Category: Tech Stocks

Netflix Stock: Unshakeable Long Term

Posted on by io-fund

This article was originally published on Forbes on Jan 20, 2020, 07:49pm ESTForbes on Jan 20, 2020, 07:49pm EST

Two of the world’s largest brands entered subscription video on demand (SVOD) over the past quarter, which means the upcoming Netflix earnings report on January 21 will be under pressure. However, financial analysts are overestimating Disney and Apple, as these companies will not easily catch up to the top streaming subscription service over the long-term.

Netflix has a Firm Hold on OTT

There are more than 190 OTT providers to keep track of in the United States. This has the market in a frenzy, which is one reason we see whipsaw reactions to news of any kind in the OTT market. For instance, Netflix shed $24 billion in market value following the second-quarter earnings release in July. This could happen again, but in the long-run, it won’t matter.

According to Digital TV Research, the OTT market is set to grow from $68 billion in 2018 to $159 billion in 2024. Subscription services will grow by $51 billion between 2018 to 2024, reaching a total of $87 billion.

Netflix is the top subscription service in the OTT market by a wide margin, claiming 87% of OTT households in the United States. In Western Europe, Netflix has a penetration of 70-87% in English-speaking countries and 55-64% in non-English speaking countries. 

Disney forecasts Disney+ to have between 60 million and 90 million subscribers by 2024. This is despite many free promotions. Netflix currently has 158 million paying subscribers and is adding roughly 28 million more per year. With this level of penetration, for Netflix, the opportunity that remains is global.

Netflix’s Stock Price Hinges on Global Logistics

Before third quarter earnings, I had pointed out that Netflix’s opportunity is global, and this is why the balance sheet looks frightening to value investors. Netflix’s stock price has most certainly reflected a market concerned with the company’s debt as the stock has posted 0.17% returns – or nearly 0% — over the past 12 months, while Disney and Comcast are up 30% and 31%, which is more in line with the broader market.

The company is in the red with free cash flow due to producing content for many geographic regions. However, as broadband coverage increases globally, and as 5G delivers faster speeds to developed countries, Netflix is well situated to grow its already-dominant user base and to reclaim these costs. Notably, Netflix’s operating margins stand at 18.9%. (More on broadband penetration below).

There is plenty of evidence that domestic OTT players will not be able to handle the logistics of going global. For instance, while Friends and The Office are leaving Netflix in the U.S., many of the shows will remain with Netflix internationally. According to Amy Reinhard, VP of Acquisitions at Netflix, only Disney can compete in international distribution at this time. Netflix also partners with companies like Warner Bros. for international film rights.

Asia’s population represents the majority of the world with gains of 2-3% being more impactful than double-digit gains in North America. According to eMarketer, Netflix’s penetration of Asia-Pacific will advance from 11.8% in 2018 to 14.3% in 2020.

Regions, such as China, have high barriers to entry for standalone services, yet Netflix has secured a promising licensing deal with Baidu-owned QiYi. Netflix’s share in Japan remains at 17%, despite launching in 2015, as the country has an older population that is averse to newer technologies.

International markets such as Central and Eastern Europe, the Middle East and Africa have upside specifically for acquired titles, an area of strength for Netflix. 

If Netflix continues to dominate globally, then the company could be serving 50-70% of all developed countries and 20% of the developing world. With the limitations of broadcast and linear television, it is unprecedented to have a truly global media company. We will see the full effects of this once broadband penetration increases and 5G speeds bring OTT content at reasonable speeds to mobile devices.

Broadband Penetration and 5G

The OTT market in the United States has taken a decade to surpass pay-TV, with Hulu launching in 2007, popular set-top-boxes launching circa 2008 and Netflix streaming service launching in 2010. This growth has been assisted with the wide availability of high-speed broadband. 

You can expect the global market to take twice that long, or maybe thrice. Broadband is slow to non-existent in many countries, although progress is being made. Brazil, for instance, reports a 20% annual improvement in households with 4 Mbps or greater (Netflix requires 3 Mbps or greater).

Japan and South Korea have nearly 50 million people with speeds of 100 Mbps or higher. Fiber technologies and broadband are prominent in Japan and South Korea, along with Australia, Hong Kong, Malaysia, Singapore, Taiwan and Vietnam. There is room for growth once higher broadband rates are achieved in New Zealand, Indonesia, Thailand, India and the Philippines.

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Overall, OTT video is projected to grow to 6.4% of emerging market households, or 103 million in total by the end of 2019. This is up from 19.4 million in 2014. By 2025, digital growth will add over a billion middle-tier consumers for telcos, which will also help to open the market for OTT players.

Media is a universal staple for quality of life, and OTT delivers cheaper content on-demand compared to broadcast or linear television. Some forecasts place 2040 as the pivotal point when essentially every person on the planet will have internet access, up from roughly 50 percent today. With the same data, others are more optimistic and are forecasting 2030.

Gene Munster told CNBC that “Netflix is not going to make a dramatic change to our lives in the next decade.” This misses the point entirely that Netflix is set to make a dramatic change for the remaining 6.5 billion people outside of the United States and Western Europe.

Beyond Subscriber Numbers: User Engagement

Netflix is not only capturing market share from cable TV attrition, but the company is also seeping into Hollywood’s addressable market.Recently, Netflix received 24 Oscar nominations, which is more than any major Hollywood studio or distributor.

High-ranking content isn’t exactly new for Netflix. In both 2018 and 2019, Netflix claimed 19 of the top 20 most streamed shows. According to Christy Ezzell, senior director of TV Time, this is partly due to Netflix’s investment in global audiences, including significant regional investments in foreign-language content and licensing partnerships. For instance, DARK and Elite are foreign-language originals that topped the top 20 list and beat out Amazon Prime on all accounts, including The Marvelous Mrs. Maisel. Notably, two of these are Marvel originals and will count for Disney+ moving forward. 

These charts are incredibly important for understanding user engagement as opposed to subscriber numbers. For instance, Amazon is reportedly in the number two spot for OTT services yet is absent from the top 20 list for content. (I suspect subscriber numbers are skewed with Amazon Prime members who subscribe for the free one-day shipping or Whole Foods discounts, yet are more loyal to Netflix in their viewing habits).

Keep this in mind, as both Disney+ and Apple+ attract users with free promotions. Subscribers may sign-up yet use the service very little compared to Netflix’s level of engagement.

Conclusion:

Interestingly enough, many criticize Netflix for continuing its lead at 87% of subscribers through 2023. Again, they are also missing the point that this is the law of large numbers, as a leader cannot hit 100% of all OTT households and now Netflix must look outside of the United States for growth.

Global OTT is not a market we’ve seen before, and there’s nothing to compare it to in terms of scale and subscription revenue potential. To think Netflix is in trouble due to domestic competitors is to misunderstand the opportunity and the slow process of OTT proliferation due to broadband access in undeveloped countries and the forthcoming 5G in developed countries.

The positive here is that the $12 billion debt overhead and competitive landscape will likely spook the market a few times in the near-term and shake up the stock price, as it did following the Q2 2019 earnings. For anyone who wants a global OTT pureplay for the long haul, this should be welcomed.

I’ve included some information regarding Netflix’s stock price below. 

Review of Netflix’s Stock Price

Netflix has held the $385 resistance zone since late 2018. This is a significant region that Netflix is looking to retest in the coming days and weeks. Netflix just reclaimed the 50-day and 200-day simple moving average (SMA), which will now act as support. It’s also worth noting that the 200-day SMA is signaling that the long-term trend is pointing downward.

Netflix Stock Price Technical Chart - KNOX RIDLEY

In the chart above, you can see decreasing volume as Netflix approaches the $385 resistance. Although the internals of Netflix are showing a clear uptrend, which is supported by the MACD and the RSI, there is also negative divergence with the price making lower highs while the RSI makes higher highs into overbought territory. It’s important to monitor whether the internals break down through their respective uptrends along with the price.

Netflix is trading between support at the 200-day SMA and resistance at $385. If Netflix fails before testing $385, the structure suggests a setup that can see a retest of the October lows. This structure can be viewed as a reverse cup & handle pattern or, from Elliott Wave, a 1-2 i-ii structure, which will be confirmed below the $250 support. This level will need to be monitored closely if we see a renewed downtrend. However, if Netflix can break above $385 and close with heavy volume above this region, we could see new highs. 

8 Predictions For Tech Stocks In 2020

Posted on by io-fund

This article was originally published on Forbes on Jan 16, 2020, 03:22pm ESTForbes on Jan 16, 2020, 03:22pm EST

Despite record highs in the market, the consensus forecast is for an earnings recession with the aggregate S&P 500 expected to fall 2.6% in the fourth quarter. This will mark the fourth consecutive quarter of year-over-year net income declines. When taking into consideration buybacks, which help to reduce companies’ shares, the S&P 500 could post 0.6% EPS growth in all of 2019 compared to 2018’s 23% increase in EPS.

Although sentiment is bordering on euphoria in the market, there are pitfalls to watch out for and winning tech verticals to lean into.

As the analyst who early-on called the top-performing stock last year (Roku) following its IPO, plus many other accurate calls such as Uber’s IPO flop, Zoom’s successful IPO, and Microsoft’s Pentagon win, here are my top 8 predictions for successful tech investing in 2020:

1. 5G is a business to business growth story; the consumer story is overblown

Investors who believe 5G will drive a “supercycle” for Apple are not taking into consideration that 5G is a replacement cycle for 4G. The consumer opportunity will not be as significant as previous generations, such as when 4G delivered mobile broadband with smartphones being the primary beneficiary.

Apple’s revenue declined 2% year-over-year and is nearly stagnant in forward estimates at 4% growth from fiscal 2018 for fiscal 2020. To put it simply, investors are paying 105% more for each dollar of Apple’s earnings as the fundamentals are flat with a decline of 7% in net income. Some of this hype is being driven by the highly speculative 5G release in September of 2020.

To determine the 5G story of the year, the following has to be taken into consideration:

  • China is ahead of the United States; the 5G story of the year will be more geographically diversified than Apple, who has conflicting reports from shipments in China. There are reports that iPhone shipments were up 18% in December, yet conflicting reports that iPhone shipments decreased by 35% in November. Regardless of how these monthly reports play out, Apple is number five in the top 5G market globally and one month’s worth of sales is unlikely to change this.
  • 5G semiconductors can sell 50% more-dollar chip content per device versus the previous 4G generation, meanwhile, handsets are in all-out price war. In other words, the profits will be more substantial at the chip level than the handset level while average sales price (ASP) continues to erode.
  • There are many areas where 5G will create major gains for investors. See #2 below.

2. Diversified 5G Small Caps and 5G Suppliers will be 2020 Winners

5G is unique from previous wireless generations due to the required change in infrastructure. While previous generations delivered increased speeds and robust internet, 5G proposes a more advanced technology stack. A brief overview of infrastructure changes include:

  • Massive Multiple Input and Multiple Output (MIMO) – more antennas will be needed.
  • 5G frequencies cannot penetrate glass and are up to 100 times worse at penetrating walls than 4G. Indoor 5G cellular is a major concern at this time.
  • Small cell sites are needed to avoid the interruptions and latency that base stations alone can cause.
  • Carriers have various strategies with low-band, mid-band and mmWave.
  • Microdata centers and the edge cloud will open up hundreds of thousands or even millions of data centers globally.
  • Orthogonal frequency domain multiplexing (ODFM) will need to condense channels into mmWave range.
  • 5G allows for virtualization, which allows traffic to be software-defined and centrally located. This greatly reduces the need for power and cooling costs.

The best 5G stocks will come from companies that solve real issues related to 5G infrastructure and performance, or who supply a broad swath of the ecosystem. Triple-digit (and maybe quadruple-digit) returns in 5G will come from scarcely-known names.

3. Ad companies will quietly outperform:

As I write this, the Consumer Electronics Show is taking place in Las Vegas with futuristic promises, such as electric air taxis from Uber and Hyundai, rollable OLED screens from LG, and autonomous security drones from Sunflower Labs.

I’ve been to tech gadget shows for over a decade and have concluded that making real money in tech is often much more boring. Ad conferences may not make headlines but they will make you money and 2020 will be another “slow-and-steady-wins-the-race” year for ad revenue.

My prediction is ad companies will continue to quietly outperform their futuristic tech peers. There are 7 billion people on this planet, or 14 billion eyeballs, and companies are flush with cash to reach them.

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According to Magna, media net advertising revenue will grow 4.1 percent in 2019 and 6.2 percent in 2020, partly due to political ads and the Olympics.

The outcome for the usual suspects of Facebook and Google is anyone’s guess, while stock market darlings, The Trade Desk and Roku, see plenty of volatility. I recommend looking far and wide as there are many companies driven by ad revenue on the public markets that target audiences while being privacy compliant.

4. Cloud companies will continue to report strong growth

The market became more prudent with valuations last year, and cloud software took the brunt of the rotation. Before the correction, cloud software was the leader in the market – and for good reason, as cloud spending is currently outpacing IT spending by 400%. According to Gartner, global IT spending will grow 3.7% in 2020 with enterprise software growing 10.9% and software-as-a-service growing 16.5%.

With cloud spending outpacing IT spending by 400%, it’ll be important to know and predict the winners. The market’s widespread categorical pullback on cloud software, coupled with forward earnings projections, places cloud software winners in an enviable position going into 2020. Keep in mind, this performance is simultaneously occurring during an earnings recession across most other industries.

The trick will be to choose wisely as there is an overabundance of cloud software companies on the market and many are unproven across various fundamentals. Silencing the noise and determining where the real long-term growth and profits will be in this burgeoning category is key.

5. Semis will not be able to sustain current valuations

Less than fifty percent of semiconductor companies will return to growth next year, or twelve out of thirty, up from three out of thirty in 2019. Most of the sales growth expected next year will be regaining lost ground to return to 2017 levels — before the U.S. trade conflict with China. Meanwhile, because of flat earnings, these stocks are incredibly expensive.

AMD is a growth stock with a forward price-to-earnings (P/E) ratio of 45, a current P/E ratio of 257 and EV to EBIT of 201. The company is posting low-single-digit revenue growth year-over-year and 18% revenue growth quarter-over-quarter. In October, AMD had a 12-month price target of $32.94 based on a 25% expected sales increase in 2020. The company has blown past this target based on 4% growth this year, and is trading near $50 per share.

6. Some AI and ML investments will continue to bleed, but will steal all the glory in the coming years

Artificial intelligence and machine learning investments will go through a period of flat growth over the next few years as the transition costs and capital expenditures exceed the output gains.

Over the next year and perhaps into 2021, investors will be able to pick up AI stocks cheap relative to the forward 5-7 year growth potential.

7. Look for the market miscalculating the competition. Netflix is a prime example.

Netflix is one example of how financial analysts overestimate the competition. Netflix is the top streaming service by a wide margin, claiming 87% of OTT households in the United States. In Western Europe, Netflix has a penetration of 70-87% in English-speaking countries and 55-64% in non-English speaking countries.

According to Digital TV Research, the OTT market is set to grow from $68 billion in 2018 to $159 billion in 2024. Combine this growth with Netflix’s current market share, and you have an unshakeable first mover. The speculation on competitors may become marginally true. Disney could do well. But, to think Netflix will be ruined, despite being in the lead on all accounts and posting $1.5 billion in yearly profits, is a rather sensational conclusion.

8. Balance sheets will matter again

Remember balance sheets? That’s where you can find the debt a company is holding. Don’t tell Tesla investors but balance sheets will eventually matter again and Tesla’s $13.3 billion in long-term debt isn’t going anywhere fast with negative operating margins. Don’t tell Uber investors either as this company’s $5 billion in debt won’t exactly evaporate with $1.3 billion in quarterly operating losses and $4 billion in annual operating losses. It’s this combination of high debt and a lack of profitability (by any reasonable margin) that causes trouble when sentiment turns.

Market Update – January 16th

Posted on by io-fund

As we have referenced in the past, we are not a research site that attempts to predict the market. We think that’s a nearly impossible task. We simply keep an eye on various, opposing scenarios while providing stock tips we think are relevant in the current environment.

Bull Count

The level I’ve been watching is the S&P 500 at 3200. The market powered through this and has overtaken 3300. This means the bull market could take us up to 3800-4000 region. This is based on basic Elliott Wave analysis where the 5th wave, more times than not, reaches the length of the 1st wave, or an extension of that wave, which we see time and time again.

My rational for such a position is based on the global loose monetary policy seen by central banks. Not only are dozens of central banks cutting rates, but the Federal Reserve publicly said the goal is to keep the expansion alive, and they are using tools used to re-stimulate an economy from a recessionary position. In other words, they are going all-in on keeping the expansion going.

Also, it’s worth noting that an accommodative Fed has historically been great for MOMO stocks. As long as inflation stays muted according to the CPI, and central banks stay accommodative, I will stay long tech with rising stops to match rising gains.

Another point of encouragement is that a record level of cash is still on the sidelines, waiting to come back in. Furthermore, one trading platform shows 69% of clients are short the S&P 500 today. As these shorts cover their losses, it will force more buying, which will force more covers. Massive levels of shorts can propel a market, and this pattern will continue until the shorts give up, which can be propelled forward if cash on the sidelines moves in because of FOMO.

So, long term, I am bullish and slow-tilting my portfolio towards a more aggressive stance. However, in the medium term – i.e., a few weeks to a month out – I am expecting a local top to take us back at minimum 3%-5%, at which point I’ll look to allocate more of my cash. Tech has led this market and I believe it will continue to lead throughout the expansion.

Flashing Bear Signals

I’m going to expand on this more next week, but the current market environment is not without some flashing signals. It’s important to understand the backdrop in which we are investing and also where we are in the current market cycle. 

 In a nutshell, these are:

  • The yield on the 2-year treasury and on the 10-year treasury have inverted. The inversion occurred in August of 2019 and the average time period before a recession following an inverted yield curve is 18.5 months.
  • According to the ISM, manufacturing peaked and has been in a steady decline since late 2019. Once again, this trend has preceded every recession, and about 31 months after the cycle peak, on average, a recession follows. So far, the ISM peaked in summer of 2018.
  • The Conference Board Leading Economic Index (LEI) is at the zero line. This is at its lowest level in over a decade. To be clear, it has not crossed yet, so it’s worth watching. I’ll expand more on this next week.
  • After several years of zero percent interest rates, corporate debt is at historic and unsustainable levels totaling over $10 trillion total, or 47% of our national GDP. Fifty percent of investment grade debt is in the BBB ratings.

I’ll go more in-depth next week on those signals. The way that I protect my gains is to have trailing stops between 10-30%. If I hit my stop on a stock that I like, I will re-enter once the price has stabilized. A recent example is when I exited Zoom at $68 and got back in at $62. This is a small-scale exit, whereas Nvidia’s crypto bust was a larger-scale exit. My gains were protected and I simply re-entered once the price stabilized again. This is the only way I’ve found that I can stay in the market when there is a lot of noise towards the end of a market cycle.

Technical Analysis:

By Knox Ridley

Alteryx (AYX)

After about a 40% drawdown, Alteryx has dragged along the bottom of the long-term trend channel, which is highlighted by the blue dotted lines. The move up appears to be overlapping, and therefore corrective in nature, with the final C-wave unfolding in a 5-wave pattern, which I’m targeting the 127.2% extension around $133. I’m treating this as a corrective move, and holding off on adding to my current position until:

(1) we break $133 with heavy volume, at which point I’ll hold this position with a very tight stop until we clear new highs. If this happens, we will be in the heart of a 3rd wave, and the bottom for wave-2 will be in.

(2) AYX stalls in the coming days/weeks, and retests the $100 level. If this support doesn’t hold, I’ll look to pick up more shares as we approach the C-wave target box that I outlined in the chart above.

Roku (ROKU)

I’ve been patiently waiting to pick up more Roku sub-$100, and the set-up is in place for this to happen. Roku has tested the $127 support level 3 times, and each time it has corrected from $127 with less momentum and lower highs.

It’s currently trading just under the Volume Weighted Moving Average, which I anchored at the all-time high (in red). This average factors in volume from a critical moment. This week, the bears are in control. Furthermore, the price is below the 55-day exponential average, which is a great measurement of the overall trend.

Also, look at the internals (MACD, RSI). They have both broken their respective trendlines and are heading lower. I take this as a warning.

But, most importantly, the final C-wave set up is intact. Corrective waves (second waves and 4th waves) unfold in 2 moves (A down, B up, C down). There are several rules patterns that we see over and over. One of the most notable is that the C wave will almost always unfold in an impulsive, 5-wave structure, which on lower time frames will have its own smaller degree 5-wave structure.

We have a 1-2, (i)-(ii), i-ii setup right at the $127 support. If $127 is broken, we will be in the 3rd wave lower. Based on basic Elliot Wave, I’m expecting this move to terminate around $100-$95, at which point, I’ll look to add to my long-term position. Just to be clear, I’m still expecting Roku to reach $200 by 2021. 

However, it’s worth noting that Roku has held the $127 support, and though the signals are suggesting that it could head lower, Roku has a tendency to move fast against bears. On a long-term basis, $127 is not a bad price to pay for this stock, based on what we are projecting for 2020.

Also, if Roku can break out on heavy volume in a 5-wave move up from $127 upwards, while the internal indicators break their downtrend (look at the green arrows), I’ll scrap this bearish set-up, and look to go long from higher levels.

Qualcomm (QCOM)

QCOM is approaching a cluster of resistance. The red box highlights a strong concentration of significant Fibonacci prices. Rarely do you see a concentration like this. QCOM will either break through on heavy volume, which would be an indication to go long, or it will break down from current levels. If we break down, I’ll be looking to add to my position in the green target box between $80 and $62.

Alibaba (BABA)

Since Alibaba broke out, we have clearly been in a 3rd wave uptrend. For anyone curious what a 3rd wave feels like, this is it – an uninterrupted bull train, where the price stays above the 10 and 20-day EMA. I’ve put my targets in the chart above as well as significant resistance zones as we continue upwards. We should have pullbacks along the way.

Twilio (TWLO)

Twilio has shot straight through the 200-day SMA and found resistance at the 61.8% retrace level around $123. If Twilio can break this region, I will likely begin layering into Twilio. I will want to see it break through the $135 region for a final confirmation that the 2nd wave is over. However, a move up like we’ve seen in Twilio, breaking the 61.8% retrace is worth noting.

Zoom (ZM)

So far, Zoom is playing out as planned. After topping out in its first wave, it retraced nearly the entirety of that move in a very deep second wave. Since then, it’s provided us with a 1-2 setup, and is now powering up towards its AVWAPS. We picked up shares in the low $60s with a stop at all-time lows. As long as this level holds, I’m expecting new highs this year for ZM. If it can power through the above AVWAP in blue, that will be a strong showing of strength, at which point I’ll add more to my position.

Silicon Valley is Losing its Entrepreneurial Spirit

Posted on by io-fund

This past week, I wrote about how Silicon Valley is losing some of its entrepreneurial spirit as venture capitalists shifted their attention to later stage deals with higher valuations. In the analysis, I pointed out that 2019 was the most lucrative year for exits in more than a decade, with $200 billion in exits generated from venture-backed IPOs.

For context, I went back to the golden years of Silicon Valley – 2006 to 2014. During this period, venture capital that was invested in deals below $5 million grew by 290%.

However, things changed in 2015, when early stage deals from below $1 million to under $100 million began to decline at a rate of 20% to 36% per year. Early stage software companies suffered most from the reallocation during this period, while early stage deals declined from 388 in 2018 to around 279 in 2019.

So how did this happen?

I identified two culprits behind the trend – Silicon Valley’s declining entrepreneurial culture and the increasing attractiveness of late stage investments.

Startup pitches and dynamic innovation have been replaced by a relatively closed circle of investors who are only targeting high valuations. In fact, we are seeing an aggregate all-time high for 180 private companies with $1 billion-plus valuations, and they have undermined the attractiveness of seed and Series A round companies.

Moreover, the IPO window is shifting from a range of six to eight years to ten to twelve years, which drove several startups to go public at valuations of over $10 billion this year. Consequently, this has made late stage investments more attractive due to their longer duration and higher valuations. The downside is that it has suppressed early stage investments (defined as deals below $5 million), which only further hampered Silicon Valley’s entrepreneurial culture.

Exciting early stage entrepreneurial stories have become rarer over the past few years, and many of the start-up tech events that I go to have either a noticeable lull or have moved overseas. The sad reality is that Silicon Valley’s entrepreneurial culture has faded, and entrepreneurs have a better chance at attracting capital from strangers on Kickstarter than from Silicon Valley angels and VCs.

Read the full article in MarketWatch here.

Image by Patrick Nouhailler

AMD Stock is Approaching a 20 Year Roadblock – Will History Repeat?

Posted on by io-fund

Advanced Micro Devices (AMD)’s stock price is up by 108% this year, making it the best-performing company in the S&P 500 this year. Its closest peer has been Nvidia, whose stock has climbed by 56%. Other peers like Intel, Broadcom, and Taiwan Semiconductor have gained by 22%, 24%, and 48% respectively year-to-date. As a result, AMD has helped power the Fidelity Select Semiconductors (FSELX), which has risen 48% this year, and the PHLX Semiconductor Sector Index (SOX), up 46% this year.

The main justification for the surge in AMD’s stock price is that the company is successfully taking market share from Intel – and to some extent, Nvidia. Since 2017, Intel has lost 10% of its PC CPU market share and 5% server market share to AMD.

Higher PC and graphics chips helped drive the most recent quarter’s performance, yet AMD’s strategy in the CPU-powered cloud-data center segment as the company takes on juggernaut-Intel is especially promising.

In the most-recent quarter, AMD reported revenue of $1.8 billion, which is the company’s highest quarterly sales in more than a decade. Revenue missed by $1 million on an expected $1.81 billion while the company met EPS forecasts of $0.18 EPS. Management guided fourth-quarter revenue of $2.05 billion to $2.15 billion, while analysts had forecast revenue of $2.15 billion. Factoring the past three quarters means that the company will likely generate $6.4 to $6.7 billion in revenue this year. This will be slightly flat from the $6.47 billion that was generated a year ago.

Also Read : Alteryx Stock Price

The issue is that the recent AMD share price surge and subsequent valuation multiples see it as a growth company. It has a one-year forward PE ratio of 36, compared to Nvidia’s 30, Taiwan Semiconductor at 20, and Broadcom at 12. Historically, the S&P 500 has an average forward PE ratio of 15. The current PE ratio for the AMD is 206, nearly 5x higher than Broadcom at 45, nearly 4x higher than Nvidia’s at 55 and an astonishing 8x higher than Taiwan’s current PE ratio at 25.

Meanwhile, AMD’s YoY revenue growth same quarter is at 8.95% and will be 52% growth YoY same-quarter Q4, if the company comes in at the $2.15 billion. (Hence the popularity of the stock and cyclical nature of semiconductors). YTD growth is around 20%, which is similar to Broadcom.

AMD’s fundamental story lies within the company’s margins, which historically, have been very low, and are impacted by average sales price (ASP), cost per unit and volume. The company’s trailing EBITDA margin of 8.35% is below that of peers mentioned above. However, over this past year, AMD’s non-GAAP margins have expanded even as revenue declined.

Intel, on the other hand, saw non-GAAP margins fall YoY. This helps support the bull case that AMD’s earnings are growing even while experiencing flattened revenue, and the company has forward-looking potential.

The main challenge with AMD’s current share price is market exuberance over the company’s rebound from the lowered guidance in July. In the technical analysis below, we attempt to reveal just how stretched AMD is, to make the case that now might be the time to take profits, or wait for confirmation if you are looking for an entry.

AMD’s Stock Price: Technical Analysis

Price is approaching a resistance zone that AMD has failed to break through twice over the prior 2 decades – once in the year 2000 and then again in 2006.

Regarding resistance and supports, the longer the region has held the more important it becomes. Also, the severity of the correction from the price region usually dictates the importance of the region as well. In other words, AMD has failed to breakthrough twice over a 20-year period at this region, and what followed these failed breakouts was two drawdowns greater than 90%. Therefore, this price zone is important for AMD to break through.

Notably, the short interest in AMD is currently around 11%, which is high. So, if AMD can break through this region, it will force shorts to cover, accelerating the price even higher. However, if AMD cannot breakthrough this zone, a healthy correction should be expected. History doesn’t always repeat, but it can rhyme, and a mere retrace to the 23.6% Fibonacci retrace level, a mild correction compared to the uptrend we’ve seen in AMD since 2016, would constitute around a 50% drawdown.

Also Read : Roku’s Stock Price

AMD Stock Price: RSI and MACD

There is negative divergence between the RSI and MACD making lower highs while the price of AMD is making higher highs. The price is thus moving up while the buying pressure is fading. This is typically a sign of a fading rally and suggests a pullback is on the horizon. Furthermore, the price is rising on decreasing volume as well, suggesting that not many investors are buying at current prices.

This divergence is not only happening in AMD’s price, but across the Semis that are trading in the U.S.

The above chart is showing the Philadelphia Semiconductor Index (SOXX) compared to the South Korean Kospi Index. South Korea is an economy that is fueled by some of the world’s largest semi-conductor companies, as well as many mid-level players. Companies such as Samsung, and SK Hynix supplied over 60% of the components used in memory chips sold globally in 2018.

Therefore, the KOSPI provides important information about the global health of semiconductors. As you can see, these indexes are historically closely correlated. Today, we are seeing a very wide divergence between the U.S. semiconductor index and the KOSPI, which is unusual. This suggests that either the PHLX or the KOSPI will need to make a move to realign. My best guess based on the evidence is the U.S. semiconductors will point downward soon.

Regarding AMD, the volume suggests buyers are drying up at current prices, which makes sense considering the overhead resistance, fundamental outlook and global slow down. If I were long, I’d be looking to take profits at current prices, or at minimum buy insurance through a put.

Top Momentum Stocks Affected by Cash Rotation in Q3

Posted on by io-fund

It has been a difficult quarter for many top momentum stocks like Slack (WORK), Veeva Systems (VEEV), Alteryx (AYX) and Zoom Communications (ZM). The companies have continued to execute well but their stock prices have declined. These companies reported better-than-expected third quarter earnings, impressive growth, and boosted their forward guidance.

In an analysis in MarketWatch this week, I reviewed why Momentum stocks are down and I look beyond the assumption it’s due to a “value rotation.” Instead, as I point out, there is a lot of volume that suggests institutional selling directly after earnings reports. This volume in momentum stocks exceeds what we saw during the Q4 sell-off.

Overview of Momentum Stocks Following Q3 Earnings:

Many YTD gains have been erased as investors rush to value stocks. Indeed, value stocks, as gauged by the iShares S&P 500 Value ETF (IVE) have started to outperform momentum stocks as gauged by the iShares Edge MSCI USA Momentum ETF (MTUM). While it is true that some investors have moved to value stocks like Caterpillar (CAT) and Target (TGT), the real concern is that many investors are rotating to cash.

In January this year, WSJ reported that investors were increasing their cash holdings at the fastest pace in a decade. In July this year, CNBC reported that the wealthy were moving to cash. Just recently, a report by DataTrek showed that this trend was continuing. The report found that there was $3.4 trillion in US money market fund in October 2. This was 14% higher than in January this year.

Narratives Driving the Momentum Market

A common narrative is that the best momentum stocks and companies are overvalued. When you look at price-to-sales and price-to-earnings, it is true they are at record highs. However, as I had pointed out in a separate analysis on MarketWatch, cloud software has also been reporting record high revenue growth. There is not a divergence between valuations and revenue that you typically see in bubbles; they’ve been aligned.

Most certainly, if the market decides to reward profitability over growth, we will see lower price-to-sales across cloud software.

Another narrative is that these companies will be affected by the soft spending on IT. In reality, IT spending in the United States and internationally has been increasing as evidenced by the increasing sales reported by AWS, Azure, and other IT-related companies (although percentages have declined due to the law of large numbers). A report by Gartner has said that IT spending will rebound by 3.7%, driven by increased spending in enterprise software spending. IDC has also forecasted that IT spending will continue to increase.

Alteryx: Momentum Stock

Many momentum companies have continued to see impressive growth. A good example of this is Alteryx (AYX), a company that offers data science solutions to companies. The company’s stock has declined by more than 21% in the past three months. Yet, Alteryx is a rare company. It is a fast-growing company, a market-leader, and one often has positive EPS.

Also Read : Alteryx Stock Price

In the most recent quarter, the company’s revenue grew by 90%. Net income grew to $16 million. The company also boosted its forward-guidance. It now expects to make between $389 million to $392 million this year. This is an annual growth rate of between 53% to 55%, but on the other hand, AYX management tends to be conservative.

In the above chart, the large volume spikes coupled with noticeable price movements suggests institutional positioning. We see sell-off volume (red spikes) is much higher over the last two months than during the Q4 selloff.

Alteryx’s shares were down in the days after the strong earnings report.

Roku

Roku (ROKU) is another company that saw some irrational sell-off. Revenue of $360 million rose by more than 50% and the company raised its outlook for the year. It expects its revenue to grow to about $1.106 billion, or 46% YoY. This is impressive growth for a company that has a strong runway for growth as I wrote before. Although Roku recovered, there was still high volume after the earnings report.

Also Read : Roku Q3 Earnings

The above chart also shows large volume, suggesting institutional positions. We see the sell-off volume is much higher than during the Q4 selloff.

Zoom Video (ZM) is another example. The company’s stock tanked and is now trading 30% below its all-time high. You would think that ZM had a very bad quarter. In reality, the company reported that revenue grew by 96% to $146 million. The company’s clients with at least 10 employees grew by 76%. Also, the company increased its Q3 guidance to between $155 million and $156 million.

I also covered Veeva in the MarketWatch analysis. Veeva Systems’ operating margins have expanded from 17% in 2016 to 27% in the most recent quarter. Veeva beat on earnings with 55 cents per share compared to estimates of 48 cents per share. Company full year guidance also exceeded analyst estimates. Veeva is also strong on cash flow, increasing from $40 million in 2014 to almost $400 million in the most recent quarter. The company has $1.4 billion in cash reserves and no debt. Despite this, Veeva’s stock price has dropped 12% from its 3-month high of $168.42 and was immediately down 3% after earnings in late August.

Pinterest, too, had a minimal miss and lost $3 billion in market cap.

While these momentum stocks have been hammered, investors have cheered slow-growing companies like Apple (AAPL) and Intel (INTC) due to buybacks. Apple’s stock price has risen by 25% in the past three months and is now near its all-time high. The company had revenue growth of negative 2% year-over-year.

Way Forward for Momentum Stocks

In a previous analysis on MarketWatch, I had cautioned investors to know their winnersknow their winners as the market clearly did not have a method for differentiating beyond traditional valuation metrics. The safest way to trade tech stocks is to align investments with an overall macro technology trend in addition to fundamental analysis (the macro trend will prevail), and to have an exit strategy, such as a trailing stop, for risk management. 

We’ve seen some stocks quickly recover, such as Roku, and others that haven’t rebounded, such as Veeva and Alteryx. Even the more solid recoveries suggest they are boosted by momentum and swing traders as they remain between support and resistance, as well as retail investors, as implied by lower volume. 

The true test will be the upcoming cloud-software earnings reports to determine if the pattern will continue.

An earlier version of this article appeared in MarketWatch on November 21st, 2019 entitled Momentum stocks are down, but not for the reason you may have thoughtappeared in MarketWatch on November 21st, 2019 entitled Momentum stocks are down, but not for the reason you may have thoughtMomentum stocks are down, but not for the reason you may have thought

Roku’s Stock Price: Will There Be Another Pullback?

Posted on by io-fund

Roku’s stock price is up by almost 500% over the past two years. Compare this to the S&P 500, which is up less than 25%. That’s 20X more returns than the average stock.

The upward trend has not been on a straight line. Roku’s stock price has had four major drawdowns that average about 52%. Two of these drawdowns were greater than 60%. Being long a volatile company like Roku since its IPO is not easy, and it especially takes increased conviction to stay long Roku as we approach the end of the current cycle. However, for those that were insightful enough to see that Roku is not a hardware play, nor a content generating OTT play, but instead a Connected TV Advertisement play from inception, have been able to hold Roku through the drawdowns despite market noise.

In this report, I will look at the fundamental case for buying Roku stock. I will also perform a technical analysis of the company’s stock price as entry and exit is crucial for high-growth stocks. This technical analysis reflects the choppy reaction to the company’s third-quarter earnings report.

Roku’s Fundamental Background

Roku is one of the most misunderstood names in technology. A common argument against Roku is that it is a small company with no moat in the streaming industry. They also argue that competition from cash gushing companies like Apple, Google, and Amazon will threaten its lead. In reality, the opposite is true. Roku may be small in comparison, yet it still leads with 39% market share in OTT hardware in the United States compared to Amazon in second place at 30%.

In the most recent quarterly release, the company announced that its users had grown to more than 32.3 million. This is nearly double what the company had in Q2 2017 with 15 million users. The average revenue per user has grown from $11.22 in Q2’17 to more than $22.

The ad platform segment of Roku’s business is the fastest growing and most important. It is also a high-margin business. In the 2017 financial year, the segment had more than $225 million in revenue. This revenue rose to $416 million in 2018. In the most recent quarter, the platform segment grew by 79% to more than $179 million.

Also Read : Roku Q3 Earnings

Another misconception about Roku is that Roku is in competition with the likes of Disney+, Netflix, and HBO Go because of the subscription service it offers. In reality, the company does not compete directly with these companies, even with its SVOD platform. This is because Roku is mostly in the business of serving adverts and using its data to provide a better ad experience. My partner, Beth Kindig, covers this in more detail in her fundamental analysis (here, here, here) .

The closest competitors to Roku are Amazon and Hulu. Comcast’s Peacock, which will be an ad-supported streaming platform, will also be a competitor, but only domestically. This is because these companies compete for connected TV ad dollars.

Roku has an added advantage because of the vast data it has on its consumers due to owning the hardware. Also, the agnostic nature of Roku’s business makes it favorable for smart TV manufacturers. This is because it does not compete with them on the level that Google or Amazon does.

One final not on Roku, valuation is a constant issue that bears have talked about. It is true that the company appears to be overvalued. The company is valued at more than $15 billion. This is a premium for a loss-making company that is expected to make more than $1.1 billion this year. The company has a forward P/S ratio of 9.9, which is a significant premium. Consider that companies like Amazon, Netflix, and Spotify have a forward PS ratio of less than 6.

Technical Outlook for Roku’s Stock Price

Roku Volume Report

The volume activity in Roku tells us a lot about the current environment we are in, as well as what institutions are thinking. “Smart money,” or institutions, have teams of analysts and professional traders moving large amounts of cash. This typically shows up as massive volume spikes, coupled with noticeable changes in the stock price. The price at which they decide to buy in bulk, or sell in bulk, typically acts as new support/resistance that the price must push through.

What’s noticeable is that around the $127 region, we went from seeing predominantly green volume spikes, to predominantly red volume spikes. The zones in which we are seeing these large liquidations is between the $158-$127 region.

Also Read : Update on $ROKU – Will Roku Miss Earnings?

This will be a lot of liquidity to make up, and we usually will see a shift in momentum when the reverse occurs, – i.e., large green volume spikes coinciding with a noticeable shift in price. Until I see us break through the $158-$163 region, with new increased volume spikes, I would be cautious of the current retracement back to new highs.

However, it’s worth noting that this shift could be starting to occur with rising green bars suggesting a renewed interest. I’d like to see institutions take out large positions at current levels before getting excited. So far, the only large volume spikes in this region has been to the downside.

Insider Activity

Insider buying is significantly more notable than insider selling. This is especially true when dealing with a high growth company that just went public; also, there could be numerous personal reasons why insiders are selling. But, it’s worth noting that all the insider activity in Roku since its IPO has been selling with zero buying. Nobody knows this business better than the insiders, and what they do, or do not do, can give insight to where they see growth vs market valuation. It’s worth noting that no insiders are buying their shares at current prices, which I’d agree makes sense if you are a buy and hold investor with a long time frame. However, in the short-term, there could be plenty of momentum left in Roku.

Internal Strength of Roku’s Stock Price

 

Going into earnings, we had cautioned our readers that $131-$127 was support and resistance was at the $156-$158 region. Any trades in this region on this stock were higher risk. We were correct, as the stock dropped to $119 but quickly bounced back. It has now been climbing and has even posted some marginal gains since prior earnings drop, and we are approaching a critical price cluster.

Simply put, if the stock price breaks $163 and closes well above this price, then I’ll be targeting the above the $200 region before any major drawdown occurs. However, this will require a broader macro bull market. I think it is more likely Roku remains choppy with lower entries available than where it is priced right now.

The internals support this position as well, as of now. In the above chart, the MACD has rolled over, and just recently flipped back up, suggesting strong short-term momentum. Until it breaks above the most recent high on the MACD, this could be a fake-out. The RSI is confirming caution as well. Until we can break the 70 line, which has historically indicated a bullish posture, I’d be cautious on the current uptrend as Roku continues to trade between support and resistance. We are currently oscillating between the 40 line, which has been bullish support and the 70 line, which has been bullish resistance.

Also Read : Here’s Why Roku Will Be The Next Tech Darling

Elliott Wave Counts and Internal Strength

Many investors are playing momentum with Roku right now, and we believe this is the correct strategy at current prices. Going long Roku today should be done with stops in place or a systematic exit strategy to protect any gains. Therefore, Elliott Wave is the preferred method for increasing the probability for successful entries on long positions for a momentum trade, as well as set ideal targets for a more long-term time frame.

Above is the 30-minute chart of Roku going back from it’s all time high. My Primary Elliott Wave count has Roku’s stock price completing its larger degree Wave 3 push just above the 138.2% extension at its all-time highs. This is historically a lower top for a typical target for a 3rd Wave, which usually targets the 161.8% extension.

If Roku can break back above the 78.6% retrace and then take back the 138.2% extension around $163, we will likely see a push to the 168.2% extension before any significant drawdown that would constitute a 4th Wave correction (this is shown as an “alt (3)” and “alt (4)” on the chart). As of now, the evidence supports that Roku is in its 4th Wave correction, and as long as it stays below to current resistance, there will be chances for lower entries on a more long-term basis. However, if we close above $163, I will likely add to my current position with tight stops to play renewed momentum as Roku powers to new highs.

Roku Q3 Earnings: Choppy But Unshakeable Long-Term

Posted on by io-fund

Roku is a company that has proven nearly every bearish prediction wrong with consistent revenue growth despite being surrounded by steep competition and tech heavyweights in over-the-top media.

Roku investors that have been long since its IPO have lived through three fifty-percent drawdowns. Therefore, the reaction to earnings this quarter was unlikely to phase anyone who has followed this stock for any length of time.

I encouraged my readers to not be phased by market reactions when Roku was priced at $30, when it was priced at $60, and when it was priced again at $30. During that sell-off, I said the company would become a tech darling and reach $100 in stock price in two years, which was bold to predict 200% returns. Of course, the company went on to reach 350% returns in a short time span of about one year.

Also Read : Update on $ROKU – Will Roku Miss Earnings?

A version of this article appeared in MarketWatch on November 6th. MarketWatch on November 6th.

Roku Earnings Report Review

The market received Roku earnings report on Wednesday after the market closed. Streaming hours passed 10 billion hours in the third quarter, while active accounts increased to more than 32.3 million. The most impressive number in the Roku quarterly earnings was the average revenue per user, which increased to $22.58. This number has more than doubled since the second quarter of 2017.

The Roku earnings report showed that quarterly revenue increased to more than $261 million. Platform revenue grew by 79% while ad revenue more than doubled. This was a 50% YoY growth and was above the consensus estimates of $256.9 million. The company lost 22 cents a share, which was 6 cents above the consensus estimates of 28 cents a share.

Overall, the company beat the consensus estimates, raised guidance, reported strong user growth, and increased ARPU.

However, Roku has double-digit negative EPS and will for some time. Roku financial statements show that EPS is declining QoQ. Its consensus EPS forecast of -$0.28 compared to -$0.09 in the year ago quarter. Annual EPS won’t improve either, per analyst consensus, with -$0.50 ending in fiscal year December 2019 and -$0.43 ending in fiscal December 2020.

Also Read : Here’s Why Roku Will Be The Next Tech Darling

Source: CNBC

We’ve already seen a few companies get crushed by the market if they have a small miss, which is the paradox for growing tech companies who are often penalized by the market by foregoing earnings to capture peak growth, which in turn, becomes rewarded by the market once it materializes into earnings. In other words, if Roku misses anytime in the next couple of years, it’ll be with EPS rather than revenue. The market, which is confused by the many OTT streaming services and hardware players, will penalize Roku. This most certainly will not be the last time the stock sees double-digit pullbacks.

I also foresee the market abandoning Roku and many other solid tech stocks that aren’t profitable yet during the inevitable value rotations. Keep in mind, investors also did this with Netflix, Google, Apple, Microsoft and Amazon during 2009.

Misunderstood Competition is an Edge

As is always the case, the market has a record of underestimating small companies that are battling with other big companies like Apple, Disney, Google, and Comcast. This is why Roku still remains one of the most volatile stocks in the market. This also proves the affinity investors have towards brands rather than technology. Yet, it is the latter that drives growth in new markets.

The nuances in strategy and technology are terribly important to understand in the crowded OTT space as it helps to have conviction when a stock drops 50% or more, yet then goes on to be the best performing stock of the 712 stocks with a market capitalization over $10 billion in 2019.

Let’s break down what I mean by Roku having very little direct competition.

SVOD vs. Connected TV Ads

Roku does not compete with Disney+, Netflix, or HBO Go because these are subscription services. Subscription video on demand (SVOD) is in a category of its own as the opportunity Roku is capitalizing on is Connected TV ads (CTV Ads). Advertisers are paying a premium for CTV ads, which is Roku’s market. The distinction between markets is important, and one that Wall Street missed when discounting Roku as a long-term opportunity by labeling it a hardware company for its first couple of years on the market.

Roku directly competes with Amazon and Hulu, as they compete for Connected TV ad dollars. However, as the market is well aware, data is king as it allows for better targeting. Hulu has to barter data as it’s a single application without a platform or hardware (i.e., it shares and connects third-party data, including with Facebook). Third-party data is always weaker targeting than first-party data and could be subject to privacy issues.

Razor-Razor Blade Model

Discounting the hardware and taking a loss is an excellent strategy to maintain a moat on data for advertising. Both Amazon and Roku own the hardware, and at current prices, the hardware likely causes negative or very thin margins. This is similar to the razor-razor blade model, where you discount the razor to sell the razor blades for life.

This positions Amazon and Roku for first-party data across OTT applications. Anything data related is subject to privacy issues and anti-trust issues. This is at the core of the controversy with Facebook and Google.

Roku is again set apart here, as the company only does OTT. The company does not share the data beyond the OTT player it owns. Amazon, however, is collecting data in a way that could come under anti-trust scrutiny as they take e-commerce data and broker this on the OTT player, which is anti-competitive with other ad exchanges.

Amazon is well aware of this, and is being proactive rather than reactive by opening up its demand-side platform to other DSPs, such as The Trade Desk, which was announced in July of this year. On a side note, Facebook learn from Amazon’s playbook as reputational damage is hard to shake.

Roku, however, does not need to worry about this as data never leaves the OTT hardware that they own, where they have a first-party relationship.

Valuation:

Connected TV ads are ballooning because they combine audience data with the viewability and completion rates of linear television. Roku’s valuation at 14 price-to-sales seems high at first, yet the one-year forward price-to-sales is trading at 9.3 due to the forward growth opportunity in Connected TV ads. Roku earnings estimates for 2020 and 2021 are $-0.29 and $0.6178 respectively. Therefore, the market may still be lukewarm with knee jerk reactions throughout 2020.

For example, last November, video-first SSP Beachfront reported that ad requests for CTV had increased 1,640% from November of 2017. While this is only one company’s growth in a single segment, the opportunity is so ripe, it’s hard to quantify. More astonishing is that Connected TV ads surpassed mobile last year for capturing the largest number of impressions and video completion rates.

Roku’s revenue growth will be exciting; however, the company is not likely to be profitable until 2021. In the third quarter Roku income statement report showed that revenue grew by almost 60%. This was almost double that of Netflix and triple that of Google.

Traditional metrics show that Roku is not a cheap company to own. Its forward EV to EBITDA ratio of 393, which reflects the lack of profitability. It’s not surprising the stock is trading in the range of $127-$131 following earnings, which was former support.

Depending on macro trends, we could see Roku trade around $100 again as this is an important psychological level, as shown below. It is also along the 50% Fibonacci Retracement level and along the 200-day exponential moving average. Long-term, I see Roku as one of the most promising tech stocks on the market and have provided projections to my premium subscribers. 

Also Read : Roku’s Stock Price

Knox Ridley, technical analyst, will be covering Roku in-depth with technicals next week. He has guided many successful entries on this stock for our premium members, including entries lower than $100.our premium members, including entries lower than $100.

A version of this analysis appeared in MarketWatch prior to earnings on November 6th, 2019.A version of this analysis appeared in MarketWatch prior to earnings on November MarketWatch prior to earnings on November 6th, 2019. It has been updated and lengthened post-earnings.

Apple is Not a Growth Company Anymore

Posted on by io-fund

I grew critical of Apple earlier this year when it became clear the company would decline in revenue year-over-year, yet investors and analysts alike continued to pump the stock. With yesterday’s earnings report, we have further confirmation that Apple is not a growth company anymore although it continues to trade at growth valuations.

While many celebrated yesterday’s earnings report, there were notable signs of erosion. To start, Apple has lost $5 billion in revenue year-over-year, from $265 billion to $260 billion. This is despite having the “best fourth quarter ever,” according to Tim Cook. The truth is that the EPS was higher due to buybacks.

My analysis in MarketWatch published prior to earnings, pointed out that the iPhone was exposed to macro smartphone saturation. Those numbers showed a deeper decline than overall revenue with a $22 billion decline reported year-over-year.

Although Apple has ceased reporting smartphone unit sales, the numbers reveal there are fewer smartphone units being sold. Moving forward, with the recent release of the iPhone, Apple will contend with a lower average sales price. This is bound to affect smartphone device revenue moving forward, which declined at a rate of 15% year-over-year.

Overview of Mobile Saturation:

The smartphone market contracted to 1.462 billion units in 2017 and to 1.420 billion units last year. While almost 1.5 billion smartphones sales a year globally is substantial, the law of saturation drives down prices. I wrote about the price effects of mobile saturation in March, prior to Apple lowering prices for the first time with the iPhone 11.

China represents about one-third of smartphone penetration compared with the U.S., at one-12th. Pricing wars are evident in Asia, where China’s Huawei has grabbed market share to become the world’s fastest-growing smartphone seller. The company has seen a 66-fold increase from 3 million units sold in 2010.

Samsung may be the true bellwether for mobile, as the company is in first position for total smartphones shipped and is the world’s largest manufacturer of memory chips. In the first quarter, the company reported a 60% drop in operating profits, followed by a 56% decline in the second quarter. Analysts expect another decrease in the third quarter. Smartphone units have been making lower highs and lower lows over the past two years.

Samsung’s disappointing performance hints at the ties between smartphone sales and consumer confidence as China’s confidence index is languishing at a two-year low.

Notably, IDC forecasts the pricing wars will continue with 5G handsets in Asia, as low-cost models are expected to hit the market next year. In the U.S., Latin America and Japan, the average selling price (ASP) of a 5G handset will be around $1,000, while it will be $600 in China.

Don’t Believe the Earnings Beat:

The fiscal Q4 earnings beat is at odds with overall performance. Although profit topped expectations, this is the first time since Tim Cook took over in 2011 that Apple declined in profit in all four quarters of a fiscal year.

The media touts the services revenue as the answer to the iPhone decline. As we saw this year, double digit declines on the segment responsible for $165 billion in revenue (iPhone) is not easily staved off by a revenue segment posting $40 billion per year (services).

If one did not look closer at the numbers, it would easy to think services was a major growth segment. We see the growth was at 18%, which is below the 20% traditional benchmark that defines growth. As of now, this doesn’t appear to be the answer to the gaping iPhone decline. This is proven by the annual decline in overall revenue.

Wearables growth of 55% to $24 billion in revenue is decent. However, again, the iPhone decline was steep enough at $22 billion to wipe out the entire Wearables category.

I had pointed out in a Fox Business News interview prior to earnings that its unlikely lightning strikes twice with the iPhone as it’s not only one of Apple’s best growth drivers historically, but it’s also one of the best growth drivers we’ve seen across the tech industry. This is evident in last year’s smartphone revenue of $165 billion, which I also pointed out will be Apple’s peak year in mobile.

Note: although I provide an entry price for Apple on Fox Business News, this is something Knox Ridley specializes in and covers as a contributing analyst to our premium site Tech Insider Research. You can catch his detailed technical analysis published on Seeking Alpha next week.Knox Ridley specializes in and covers as a contributing analyst to our premium site Tech Insider Research. You can catch his detailed technical analysis published on Seeking Alpha next week.

Here is a snapshot of Apple’s performance over the past year. If the stock ticker was not attached to the graph, it would be hard to guess this is the world’s most valuable company.

As most investors know, Apple has plenty of cash. It produces about $50 billion-$60 billion a year in free cash flow and has over $100 billion in cumulative reserves to fund new projects. While analysts are optimistic about many new pivots, these will weigh on margins. This is especially true for Apple TV+, which comes with a high content bill and low subscription revenue, as the OTT streaming service will be bundled for free or priced at $5.

Keep in mind, Apple’s cash reserves are seeing the effects of the buybacks, and Alphabet has now surpassed Apple in cash reserves. Apple has $102 billion compared to Alphabet’s $117 billion. This is due to Apple spending $122 billion on stock buybacks since the beginning of 2018. Alphabet is growing, as well, at a rate of 20% year-over-year.

Analysts who are raising Apple’s price target based on fiscal 2020 cite Apple TV+ revenue as a primary reason with little discussion of the forecast for Apple’s main growth driver. Apple TV+, which will compete with Amazon Prime Video, Netflix and other TV-streaming services, is more likely to cause bottom-line losses in the short term as Verizon is offering the subscription for free while requiring costly original content from headliners such as Oprah. (She doesn’t come cheap.)

In my opinion, these new price targets seem more like an attempt to cover current positions, as the majority of institutions are holding this stock at lower entry points.

Also Read: Apple’s Stock Price is at Inflection Point

EPS not as Relevant Due to Buybacks

Many Apple proponents will use the stock as an income stock, yet the company trades at growth valuations. The buybacks Apple is doing on a consistent basis is alarming for a tech company, who should be innovating with cash reserves rather than propping up the stock price to beat earnings per share.

In the most recent quarter, Apple disclosed it had spent $17.9 billion to buy back 92.6 million shares during the fiscal fourth quarter. During the three prior quarters in the fiscal year, Apple had spent $49.2 billion. There is $78.9 billion remaining in its stock buyback program. The reduced share count this year has helped Apple beat earnings per share of $2.91 with $3.03 reported with fewer outstanding shares as a result of the buyback.

Apple has bought a total of 2 billion shares over the past six years, which brings the shares outstanding to their lowest level since 1999, according to Charlie Bilello, who is also a Seeking Alpha contributor.

Conclusion:

Apple will be particularly exposed to lower consumer confidence when this occurs. Mobile saturation is already showing its effects with a $22 billion loss in iPhone revenue year-over-year. In fact, the saturation of the iPhone could prove to be one of Apple’s biggest challenges to date, as the company attempts to make many pivots, all of which will add noise to the big picture that mobile’s golden days are behind it. This will not be resolved by a single quarter’s earnings “beat,” nor will it be absorbed by services revenue until at least 2023.

If your investment thesis is to focus on primarily cash reserves and cash flow, while ignoring growth and the leverage of buybacks to boost EPS, then Apple is likely in your portfolio. As a tech analyst, who look towards future growth for the highest gains, this is a company where I am personally on the sidelines and is not a company I can recommend long-term.

A version of this analysis appeared in MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.A version of this analysis appeared in MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.

Microsoft Earnings Likely to Prove Cloud Isn’t Slowing Down

Posted on by io-fund

This week, Microsoft’s earnings will shed light on whether the fear over cloud valuations is warranted or not.

Just last week, IBM results showed that its cloud segment grew by just 14%, boosted by its Red Hat acquisition. In more signs of trouble in the industry, Workday (WDAY) stock declined sharply last week after the company said that growth in its once-lucrative human capital management was slowing to 20%. This led to analyst cuts from Stifel, Deutsche Bank, and RBC. Morgan Stanley (MS) and Evercore ISI analysts have also rushed to downgrade the cloud industry ahead of the busy earnings extravaganza. Companies like Slack, Okta, Splunk, and Salesforce have dropped by 27%, 25%, 20%, and 8% respectively in the past three months.

This week, Microsoft earnings will be important because they will provide a picture about whether this sell-off and pessimism is warranted. Microsoft is important because it is the biggest cloud computing company in the world. It’s impressive growth in cloud has pushed it to become the second-biggest company in the world with a valuation of more than $1.07 trillion. Don’t be surprised if the sector ignores the market sentiment and reports impressive earnings.

Microsoft will provide a good indication of the cloud sector because of its broad offerings. The company has a large portfolio of cloud software (SaaS) and cloud infrastructure (IaaS) products. The IaaS and SaaS industries have grown to almost $40 billion and $95 billion in the past decade. This growth is expected to accelerate in the coming years as global corporation and governments embrace the efficiency of cloud. The industry revenue could double in the next three years. Although there will be many winners in the cloud race, Microsoft is well-positioned because of its scale and its approach of the industry. Just this week, the company acquired Mover, a small company that will help it simplify and speed migration to Microsoft 365.

Also Read : Why Microsoft (Not Amazon) Will Win the Pentagon Contract

Cloud Cycle

The cloud sector has had impressive growth in the past decade. This growth is just getting started. According to Gartner, cloud spending will accelerate at nearly three times the rate of the overall IT sector through 2022. The research firm expects IaaS sector to grow by 27.5% in 2019 to $38.9 billion. It is expected to reach $76.6 billion by 2022, which is an incredible growth.

Not only this, Gartner expects other cloud sectors like Platform-as-a-Service (PaaS) and SaaS to nearly double. Another estimation is that 90% of companies will purchase these products from a single company. As a market leader, with a diverse suite of PaaS, IaaS, and SaaS products, Microsoft will likely be a potential beneficiary in the cloud cycle.

To be clear. Quarterly results will be inconsistent. It has been like this in all fast-growing sectors.

Source: Gartner

Microsoft

The past few months have been challenging for technology stocks. Yet, Microsoft has been a better performer. In the past one year, Microsoft’s stock has soared by 27% compared to Amazon’s 1.2%, Alphabet’s 13%, and Apple’s 9.6%.

Microsoft has beaten its peers mostly because of its approach to the cloud sector. The company was early to embrace hybrid cloud strategy, which started to take hold in 2018. This was two years after the company’s first technical preview in 2016.

Also Read : Here’s Why Microsoft Stock Could Overtake Amazon on Cloud Infrastructure

This growth has happened even as the company’s valuation has gotten cheaper. The company has a trailing PE ratio of 27.5, which is much lower than last year’s ratio of 46. This implies that the 27% stock gain has been well-earned.

In the past quarter, the company reported great results. Its revenue of $33.72 billion beat the consensus estimates by $920 million. The EPS rose to $1.37, which was 16 cents better than what the market was expecting. In the previous quarter, Microsoft’s revenue of $30.57 billion was $760 million higher than the consensus estimates. Since 2014, the company has had just one EPS miss and three revenue misses.

In the most-recent quarter, the company’s growth momentum continued. Commercial cloud grew by an annualized rate of 39% while Azure grew by 64%. Dynamics 365 grew by 45% while Office 365 grew by 31%. These are excellent numbers for a company that was ignored and ridiculed by the investment community.

Investors should pay close attention to hybrid cloud when looking at Microsoft. Looking at it carefully will give them perspectives about how the company is positioned to set itself apart from other cloud companies like Microsoft and Google.

Hybrid cloud is a technology which enables companies to store some of their data on their own servers while simultaneously sending other data to the private and public cloud. Companies love hybrid cloud because it is cost-efficient, transparent, and safe. Azure’s strength in hybrid computing has made it the main player in the industry. The product is used by 95% of Fortune 500companies.

Government agencies like the Department of Defense are starting to invest in this technology. Last year, I wrote a long-form article explaining why Microsoft would be a better contender for the $10 billion Joint Enterprise Defense Infrastructure (JEDI) contract. In August, the department, which had favored Amazon paused the procurement process on Amazon security concerns. There were also concerns over why single-sourcing was used for such a sensitive contract.

The decision by the DoD to pause means that Microsoft could be at play to win the contract. Microsoft is a leading contender because of its track record with the DoD. Recently, the department awarded the company a software computing contract worth about $7.6 billion. The Defense Enterprise Office Solution (DEOS) will provide productivity tools to the U.S. military.

Microsoft’s cloud products are also used widely in the country’s intelligence sector. In May 2018, the U.S. Intelligent Community announced that it would continue to use Microsoft’s products like Azure Government, Office 365 for US Government, and Windows 10. In the announcement, Microsoft said that its Microsoft Cloud for Government solutions were used by over 10 million government customers.

In 2018, the company won a $480 million contract to supply about 100k augmented reality devices to the US military. The company won this contract after competing with other companies like Magic Leap, Lockheed Martin, and Raytheon. The military bought these devices because it wanted to incorporate night vision and thermal sensing in its training.

The U.S. Department of Defense has partnered with Microsoft on more projects. This means that there is a possibility that the company could be a leading contender on the JEDI project.

Also Read : Microsoft Stock Price: Technical Analysis

Conclusion

Microsoft will release its Q1’20 earnings on Wednesday. Analysts expect the company’s earnings to increase to $1.24 from $1.14 a year ago. Revenue is expected to jump from $29.08 billion to $32.24 billion. As with all of its earnings, the market will be focusing on the cloud segment. There is no evidence that this revenue will slow down. While uncertainties on trade and economic growth could lead to some fluctuations, Microsoft has an advantage because of its cloud strategy and execution.

A version of this article originally appeared on MarketWatch October 22nd, 2019.