointed out that optimizations are slowing. “Similar to what we shared last quarter, we continue to see the diminishing impact of cost optimizations. And as these optimization slow down, we're seeing more companies turning their attention to newer initiatives and reaccelerating existing migrations.”
Google Cloud
Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI, beating the estimates of $8.94 billion.
Even though the growth is lower when compared to the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.
The strong growth in the quarter also helped the company narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.
In the earnings call, CFO Ruth Porat said, “The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.” The company launched Gemini in December and offers three versions: Gemini Ultra, Gemini Pro, and Gemini Nano.
The company’s CEO Sundar Pichai also echoed the thoughts of Microsoft and Amazon’s management on cost optimizations reducing, saying “the cost optimizations in many parts are something we have mostly worked through.”
Best of Breed
We took a sample of the top-ranking cloud stocks on revenue growth, free cash flow, adjusted operating margin, and valuations.
Best-of-breed cloud companies are expected to decline sequentially by 4-points; from 5% QoQ growth last year to the expected 1% QoQ this year. This is the same as we noticed in Q3 to Q4, wherein it showed an improvement from a decline of 11 points in Q1 to Q2 of last year.
However, on a percentage basis, the recent QoQ/YoY deceleration is 72% compared to the 47% decline in Q3 to Q4 estimates and slightly better than the 83% decline in the same period last year.
All the best-of-breed cloud companies showed a deceleration similar to the trend seen in our previous analysis. CrowdStrike has the lowest deceleration, from 9% last year to 7% expected this year. Bill Holdings has the highest deceleration, from 5% growth last year to (4%) this year. In our previous analysis, Bill Holdings had the lowest deceleration.
Earnings Beats
Bill Holdings led with a revenue beat of 6.8%. The company’s revenue grew by 22% YoY to $318.5 million. The core revenue, which includes subscription and transaction fees, grew by 19% YoY to $275 million. Management highlighted the better-than-expected standalone total payment volume (TPV) growth of 10%. However, they are still cautious on macro, “It's too early to call a trough in B2B spend, and we expect the current interest rate environment will continue to depress overall spend growth.” The management guide for the next quarter is $299 million to $309 million, representing a YoY growth of 11.5% at the midpoint.
MongoDB’s revenue exceeded analyst expectations by 5.2%. The company’s revenue grew by 27% YoY to $458 million. However, the stock sold off post earnings as the FY guidance missed estimates. Management FY revenue guide was $1.9 billion to $1.93 billion below the estimates of $2.03 billion. The adjusted EPS guide was $2.27 to $2.49, far below the estimates of $3.22.
HashiCorp’s revenue grew by 15% YoY to $155.8 million, beating estimates by 4.3%. Management revenue guide for the next quarter is $152 million to $154 million, representing a YOY growth of 10.9% at the midpoint. The management highlighted in the earnings call that they are targeting 20% growth sometime in FY2026. Per CFO, “And then what follows is basically progressive improvement on the growth rate until it reaches 20% in the fiscal 2026 period, not that fiscal '26 will be 20%, just to be clear. So what we're signaling is that — the fourth quarter was a great quarter, and we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”
HashiCorp’s adjusted EPS came at $0.05 compared to ($0.07) in the same period last year, beating estimates by 501%. This was the second consecutive non-GAAP profitability for the company. Snowflake’s adjusted EPS grew by 150% YoY to $0.35, beating estimates by 98%. MongoDB ranked third with a beat of 82.6% and its adjusted EPS grew by 50.9% YoY to $0.86.
Bottom Line and Free Cash Flow
GAAP profitability is another crucial metric to monitor closely, especially with macroeconomic uncertainty. Most of the names listed in the chart below are unprofitable on a GAAP basis because they pay high stock-based compensation.
This is one of the more important metrics that separates the winners from the laggards. For example, CrowdStrike recently achieved the feat of four consecutive quarters of GAAP profits and a full year in GAAP profits. The stock has been up 140% in the past year.
Bill Holdings has improved its operating margin to (13%) from (43%) in the same period last year. CrowdStrike has improved to 4% from (10%) in the same period last year. Zscaler reported (9%) compared to (17%) last year.
ServiceNow has the highest free cash flow margin of 55%, up from 52% in the same period last year. Snowflake ranks second with a free cash flow margin of 42% and Datadog ranks third with a free cash flow margin of 34%.
Valuations
CrowdStrike has the highest forward P/S ratio of 19.5 among the best-of-breed cloud stocks. It is followed by Cloudflare at 19.3 and Datadog at 15.5.
Ranking based on revenue estimates change for next quarter.
GitLab’s revenue estimates have been revised by 2.5% and Zscaler ranks second with a positive revision of 1%. MongoDB had a negative revision of (2.1%) after the company’s FY guidance came in below analyst expectations.
Ranking based on adjusted EPS estimates change for the next quarter.
Zscaler had the highest adjusted EPS revision of 10.5% among the best-of-breed cloud stocks. It is followed by CrowdStrike at 8.3% and Snowflake at 0.8%.
Highlights and Lowlights in Q4
CrowdStrike reported the fourth consecutive quarter of GAAP profits and the first full year of GAAP profits. The turnaround in GAAP profitability is most impressive compared to its cloud peers. The company’s key metrics are also accelerating. Notably, the net new ARR accelerated by 14% to 27% growth in the recent quarter from 13% in Q3. The company is in a unique position by combining cybersecurity with AI in a single platform with a data-centric architecture. Our complete post-earnings analysis is here.
Cloudflare beat revenue estimates by 2.7% and adjusted EPS by 26.3%. The company’s adjusted operating margin grew by 500 bps to 11% in the recent quarter. The free cash flow margin improved by 200 bps to 14%. CEO and co-founder Matthew Prince said in the earnings call, “The machine that underlies Cloudflare is firing efficiently on all cylinders, and we've been able to execute even as the macro environment remains choppy.” Key metrics accelerated, RPO accelerated to $1.245 billion, up 37% YoY compared to 30% YoY growth last quarter. We have discussed the company further in our post-earnings analysis here.
Zscaler beat revenue estimates by 3.6% and adjusted EPS estimates by 31%. On the macro, the company’s CFO said in the earnings call, “We believe we are still operating in a challenging macroenvironment and customers continue to scrutinize large deals.” Despite the beat and raise, the stock sold off post-earnings since the company guided for a (7%) sequential decline in calculated billings, suggesting further deceleration in this key metric to the low-20% range. We have discussed the company further in our cybersecurity analysis here.
Conclusion
The hyperscalers growth accelerated with a boost from AI. Cloud optimizations are reducing, which is positive. However, the macro conditions are still challenging. We will continue to look for outliers in the cloud category as we move into next quarter’s earnings season. We added CrowdStrike and Cloudflare to our portfolio partly informed by scans such as these, which revealed bottom line strength coupled with strong growth. We also use these overviews to keep an eye on valuation, of which cloud stocks are particularly sensitive to in this environment with very few successfully trading over 20 Fwd P/S since Q4 of 2021.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
Every quarter, we provide an overview of the cloud sector including hyperscalers and best-of-breed companies. We had discussed in our last analysis that the hyperscalers are showing signs of stabilization. In a further positive development, the hyperscalers growth accelerated in the recent quarter, helped by a much-needed boost from AI.
Below, we look at best-of-breed companies that are expected to decline sequentially by 4 points, the same deceleration we noticed in Q3 to Q4. This is an improvement from an 11 point decline in Q1-Q2 of last year. We also discuss various financial metrics that can help determine which cloud companies will continue to lead.
Tracking the Cloud ETFs YTD performance, SKYY beat the QQQ (tracks the Nasdaq-100 Index) by one percentage point and other ETFs are trailing with WCLD with (1.37%) return and CLOU with (4.06%) YTD returns.
Big Tech is the Best Proxy for Cloud
Big Tech Companies are more insulated than Best-of-Breed cloud and offer a 360-degree view of how the cloud industry is faring. The Big 3 cloud providers are the best proxy since they account for 67% of the cloud market. They also represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services.
Microsoft Azure had the fastest growth of 30% among the Big 3 and all the three companies showed an acceleration that was helped by AI revenue. Microsoft Azure Q4 growth rate and AWS accelerated by 1%, while Google Cloud accelerated by 4%. This is an improvement from the trend in the previous quarter when we noted, “Microsoft Azure’s Q3 growth rate was the outlier among the Big 3 as its growth rate accelerated by 3%, while AWS remained steady albeit at a slower growth rate, and Google Cloud decelerated by 6%. The steep deceleration in Google Cloud was a negative surprise as analysts were expecting it to grow 26% compared to the actual 22%.”
According to Synergy Research Group the combined Q4 YoY growth of the Big 3 cloud providers marked the highest growth compared to the previous three quarters and also the largest sequential increase ever. “The year-on-year growth rate was 20% in Q4, markedly higher than the previous three quarters. Notably, the market grew by $5.6 billion from Q3. That is by far the largest quarter-on-quarter increase ever achieved.”
Microsoft
Microsoft Azure grew 30% YoY and 28% in constant currency, including a 6% incremental contribution from AI.
Growth accelerated from 29% in the previous quarter and was slightly down from 31% in the same period last year.
The company’s CFO, Amy Hood, said Azure growth will remain stable in the next quarter. “In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI.”Growth will be driven by our Azure consumption business with continued strong contribution from AI.”
AI’s impact on Azure was notable: Microsoft said that Azure’s 30% growth stemmed from “strong demand for our consumption-based services including 6 points from our AI services.” This 6-point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4. While that may seem small, it is significant considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate.
Microsoft’s earnings call reflected growing AI optimism, with strong key metrics for its AI offerings across its product suite. Satya Nadella also signaled in the earnings call Q&A that optimization is over for now on traditional workloads, which is positive. “I'll call it, optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycle by customers, both whether it comes to AI or whether it comes to the traditional workloads.”
AWS
AWS revenue grew by 13% YoY to $24.2 billion and is now approaching a $100 billion annualized run rate.
Growth accelerated by one percentage point from 12% in the last quarter yet was lower than the 20% in the same period last year.
The company’s CEO, Andy Jassy, sounded very optimistic in the earnings call on the prospects of AI. “Gen AI is and will continue to be an area of pervasive focus and investment across Amazon, primarily because there are a few initiatives, if any, that give us the chance to reinvent so many of our customer experiences and processes, and we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”
The company’s CFO pointed out that optimizations are slowing. “Similar to what we shared last quarter, we continue to see the diminishing impact of cost optimizations. And as these optimization slow down, we're seeing more companies turning their attention to newer initiatives and reaccelerating existing migrations.”
Google Cloud
Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI, beating the estimates of $8.94 billion.
Even though the growth is lower when compared to the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.
The strong growth in the quarter also helped the company narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.
In the earnings call, CFO Ruth Porat said, “The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.” The company launched Gemini in December and offers three versions: Gemini Ultra, Gemini Pro, and Gemini Nano.
The company’s CEO Sundar Pichai also echoed the thoughts of Microsoft and Amazon’s management on cost optimizations reducing, saying “the cost optimizations in many parts are something we have mostly worked through.”
Best of Breed
We took a sample of the top-ranking cloud stocks on revenue growth, free cash flow, adjusted operating margin, and valuations.
Best-of-breed cloud companies are expected to decline sequentially by 4-points; from 5% QoQ growth last year to the expected 1% QoQ this year. This is the same as we noticed in Q3 to Q4, wherein it showed an improvement from a decline of 11 points in Q1 to Q2 of last year.
However, on a percentage basis, the recent QoQ/YoY deceleration is 72% compared to the 47% decline in Q3 to Q4 estimates and slightly better than the 83% decline in the same period last year.
All the best-of-breed cloud companies showed a deceleration similar to the trend seen in our previous analysis. CrowdStrike has the lowest deceleration, from 9% last year to 7% expected this year. Bill Holdings has the highest deceleration, from 5% growth last year to (4%) this year. In our previous analysis, Bill Holdings had the lowest deceleration.
Earnings Beats
Bill Holdings led with a revenue beat of 6.8%. The company’s revenue grew by 22% YoY to $318.5 million. The core revenue, which includes subscription and transaction fees, grew by 19% YoY to $275 million. Management highlighted the better-than-expected standalone total payment volume (TPV) growth of 10%. However, they are still cautious on macro, “It's too early to call a trough in B2B spend, and we expect the current interest rate environment will continue to depress overall spend growth.” The management guide for the next quarter is $299 million to $309 million, representing a YoY growth of 11.5% at the midpoint.
MongoDB’s revenue exceeded analyst expectations by 5.2%. The company’s revenue grew by 27% YoY to $458 million. However, the stock sold off post earnings as the FY guidance missed estimates. Management FY revenue guide was $1.9 billion to $1.93 billion below the estimates of $2.03 billion. The adjusted EPS guide was $2.27 to $2.49, far below the estimates of $3.22.
HashiCorp’s revenue grew by 15% YoY to $155.8 million, beating estimates by 4.3%. Management revenue guide for the next quarter is $152 million to $154 million, representing a YOY growth of 10.9% at the midpoint. The management highlighted in the earnings call that they are targeting 20% growth sometime in FY2026. Per CFO, “And then what follows is basically progressive improvement on the growth rate until it reaches 20% in the fiscal 2026 period, not that fiscal '26 will be 20%, just to be clear. So what we're signaling is that — the fourth quarter was a great quarter, and we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”
HashiCorp’s adjusted EPS came at $0.05 compared to ($0.07) in the same period last year, beating estimates by 501%. This was the second consecutive non-GAAP profitability for the company. Snowflake’s adjusted EPS grew by 150% YoY to $0.35, beating estimates by 98%. MongoDB ranked third with a beat of 82.6% and its adjusted EPS grew by 50.9% YoY to $0.86.
Bottom Line and Free Cash Flow
GAAP profitability is another crucial metric to monitor closely, especially with macroeconomic uncertainty. Most of the names listed in the chart below are unprofitable on a GAAP basis because they pay high stock-based compensation.
This is one of the more important metrics that separates the winners from the laggards. For example, CrowdStrike recently achieved the feat of four consecutive quarters of GAAP profits and a full year in GAAP profits. The stock has been up 140% in the past year.
Bill Holdings has improved its operating margin to (13%) from (43%) in the same period last year. CrowdStrike has improved to 4% from (10%) in the same period last year. Zscaler reported (9%) compared to (17%) last year.
ServiceNow has the highest free cash flow margin of 55%, up from 52% in the same period last year. Snowflake ranks second with a free cash flow margin of 42% and Datadog ranks third with a free cash flow margin of 34%.
Valuations
CrowdStrike has the highest forward P/S ratio of 19.5 among the best-of-breed cloud stocks. It is followed by Cloudflare at 19.3 and Datadog at 15.5.
Ranking based on revenue estimates change for next quarter.
GitLab’s revenue estimates have been revised by 2.5% and Zscaler ranks second with a positive revision of 1%. MongoDB had a negative revision of (2.1%) after the company’s FY guidance came in below analyst expectations.
Ranking based on adjusted EPS estimates change for the next quarter.
Zscaler had the highest adjusted EPS revision of 10.5% among the best-of-breed cloud stocks. It is followed by CrowdStrike at 8.3% and Snowflake at 0.8%.
Highlights and Lowlights in Q4
CrowdStrike reported the fourth consecutive quarter of GAAP profits and the first full year of GAAP profits. The turnaround in GAAP profitability is most impressive compared to its cloud peers. The company’s key metrics are also accelerating. Notably, the net new ARR accelerated by 14% to 27% growth in the recent quarter from 13% in Q3. The company is in a unique position by combining cybersecurity with AI in a single platform with a data-centric architecture. Our complete post-earnings analysis is here.
Cloudflare beat revenue estimates by 2.7% and adjusted EPS by 26.3%. The company’s adjusted operating margin grew by 500 bps to 11% in the recent quarter. The free cash flow margin improved by 200 bps to 14%. CEO and co-founder Matthew Prince said in the earnings call, “The machine that underlies Cloudflare is firing efficiently on all cylinders, and we've been able to execute even as the macro environment remains choppy.” Key metrics accelerated, RPO accelerated to $1.245 billion, up 37% YoY compared to 30% YoY growth last quarter. We have discussed the company further in our post-earnings analysis here.
Zscaler beat revenue estimates by 3.6% and adjusted EPS estimates by 31%. On the macro, the company’s CFO said in the earnings call, “We believe we are still operating in a challenging macroenvironment and customers continue to scrutinize large deals.” Despite the beat and raise, the stock sold off post-earnings since the company guided for a (7%) sequential decline in calculated billings, suggesting further deceleration in this key metric to the low-20% range. We have discussed the company further in our cybersecurity analysis here.
Conclusion
The hyperscalers growth accelerated with a boost from AI. Cloud optimizations are reducing, which is positive. However, the macro conditions are still challenging. We will continue to look for outliers in the cloud category as we move into next quarter’s earnings season. We added CrowdStrike and Cloudflare to our portfolio partly informed by scans such as these, which revealed bottom line strength coupled with strong growth. We also use these overviews to keep an eye on valuation, of which cloud stocks are particularly sensitive to in this environment with very few successfully trading over 20 Fwd P/S since Q4 of 2021.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
For reference to terminology used, please look at technical analysis under our resources section here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
Broad Market Technical Analysis
Price Analysis
When you funnel the global community of investor into a quantifiable arena, like the stock market, interesting and repeatable patterns emerge. These patterns are the basis of technical analysis, and are used by analysts to predict market trends and establish risk parameters. The discipline of Elliott Wave analysis is simply an in depth study of these repeatable patterns, which provides the best context to market behavior that I know of.
For those new to this analysis, I have written up a detailed introduction here. The fundamental idea is that markets move up in a 5 wave pattern, and once this 5 waves pattern completes, we then see a 3 wave retrace/correction, which will make a higher low. This simple movement is not only happening on all time frames, and in all markets where people interact to find price discovery, but it is fractal. So, a small 5 wave pattern develops into a larger one, which then develops into a larger one, and so on.
Because of the fractal nature within market patterns, we are able to fit the entirety of price information into a cohesive pattern. This means that the price action from the 1929 top, and 1933 bottom has an effect on the current 2024 price action. The below chart is the entirety of the Dow Jones Industrial Average’s price information, which is organized into an on-going Elliott Wave pattern.
The reason that I am providing this chart today is because I want our readers to understand the larger backdrop of the current market. Within this context, the 1929 top to the 1933 bottom, was a very large degree 2nd wave. What followed has been a 3rd wave within the same large degree time frame. When you analyze the internal wave structure, it appears that we are coming to the end of this large degree 3rd wave, which is suggesting the start of a secular bear market. This secular bear market would constitute the large degree 4th wave.
Furthermore, what this pattern is telling us is that the secular bull market that started in 2009 has actually been the 5th wave of this very large degree 3rd wave pattern. The below chart outlines this 5th wave, and organizes it into a its own 5 wave pattern.
We can further dissect this analysis and focus our attention deeper. According to the wave pattern above, the COVID low started the final 5 wave pattern within the larger 5 wave pattern above. As stated prior, these patterns are fractal, which allows us to organize each move into a cohesive pattern.
The below chart focuses on the smaller 5 wave pattern that started at the COVID low. With the above information in mind, we are able to have the proper context when trying to understand the current market. As of now, I have 2 potential scenarios on how to understand the final push in the secular bull market that started in 2009.
Blue – This count has the 2022 bear market as a 4th wave within a larger uptrend. What this means is that the 2023 bull market is the final 5th wave, which is taking the shape of an ending diagonal (I discussed this pattern in last month’s report here). This is an overlapping 5 wave pattern that is characterized by large swings in both directions. It is very common to show up as a 5th wave. Considering that the pattern is almost complete, if not already, the risk within this market is greater than many believe.
Red – This count is based on the secular bull market ending on January 2022. What this means is that 2022 was the A wave of this new secular bear market, while 2023 was the B wave bounce. In other words, 2023 to now is a cyclical bull market within a secular bear market. If accurate, the next larger drop will take the shape of a vertical 5 wave pattern pointing down. This 5 wave pattern would retrace the entirety of cyclical bull market that started in October of 2022.
If we zoom in on the ending diagonal pattern that started in October 2022, we can get an idea of how much farther this market can stretch. We are currently in the toping zone between 5145 – 5345. As long as we hold 5090 SPX, we can keep pushing higher. Below 5090 will be the first warning to the bulls. A break below 5050 and then 4945 SPX will confirm that a larger top is in.
Once a top is in place, we can then get a better idea of whether the red or blue count is in play. The red count will be a large degree C wave, which always takes the shape of a 5 wave pattern. It would be a more direct path to our final downside targets. The blue count would be less of a direct path, which would have large bounces followed by breakdowns to new lows. It would be messier, and characterized by a multi-month rangebound market.
In conclusion, if we are entering a secular bear market, this does not mean we should leave the markets. It simply means that we will have a period line 2000 – 2013 where the market goes sideways. These sideways periods have bear markets that are punctuated with multi-year bull markets. It is a period where buy and hold tends to struggle, and where a more active approach with a risk management focus could potentially navigate it profitably.
Supporting Markets
No one doubts that tech has been leading this uptrend higher. Since bottoming on October 13th 2022, the S&P 500 is up just over 40%. During the same time frame, small caps are up only 20%, while the tech heavy NASDAQ-100 is up over 70%, and The PHLX Semiconductor Index is up over 115%.
The consensus belief is that tech is leading the weaker markets, like small caps, higher. If true, then buying these weak markets appears to be a winning strategy, as they have a long way to go in order to final catch up with the market leaders.
However, when we view these markets through the lens of technical analysis, I believe that the stronger markets, like tech, are the ones playing catch-up, while the weaker ones, like small caps, are leading the larger trend. That being said, there are two types of markets – the ones that have topped, and the ones that are close to topping.
Small Caps
The Russell 2000 (IWM) is the most obvious pattern to track. From the 2009 low, we have a very clean 5 wave pattern into the 2021 top. Note how small caps have been trending sideways since the 2022 low, and they are substantially below their 2021 top. This looks like a large degree correction that has one more large leg pointing down before completing.
When we zoom into this sideways pattern, it appears to be tracing a B wave bounce within a larger decline. The key is the final move of the larger (B) wave being a 5 wave push higher. Note how we have a clear 5 wave pattern that tagged our $210 target (below).
Further, the 5th wave is taking the shape of a clear ending diagonal pattern on decelerating momentum. If the next larger drop is a direct 5 wave move, then we have confirmation that we are setting up for a push below the 2022 lows.
There are several markets that resemble the small cap index above. In other words, they have been trending up from the 2022 lows in an overlapping pattern that resembles a bounce within a larger correction. The key is that these markets have trended sideways to up and are well below their 2021/2022 highs. Here are a few examples:
Consumer Discretionary (XLY)
Retail Sales (XRT)
Financials (XLF)
The 2nd type of market is the one that is still in their secular bull market. In other words, while the above markets ended their bull market in 2021/2022, the bellow leaders are completing their final 5th wave of the secular bull market.
Technology (XLK)
The tech sector has the 2022 bear market as a 4th wave drop within a larger uptrend. This larger uptrend is coming to an end soon. Note now clear the 5 wave pattern is off the 2022 low. This 5 wave pattern is mature and full, as we push slightly higher on less momentum.
Industrials (XLI)
Interestingly, Industrials appears to be completing a large 3 wave push to new highs. This appears to be within the context of a large degree ending diagonal pattern.
Home Builders (XHB)
This market looks a lot like the S&P 500. It is completing an ending diagonal pattern for wave 5. Once complete, this should end the secular bull market for home builders.
In conclusion, from a basic understanding of technical analysis, one can see tech leading, with industrials and home builders breaking out to all-time highs and conclude that the weak markets will follow. This is simply not the type of market behavior we see going into a recession. Further, we are in a roaring bull market that seems to have no end, so it’s no wonder we see investors touting these weaker markets, like small caps, as the ones that will start playing catch-up.
However, within the context of Elliott Wave, these breakouts to new highs appear to be in the form of 5th waves, which are close to ending. What this means is that the weaker markets topped first in 2021/2022, while the stronger markets are the ones playing catch-up. This is also why there is such a bifurcation amongst analysts trying to put a cohesive narrative to this strange market behavior.
Divergences
When markets are moving in unison, you have a strong trend. However, when markets start diverging, we tend to see this behavior at the end of the trend. This is what is happening now.
There is no question that big tech has been the market leaders throughout the entirety of this bull market that started in 2022. This is evident by the name given to these leaders – the “Magnificent 7.” However, what we are now seeing is that these market leaders, which were once moving in unison, are now starting to fall like dominoes.
First, Tesla topped in July of 2023, followed by Apple in December of 2023. We then saw Google top in late January of this year, followed by Microsoft in mid-February. What was once the Magnificent 7 is now the Magnificent 3, as the majority of past market leaders are now in a notable downtrends.
One could easily claim that we don’t need these stocks to move higher, obviously. However, when prior market leaders start to fall, more times than not, they are signaling exhaustion in the broader trend. What makes this instance so notable is the extreme weightings that these 4 stocks take up in the S&P 500. Together, they account for ~17% of index weighting. This is a large weight around the broad market, which should not be ignored.
Regional Banks are also diverging with the larger banks. These markets historically move together, and when they start separating, something isn’t right. Regional banks have made a series of lower highs while the bigger banks have gone to test all-time highs. One of these markets is leading, and until regional banks start making new highs, I do not trust this move higher with the big banks.
The transportation sector is also signal a similar warning. The Dow Jones Transportation index is comprised of standard transportation stocks, while the iShares index has the same stocks, except with a higher weighting in the tech focused transportation stocks, like UBER and LYFT. Like the banks above, these two markets tend to move in unison. This is not the case today, as we see a sizable divergence that is not healthy.
The most notable divergence is between long-dated bonds (TLT) and the equities. Bonds tend to top/bottom long before equities get the message. Today, TLT is making a series of lower highs, while equities continue to power higher. The bond market is simply not buying this move higher, which is typically a harbinger for equity volatility.
Time Analysis
Elliott Wave analysis can tell you when a trend is coming to an end. It can also provide levels that must hold or break in order to confirm a pattern will extend or a counter pattern is emerging. Gann analysis provides you with time analysis. Markets move in cycles, and these cycles tend to create inflection points. More times than not, these inflection points mark trend reversals, and on occasions they mark large breakout/breakdown moves. I went through the Elliott Wave analysis for some key markets above, this section will look at the time analysis. Together, they are signaling caution.
Russell 2000 (IWM)
We discussed the concerning price analysis above. This market appears to have reached our target in a fully developed 5 wave pattern. This 5 wave pattern, I believe, is the final swing in a large corrective bounce that started in 2022 and is part of a larger bear market.
When we add the time analysis, we can see another layer of risk. The below chart tracks 3 cycles that have an effect on the price of IWM. Note how price tends to reverse its trend when it moves into one of these cycles. The most important piece of information regarding this cycle analysis is how price is moving into them. As of now, IWM’s price is moving up into all 3 of these cycles clustering right now.
Furthermore, when we place a Gann Fan at the 2018 low, note how the following price patterns reacted to these angles. Today, price is hitting against the most important angle in red. This is the 45 degree angle, and we tend to see strong reversals at this angle.
So, we have a significant confluence of price and time, which in Gann’s world tends to mark a meaningful trend reversal. When we factor this information in with the Elliott Wave analysis showing that we are in an ending diagonal pattern in the final 5th wave, it warrants caution.
Dow Jones Industrial Average (DJI)
I’ve discussed the Dow’s price pattern in several prior reports. No matter how you count this, the uptrend pattern off the 2022 low is setting up for a large pullback. The below chart shows various long-term cycles that have had an effect on DJI’s price movements. Note how we are seeing a cluster of these cycles show up now. When cycles cluster, it tends to mark a meaningful inflection point. For example, the last time these cycles clustered was around the 2020 top.
The NASDAQ-100
This index looks very similar to XLK above. It is completing a large degree 5 wave pattern off the 2022 low, and setting up for some type of trend reversal. Furthermore, it is trending up into a cluster of long-term cycles and hitting the 45 degree angle from the 2018 high. Much like other key markets, there is a confluence of price and time, which tends to mark trend reversals.
In conclusion, we are seeing several key markets trending up into a cluster of key cycles. Many of these markets are also hitting important angles from key inflection points in the past. These angles, along with the cycles tend to mark meaningful trend reversals. When we factor in price analysis, we can see that these same markets are in the final moves of very mature uptrend patterns. Price and time are coming together right now in a way that warrants caution until we see a resolution. If the market instead ignores these angles and cycles, it will be a show of strength that we will factor into our portfolio management.
What If We Are Wrong?
I’ve laid out a strong position for an imminent market reversal. Both time and price seem to be suggesting this is the case amongst multiple key markets. However, all positions must have a point at which they are scraped and a pivot has to happen. Since our inception there have been a handful of pivots we have had to make, once a thesis appears to not be playing out. That being said, my alternative count is below. We would need to see SPX hold 4775 on the coming pullback, followed by a direct, 5 wave push to new highs.
Further, the divergences that I discussed prior would need to resolve. We would need to see all sectors in the S&P 500, along with the lagging FAANGs, resume their uptrend and make new highs. If this happens, you ‘ll will see us layer back into the market for the resumption of the larger bull market as we. Extend this bull cycle into 2025. I find this hard to believe, as most markets, like IWM, simply do not have an alternative interpretation that lines up with the above chart. However, we are prepared to pivot if this analysis is proven wrong.
I/O Fund Portfolio
Because of the warnings stated above, the I/O Fund has taken a barbell approach to our portfolio in 2024. On one end, we are maintaining a defensive posture within our portfolio by holding a sizable cash position. On the other end, we are highly concentrated in market leaders such as NVDA, AMD, and Crypto. This strategy has worked out well for us this year, so far, as we continue to show relative outperformance while also being prepared for a sizable trend reversal.
Regarding our risk management, we have been very clear with the risks we see in this market. As a result, we have gone from being 85% net long in early November 2023 to 30% net long today. We are currently 35% hedged and waiting for our hedge signal to tell us when to go 100% hedged, and thus move toward being market neutral.
The below pie chart is the percentage allocation of our invested assets, not including cash.
Hedge Signal
The below is an update from Vincent Duchaine of WealthUmbrella, who created the hedge signal that we currently use.
Since the start of this year, market breadth has been considerably deteriorating. While some stocks continued their parabolic move higher, several stocks, including high beta stocks have declined considerably since their peak at the end of December 2023. Tesla is probably the most well-known example, being approximately down 35% from its July 2023 peak.
Market breadth is one of the primary components of the hedge signal. The on-going deceleration in market breadth has led to this component rising above the zero line for the third time since the beginning of this year.
This may seem insignificant, but just having a signal above 0 is something we typically do not see in strong uptrends. For example, during the bull market between June 2020 to December 2021, the signal stayed below 0 the entire run, and only rose above zero at the end of that bull market, just before the start of 2022.
Moreover, when the breadth component of the hedge signal rises above the zero line while the market continues to push higher, or even goes sideways, it has a high correlation with abrupt corrections. Though breadth is moving closer to a sell signal within the hedge, it is still in buy, for now.
Another way we could see the hedge signal trigger a sell would be if the VIX rises drastically and enters full backwardation. Some components of the VIX ribbons are already in backwardation, so this scenario is a reasonable assumption to track.
The other component of the signal that could trigger a sell is the options market. This component is less likely to trigger a sell, considering how the market has continued to defy gravity for so long now. This behavior is filtering into sentiment within the options flow. I think the option market is as confused as everyone else, so it will likely not lead to a sell signal.
Regardless, one interesting aspect of the current state of options dynamics is in the SKEW. The SKEW printed a record high a few weeks ago. This is highly correlated with a more a pronounced drop in equities and something we are tracking closely.
Furthermore, with our proprietary market risk indicator comfortably in the red, we believe a more cautious stance in warranted.
Nvidia (NVDA)
Nvidia has either topped, or will see one more swing to, at least, the $1025 level. Price is in a wedge pattern and how it breaks will likely be the deciding factor. If we do break lower, the odds will favor a top. However, as long as it holds above $785, and then breaks above $915, we could see a new pattern develop that can take us higher in an extended 5th wave. Below $785 and the top is in for NVDA.
Advanced Micro Devices (AMD)
AMD appears to be at odds with NVDA and the rest of the market. The count below is what makes the most sense from the price action; however, it is suggesting a much larger uptrend is underway. I could see something like this happen as the broad market stays within a 5 – 12% range for the remainder of the year. As many stocks and markets make lower highs, AMD will go on to make higher highs, and thus complete the above pattern. I’m willing to hold onto this count as long as any weakness holds $159. Below this level and larger uptrend fails.
Another point of concern, AMD is now below $191. There was substantial institutional activity at this price level. For AMD to move higher, this level has to get reclaimed. We simply do not see block sales of this caliber and price continuing in a 3rd wave. So, as long as we stay below $191, we remain cautious.
Bitcoin (BTCUSD)
There is no reason to doubt the above uptrend pattern in play as long as critical support holds on any weakness. The higher Bitcoin goes, the higher this critical support is raised. Today, the level that must hold in $42,500.
We are do for a pullback, which would be wave 4 of 3. These targets are around $57,000 – $48,000. Remember, $57,000 was strong resistance, and it is now strong support. If we get back to this price, we will likely add. However, we are in a 3rd wave; one we have accumulated for going back to late last year. Third waves tend to be marked with shallow pullbacks that leave investors behind. So, if we continue to see a push over $70,000, the odds will start shifting that the low is in for this drop.
Netflix (NFLX)
Note the bearish engulfing candle from last Friday. Netflix started the day green and then ended the day deep in the red. This happened on heavy volume, and it is what is called a key reversal candle. In other words, the type of candle that tends to happen close to a trend reversal. Netflix is completing the 5th wave of a larger 5th wave, so any additional upside should be limited from here. Below $544 and the top is in.
Ethereum (ETHUSD)
Ethereum is setting up for a bounce. Look at how deep the composite index went on this drop. This is typically where bounces occur. I’m expecting a b wave and final leg lower, but we may not get that if the next bounce is a 5 wave move higher. If this happens, it suggests the low is in for this drop.
Ethereum’s uptrend should continue higher as long as any weakness holds $2990. Below this level and my old red count will get reintroduced. As always, and especially within crypto, it’s best to not get married to a count and to be prepared to bail if a support region gets broken. As of now, this is not the case, so we will keep looking up.
Super Micro (SMCI)
The 1st, 2nd and 3rd largest trade in SMCI’s history came within 72 hours of each other, and around the $1065 price level. We are significantly below this level, which implies institutional selling. The next meaningful support levels are $865 and then $775. Below these levels and the odds build that the top is in. We have taken significant gains in this stock. In fact, we’ve sold about 12%, while only adding 6% at much lower levels. So, we have taken our cost basis off the table, plus ~100% gain. If we do see any further strength, we will continue to sell this position.
Crowdstrike (CRWD)
CRWD looks to have topped in a 3rd wave. The last push to new highs was in a 3 wave pattern, which looks like a B wave. This means the correction is an expanded flat, and the C wave should be quite sharp. I’m targeting around $265 for the 4th wave decline. If we break above the recent high, we can extend the 3rd wave, but eventually, and sooner rather than later, the 4th wave will have to happen.
Chainlink (LINKUSD)
Though it may appear that we are getting a 5 wave drop from the high, this drop appears to be part of an expanded flat correction. If so, this should be the A wave, followed by a 3 wave bounce for b and then another 5 wave drop pointing toward the $12 range.
Below is the count that makes the most sense from the price action. Note how we have 3 waves down, then 3 waves up to new highs. This is most likely the A and B of the expanded flat. If this plays out as expected, look for a 3-5% buy in our target zone.
Micron (MU)
The move over $102 has forced me to rethink the potential counts in play. Since we are getting a gap over $102, then we should be heading to $154 in a larger 5th wave push. This breakout has to hold $102 or we could see a reversal. However, after that report, I find that to be unlikely.
Solana (SOLUSD)
Solana is in a 3rd wave. The 4th wave should take us back to the $137 – $85 range before turning back up for the 5th wave higher. If this drop from the high is a 5 wave move down, we will likely sell half of our gains on the bounce. Unfortunately, because we are dealing with such a large pattern, the critical support is below $85, for now. So, we will have to rely on the structure of the drop – 5 waves down will be an early warning sign.
Cloudflare (NET)
I still hold to NET being in a very complex B wave. The final C wave of this B wave is a 5 wave push higher, and the final move in this corrective bounce. Either we topped with a break below $90, or we can hold $90 and see one more push towards $145.
Microsoft (MSFT)
MSFT broke the February 13th high for a day, before falling back. The push higher appears to be a 5 wave pattern. It’s hard to believe, but this 5 wave pattern is wave 5 of 5 of 5 of 5 of 5, going all the way back to 2009. Below $397 and the top is in.
Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
Broad Market Technical Analysis
Price Analysis
When you funnel the global community of investor into a quantifiable arena, like the stock market, interesting and repeatable patterns emerge. These patterns are the basis of technical analysis, and are used by analysts to predict market trends and establish risk parameters. The discipline of Elliott Wave analysis is simply an in depth study of these repeatable patterns, which provides the best context to market behavior that I know of.
The fundamental idea is that markets move up in a 5 wave pattern, and once this 5 waves pattern completes, we then see a 3 wave retrace/correction, which will make a higher low. This simple movement is not only happening on all time frames, and in all markets where people interact to find price discovery, but it is fractal. So, a small 5 wave pattern develops into a larger one, which then develops into a larger one, and so on.
Because of the fractal nature within market patterns, we are able to fit the entirety of price information into a cohesive pattern. This means that the price action from the 1929 top, and 1933 bottom has an effect on the current 2024 price action. The below chart is the entirety of the Dow Jones Industrial Average’s price information, which is organized into an on-going Elliott Wave pattern.
The reason that I am providing this chart today is because I want our readers to understand the larger backdrop of the current market. Within this context, the 1929 top to the 1933 bottom, was a very large degree 2nd wave. What followed has been a 3rd wave within the same large degree time frame. When you analyze the internal wave structure, it appears that we are coming to the end of this large degree 3rd wave, which is suggesting the start of a secular bear market. This secular bear market would constitute the large degree 4th wave.
Furthermore, what this pattern is telling us is that the secular bull market that started in 2009 has actually been the 5th wave of this very large degree 3rd wave pattern. The below chart outlines this 5th wave, and organizes it into a its own 5 wave pattern.
We can further dissect this analysis and focus our attention deeper. According to the wave pattern above, the COVID low started the final 5 wave pattern within the larger 5 wave pattern above. As stated prior, these patterns are fractal, which allows us to organize each move into a cohesive pattern.
The below chart focuses on the smaller 5 wave pattern that started at the COVID low. With the above information in mind, we are able to have the proper context when trying to understand the current market. As of now, I have 2 potential scenarios on how to understand the final push in the secular bull market that started in 2009.
Blue – This count has the 2022 bear market as a 4th wave within a larger uptrend. What this means is that the 2023 bull market is the final 5th wave, which is taking the shape of an ending diagonal (I discussed this pattern in last month’s report here). This is an overlapping 5 wave pattern that is characterized by large swings in both directions. It is very common to show up as a 5th wave. Considering that the pattern is almost complete, if not already, the risk within this market is greater than many believe.
Red – This count is based on the secular bull market ending on January 2022. What this means is that 2022 was the A wave of this new secular bear market, while 2023 was the B wave bounce. In other words, 2023 to now is a cyclical bull market within a secular bear market. If accurate, the next larger drop will take the shape of a vertical 5 wave pattern pointing down. This 5 wave pattern would retrace the entirety of cyclical bull market that started in October of 2022.
If we zoom in on the ending diagonal pattern that started in October 2022, we can get an idea of how much farther this market can stretch. We are currently in the toping zone between 5145 – 5345. As long as we hold 5090 SPX, we can keep pushing higher. Below 5090 will be the first warning to the bulls. A break below 5050 and then 4945 SPX will confirm that a larger top is in.
Once a top is in place, we can then get a better idea of whether the red or blue count is in play. The red count will be a large degree C wave, which always takes the shape of a 5 wave pattern. It would be a more direct path to our final downside targets. The blue count would be less of a direct path, which would have large bounces followed by breakdowns to new lows. It would be messier, and characterized by a multi-month rangebound market.
In concussion, if we are entering a secular bear market, this does not mean we should leave the markets. It simply means that we will have a period line 2000 – 2013 where the market goes sideways. These sideways periods have bear markets that are punctuated with multi-year bull markets. It is a period where buy and hold tends to struggle, and where a more active approach with a risk management focus could potentially navigate it profitably.
Positions Report of Nvidia, Bitcoin, and Microsoft
Nvidia (NVDA)
Nvidia has either topped, or will see one more swing to, at least, the $1025 level. Price is in a wedge pattern and how it breaks will likely be the deciding factor. If we do break lower, the odds will favor a top. However, as long as it holds above $785, and then breaks above $915, we could see a new pattern develop that can take us higher in an extended 5th wave. Below $785 and the top is in for NVDA.
Bitcoin (BTCUSD)
There is no reason to doubt the above uptrend pattern in play as long as critical support holds on any weakness. The higher Bitcoin goes, the higher this critical support is raised. Today, the level that must hold in $42,500.
We are do for a pullback, which would be wave 4 of 3. These targets are around $57,000 – $48,000. Remember, $57,000 was strong resistance, and it is now strong support. If we get back to this price, we will likely add. However, we are in a 3rd wave; one we have accumulated for going back to late last year. Third waves tend to be marked with shallow pullbacks that leave investors behind. So, if we continue to see a push over $70,000, the odds will start shifting that the low is in for this drop.
Microsoft (MSFT)
MSFT broke the February 13th high for a day, before falling back. The push higher appears to be a 5 wave pattern. It’s hard to believe, but this 5 wave pattern is wave 5 of 5 of 5 of 5 of 5, going all the way back to 2009. Below $397 and the top is in.
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Micron delivered an exceptional fiscal Q2, with revenue rising nearly 58% as strong AI demand led to pricing power coupled with tight supply dynamics to accelerate its return to profitability this quarter. Q3 was guided 10% above consensus to $6.6 billion at midpoint, representing 76% YoY growth, pointing to an impressive rebound from declining growth just three quarters ago.
Margins were significantly ahead of expectations, driving a strong shift to profitability. Micron was initially expected to return to profitability next quarter, but reported a solid 13.6% GAAP net margin this quarter as operating margin expanded nearly 20 percentage points QoQ.
CEO Sanjay Mehrotra said Micron’s “preeminent product portfolio positions us well to deliver a strong fiscal second half of 2024,” as he believes the company “is one of the biggest beneficiaries in the semiconductor industry of the multi-year opportunity enabled by AI.”
There were many strong, bullish statements on the call: “AI server demand is driving rapid growth in HBM, DDR5 and data center SSDs, which is tightening leading-edge supply availability for DRAM and NAND. This is resulting in a positive ripple effect on pricing across all memory and storage end markets. We expect DRAM and NAND pricing levels to increase further throughout calendar year 2024 and expect record revenue and much improved profitability now in fiscal year 2025.”
For more information regarding the importance of HBM3 and HBM3e in Nvidia and AMD’s 2024 product road map for AI Accelerators, please reference our past analysis noted at the end of this analysis.
Revenue and EPS:
Revenue shows a clear and obvious rebound in the memory market and EPS was a blowout:
Revenue of $5.82 billion beat estimates by ~9%, and represented YoY growth of 58% and QoQ growth of 23%.
Fiscal Q3 revenue was guided at $6.6 billion, +/- $200 million, for YoY growth of 76% and QoQ growth of 13%.
GAAP EPS was $0.71, compared to estimates for ($0.38). This compares to GAAP EPS of ($1.12) in Q1 and ($2.12) in the year ago quarter.
Adjusted EPS was $0.42, compared to estimates for ($0.24). This compares to adjusted EPS of ($0.95) in Q1 and ($1.91) in the year ago quarter.
GAAP EPS was guided at $0.17 +/- $0.07, compared to estimates for $0.08.
Adjusted EPS was guided at $0.45 +/- $0.07, compared to estimates for $0.20.
Margins:
GAAP gross margin was 18.5%, an expansion of 5120bp YoY from (-32.7%) and 1920bp QoQ from (0.70%). Management had guided for a gross margin of 12%.
Adjusted gross margin was 20.0%. Gross margins “benefited from $382 million associated with selling the remainder of previously written-down inventories.”
GAAP operating margin was 3.3%, an expansion of 6570bp YoY from (-62.4%) and 2720bp QoQ from (-23.90%). Management had guided for (-8.2%). Adjusted operating margin was 3.5%.
GAAP net margin was 13.6%, an expansion of 7620bp YoY from (-62.5%) and 3970bp QoQ from (-26.1%). Adjusted net margin was 8.2%.
For Q3, GAAP gross margin was guided at 25.5% +/- 1.5%, an expansion of 700bp QoQ at midpoint. Adjusted gross margin was guided at 26.5% +/- 1.5%. Despite the rather large benefit in Q2 from selling written-down inventories, strong increases in DRAM and NAND pricing are driving this sequential expansion.
For Q3, GAAP operating margin is implied to be 8.7% at midpoint, an expansion of 540bp QoQ. Adjusted operating margin is implied to be 11.5%, an expansion of 800bp QoQ. Micron is forecasting continued operating income through the rest of FY24.
Management made it crystal clear that HBM3 is accretive to margins. This has been a concern since it’s 3X more expensive to manufacture. The strength in the margin is due to pricing power.
“So with respect to the accretive nature of HBM, look, HBM carries a higher cost, but it also carries a significantly higher pricing because it brings such great value in the applications in terms of its performance and power. And we are executing well. Our yield ramp is going well as well according to plan.”
“And therefore, we are pleased that in this quarter, when we have begun our production shipments, we will be having it accretive to our gross margins in the quarter. And of course, this momentum will continue to build in the quarters ahead.”
“Answer Mark Murphy (Executives)
Yes. Brian, it's Mark. We won't break it out specifically, but maybe just to give you a sense of the trajectory of gross margins. The increase from first quarter of 1% to 20% in the second quarter was dominantly price. And obviously, a lot of other things going on, but the dominant feature of that increase was price.
Likewise, in the 20% second quarter actuals to the 26.5% guide, price remains the largest contributor. And offsetting part of that is, of course, what CJ mentioned on the benefit of those lower cost inventories fade away. So — but price is still the largest factor.”
Cash and Debt:
Cash and short-term investments totaled $9.0 billion.
Debt totaled $13.7 billion.
Operating cash flow was $1.22 billion, an increase of 256% YoY but a decrease of (13% QoQ). The sequential decrease may have been impacted by strong pre-payments in the prior quarter from customers aiming to secure supply. Management commented last quarter there were $600 million in prepays but declined to comment on prepays this quarter.
Adjusted free cash flow was ($29 million), compared to adjusted FCF of ($333 million) in Q1 and ($1.81 billion) in the year ago quarter. Micron is expecting to generate positive adjusted FCF in both Q3 and Q4.
Key Metrics:
DRAM revenue was $4.2 billion, an increase of 21% QoQ. DRAM pricing increased by the high-teens QoQ. DRAM had increased 24% QoQ in the previous quarter, so this was the second quarter of strong DRAM growth which we covered here.
NAND revenue was $1.6 billion, an increase of 27% QoQ. NAND pricing increased by more than 30% QoQ, offsetting a low single-digit QoQ decrease in bit shipments.
Compute and Networking (CNBU) revenue was $2.19 billion, representing an increase of 26% QoQ and 59% YoY. Per mgmt comments: “Data center revenue grew robustly, and cloud more than doubled sequentially.”
Mobile (MBU) revenue was $1.6 billion, representing an increase of 24% QoQ and 69% YoY. Per management comments: “an expected decline in volume was more than offset by improved pricing” and management confirmed mobile will recover this year: “Smartphone unit volumes in calendar 2024 remain on track to grow low to mid-single digits.”
Embedded (EBU) revenue was $1.1 billion, representing an increase of 7% QoQ and 28% YoY.
Storage (SBU) revenue was $905 million, representing an increase of 39% QoQ and 79% YoY. Per management comments: “Data center SSD revenue more than doubled from a year ago driven by share gains from Micron's products.”
Revenue Acceleration Strongly Underway
Fiscal Q2 reaffirmed that Micron’s revenue acceleration is strongly underway, as revenue and Q3’s guide came in well above expectations. Micron added that they are expecting to generate record revenue with “much improved” profitability in fiscal 2025.
Fiscal Q3’s guidance would mark the highest quarterly revenue in seven quarters, coming in above $6 billion for the first time since the fourth quarter of fiscal 2022. This is driving the fastest acceleration that we have seen for Micron since late 2017.
Q3 is expected to see ~76% YoY revenue growth at midpoint, a 18 percentage point acceleration from Q2 and a 61 percentage point acceleration from when revenue inflected back to positive growth in Q1. However, it’s important to note that these YoY growth rates are viewed against extremely weak comps – the real test for the strength and scale of this acceleration will be fiscal 2025’s growth rates; for example, how close each quarter can stay to the 60% expected revenue growth in fiscal Q1 2025.
An improved pricing environment driven by AI server demand is aiding the revenue growth story. Micron said it was able to drive “robust price increases as the supply-demand balance tightened.”
In particular, AI server demand was seen “driving rapid growth in HBM, DDR5 (D5) and data center SSDs, which is tightening leading-edge supply availability for DRAM and NAND.” Micron said this is causing “a positive ripple effect on pricing across all memory and storage end market.” As a result, Micron is expecting prices to continue to increase through 2024 and into 2025.
Management expressed how unusual the demand for HBM3 is: “And 2024 volume as well as pricing is all locked up. 2025, as I mentioned, the volumes are largely allocated. A vast majority of our production supply is allocated, and some of the pricing is already firmed up. Keep in mind, this has never happened before, right, that we are talking about 2025, and we are sitting in CQ1, and we already have so much discussion around supply and pricing for 2025 getting locked up here as we speak.”
Tight Supply:
Once semiconductor segments are aligned in terms of a rebound, the impact from AI will be more evident. Inventory helps to foreshadow the strength of the rebound.
This is what management stated: “Inventories for memory and storage have improved significantly in the data center, and we continue to expect normalization in the first half of calendar 2024. In PC and smartphone, there were some strategic purchases in calendar Q4 in anticipation of a return to unit growth. Inventories remain near normal levels for auto, industrial and other markets.”
The words “tight supply” were repeated 7 times, which tends to translate to strong pricing power. Here are a few of the comments, which are important to note as the tone of the call was that this pricing power should only increase:
“We anticipate strong HBM demand due to AI, combined with increasing silicon intensity of the HBM road map, to contribute to tight supply conditions for DRAM across all end markets.”
“The trade ratio of 3:1, increasing demand in HBM, increased profitability of HBM is putting a non-HBM part of the memory in tight supply. This is why we say that leading-edge nodes are in very tight supply. And as a result, we would fully expect that D5 as well as other DDR products will improve in their profitability picture as well, given they're very much tight supply there.”
“And so, I mean, this overall tight supply environment bodes well for our ability to manage the pricing increases as well as keep an eye on demand-supply balance and remain extremely disciplined in driving the growth of our business in revenue and profits while continuing to execute our strategy of maintaining stable bit share.”
Note on HBM3e Progress
Micron’s HBM3e was a core part of our multi-faceted AI-driven growth thesis in December, and the company has provided positive updates on HBM3e development and revenue generation.
Management said “we commenced volume production and recognized our first revenue from HBM3E in fiscal Q2 and now have begun high-volume shipments of our HBM3E product.” The company is “on track to generate several hundred million dollars of revenue from HBM in fiscal 2024.”
Micron is expecting these HBM revenues “to be accretive to our DRAM and overall gross margins starting in the fiscal third quarter.” This is an important quote – Micron has already driven tremendous improvement in gross and operating margins in Q2, and this implies that HBM pricing power provided a tailwind to margins. Moving beyond fiscal Q3 and Q4 and into fiscal 2025, margins are expected to continue to expand at a fairly strong rate as HBM revenues ramp significantly.
Micron shed light on customers and capacity, noting that while its HBM3e will be a part of Nvidia’s H200 Tensor Core GPU, it is “making progress on additional platform qualifications with multiple customers.”
Micron’s upcoming 12-high HBM3e has been sampling to customers, and Micron said it will begin ramping the cube in high volume production throughout 2025: “Earlier this month, we sampled our 12-high HBM3E product, which provides 50% increased capacity of DRAM per cube to 36 gigabytes. This increase in capacity allows our customers to pack more memory per GPU, enabling more powerful AI training and inference solutions. We expect 12-high HBM3E will start ramping in high-volume production and increase in mix throughout 2025.”
Nvidia’s H200 win is major win for Micron, as competition in the HBM landscape remains stiff. Per management: “NVIDIA announced its next-generation Blackwell GPU architecture-based AI systems, which provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU. Micron's industry-leading high-bandwidth memory HBM3E solution provides more than 20x the memory bandwidth compared to standard D5-based DIMM-server module.”
Market leader SK Hynix, who had shipped HBM for Nvidia’s H100, is investing at least $1 billion this year to improve stacking and yields for HBM3/3e, while Nvidia just confirmed that it is qualifying Samsung’s HBM for next-gen GPUs.
While it is not certain that Samsung will pass the qualification stage, it raises questions whether this qualification is for the B200 or another upcoming GPU, or whether Nvidia is seeking to qualify HBM products from all three manufacturers in order to secure ample supply in 2025 and 2026 (given that Micron’s capacity is nearly booked and SK Hynix just commenced HBM3e mass production).
Per Micron, the following sets them apart: “Customers continue to give strong feedback that our HBM3E solution has a 30% lower power consumption compared to competitors' solutions. This benefit is contributing to strong demand.”
Though it is rumored that SK Hynix is shipping to Nvidia’s Blackwell lineup, Micron raises a critical point: the architecture “provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU.” This trend for higher memory content to support larger and faster GPUs is likely to continue especially as chipmakers such as AMD work quickly to encroach on Nvidia’s share with comparable or faster GPUs.
Additional Growth Opportunities
HBM3e is stealing the spotlight but it’s worth mentioning a few additional growth opportunities for Micron:
The company is releasing a 128-gigabyte server DRAM module that will provide high bandwidth D5 capability and greater than 20% energy efficiency with 15% better latency compared to Samsung’s 3D TSV solutions. This product has “strong customer pull” with “several hundred million dollars of revenue in the second half of fiscal 2024.”
Micron reported record revenue share in the data center SSD market last year. In the current quarter, MU grew revenue by 50% QoQ for the 232-layer based 6500 30 terabyte SSDs. These are used for AI data lake applications.
Edge AI – PCs will be a growth market for Micron. As stated above, mgmt expects PCs to return to growth in CY2024 in the “low single-digit range.” The neural processing units (NPU) chipsets that AI PCs require will see 40% to 80% more DRAM content than non-AI PCs.
Edge AI – AI phones will require 50% to 100% more DRAM content than non-AI phones.
Conclusion:
A company that is supplying Nvidia (and likely AMD, perhaps Broadcom) on critical memory components for GPUs this year, HBM3E, plus will afford us an early entry for Edge AI with spring-loaded margins and strong pricing power that is expected to increase? Yes, please.
I’m quite positive you will see a new buy alert on Micron tomorrow and we are also looking at entering Lam Research (see below for LRCX analysis).
The report tonight has many implications for a thesis we have been carefully building on a memory rebound, which with some careful risk management, should have a long runway with Edge AI up to bat next (2025).
A special thank you to my team of analysts – Damien, Royston and Knox — who have worked diligently to identify this thesis. Go team go.
