Nvidia's Blockbuster Quarter

In this podcast, Motley Fool senior analyst Jim Gillies and producer Ricky Mulvey discuss:

• Nvidia's blockbuster quarter and valuation questions to consider.
• The history of tech cycles and lessons for investors.
• If Best Buy needs sales growth to reward shareholders.

Plus, Motley Fool analysts Tim Beyers and Meilin Quinn interview DigitalOcean CEO Yancey Spruill about how the cloud service provider differentiates itself from competitors like Microsoft and Amazon.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on May 25, 2023.

Ricky Mulvey: The video grows by more than $200 billion. All in a day's work, you're listening to Motley Fool Money. I'm Ricky Mulvey joining us now is former NVIDIA shareholder Jim Gillies. Good to see you on this day of all days.

Jim Gillies: You're going to stick the knife in right to start, are you Ricky? Okay.

Ricky Mulvey: I think you've got some knives to stab back. This morning, investors cheered NVIDIA's place in the AI race. NVIDIA builds graphic processors and the company made $7 billion this quarter. But analysts really liked the guidance. NVIDIA expects an extra $4 billion in sales next quarter. Jim, what went through your mind when you saw that the stock gained a full McDonald's today?

Jim Gillies: I should clarify a couple of things. One, I think I sold my shares in 2010, so it's been a while. They were part of an option strategy that doesn't look too good now, but I did a crystal ball at the time and still like one today. Also too is it NVIDIA or NIVIDIA? I've always maybe it's a Canadian thing. I've always called it NVIDIA, but anyway.

Ricky Mulvey: NVIDIA I've heard both.

Jim Gillies: I'm curious, but yes, what went through my head? It's a fantastic quarter really was I'm not much of a tech investor. I think a lot of people know. There's facets of a lot of business models that make it difficult to pick long-term winners. I sound Berkshire-Esque, I think on that one, it's not that I'm opposed to owning some, but I think that there's also some valuation concerns that sometimes come to play, and I think would suggest that sometimes is with us with NVIDIA today. I don't think I've ever seen a guidance revision or guidance update like they gave for their Q2 where I think analysts were broadly expecting the mid-seven billions in revenue. As you say, they were saying, oh no, we're going to do 11 billion. We're going to add four to that. Of course the stock is up 30%, I think this morning. It really is great. But my take on that is look, NVIDIA, fantastic quarter, fantastic company. I think the longs people who own it should rejoice today, I think it's really great, but just be cognizant of what today's price and I did this work before the market opened. Might be slightly different, but it's roughly right. Before last night's beat and raise.

NVIDIA was already trading at 39 times sales and about 20 times EBITDA, incorporating in last night's results for cash generation, it's trading for about 190 times the last four quarters, including last night. The last four quarters free cash flow. What that means is if NVIDIA started today was little thought experiments started today to pay out, say we're going to have a dividend policy paying out 100% of free cash flow. But remember, free cash flow is the money that's left over after the company has paid all of its bills, made all of its capital expenditure choices. This is money that it has in theory to pay out as dividends, buyback stock, make acquisitions, pay down debt, make additional growth-oriented CapEx things. There's not many more things you could do with free cash flow, but assume that NVIDIA wanted to pay out 100% of its free cash flow. It would take you to centuries basically to get your money back. I don't like your chances of making it to the end. Now, of course, the big glaring thing that I'm omitting there is the potential for growth. That is why people are willing to pay 190 times free cash flow for this one. I very much think two things are true. One, NVIDIA is not about to start paying out 100% of free cash flow. That's just as a construct. The second thing is, I'm reasonably sure there will be some growth here. I think the open question is, how much growth? Because the way that investors are pricing this thing, they are pricing it to be a multi-trillion-dollar company in the not-too-distant future, it could get to a trillion this week, frankly, on market cap basis. Do you want me to go down? I could go down a little bit of a history lesson here or.

Ricky Mulvey: Let's, go down the history lesson of Tech adoption cycles for I'm rocking with NVIDIA. Because I do think we can occasionally learn a couple of lessons from history and especially maybe the boom of the early .com internet cycles for a lot of those tech companies.

Jim Gillies: I've looked at the last couple of years of COVID craziness, the rise of SaaS, the rise of AI, the rise of a lot of these techniques. I've said history doesn't repeat, but it does rhyme thing. I thought the last few years have been not dissimilar to the tech bubble and the tech wreck of say, circa 1997 through 2002, which I had the fortune or misfortune depending on your point of view to invest through. I was a young investor, so I hope I learned a few things through that experience. My framework today is I've looked at these things as I call it the tech bubble stocks. There's four categories. The garbage that went to zero, ignore it, the stuff that it was fine. But a lot of the stuff that was fine because it was only mediocre and fine it got to such ridiculous valuations. Today, it's down 80% from all-time peaks, or it took so long to climb back. The third category is my most interesting why spend the most time as I call it the generals. The guys that were setting the tone for that era. The companies that you couldn't miss, fantastic company and they're all by-and-large good companies. But it was a valuation thing. The four, I like to call the four horsemen or Intel, Cisco, Microsoft and Qualcomm. Intel and Microsoft basically owned PCs, which was the hot tech trend of the day. I suppose you could throw Dell in there as well, but let's talk Intel and Microsoft in everyone. Intel today is down 60% from its all-time high set 23 years ago. That is, after bringing out a dividend, raising it every year, buying back about 40% of their stock, never recovered. Cisco, which was the router King with some new thing called the Internet, is going to take over all facets of our lives. Cisco down about 40% never from its all-time high, never recovered.

Again, same drill, dividend, raise the dividend annually, buyback 40% of the stock. Long-term shareholder from there is still down. Microsoft was dead money for 15-16 years, but really only is recovered because of Satya Nadella took the reins of the company and going in a different direction. They're the gold standard of the big four generals that I talked about. Whereas they have returned about 7.4% annualized before dividends since their peak in 2000. Which is fine, but you could have got that with less risk by buying an index fund. The fourth one is Qualcomm, who had a royalty on every new mobile phone sold then. Qualcomm has given a non-dividend adjusted return of about 15% since 2,000 not 15% annually, Ricky, 15% total. That's Category 3, the general, so the garbage define the generals. Then the fourth category I'd call it is Amazon, which is of course it's own thing. I think it's very safe to say NVIDIA is not bucket one or two. It's not garbage obviously, it's not fine obviously I hold that they are general.

Then the question becomes, where in this cycle are we buying NVIDIA today because I lack the ability to go back and buy it at last week's prices. Maybe there's some time travelers out there, which point call me but I don't have it. I think it's a bucket three, I think it's a general. Where are we buying it if we're buying a general in say, early '98, late '97, that's much better, but are we buying it at the 99-2000 peak? That is problematic. I think we're buying a general earlier in the cycle, but that valuation, just be aware Fools, if you're going to be buying NVIDIA today after what was a really spectacular quarter. Be prepared to put it away for five years. Don't look at it. Don't put 20% of your portfolio into it. Take the time to say, OK, I am buying this high-quality company for the long term and I'm not going to get spooked if margin compression say, takes us down 50% in year two, I'm here for additional gains and also recognize the limitations of large number investing. As I said, Ricky, this is probably going to be about a trillion-dollar company or trillion market cap by the end of the week, it looks like if it triples from here, it's the largest company in the world. I don't like those odds very much, but others mileage may vary.

Ricky Mulvey: I think this is also for me, at least somewhat difficult company to understand. NVIDIA expects a lot of their growth to come from data center usage with those large language models and generative AI, those are the words. I still think that a lot of the business is incredibly technically complex, at least for me. This makes me put it in the too hard bucket, at least for me, Jim. Let's move on to the complete opposite ends of the spectrum to a more, I would say Jim Gillies company. That is Best Buy. A retail electronics store where shoppers are slowing down on big-ticket purchases. We've seen this at Walmart, Home Depot, Target is well this quarter for Best Buy comparable sales growth is down 10% from last year, but management affirmed full-year sales guidance of about 44-ish billion dollars. What were your big takeaways from Best Buy's quarter.

Jim Gillies: I'm a little hurt. I'm going to point out I did own NVIDIA at one point. I've never owned, to my knowledge, Best Buy. But, I love the Jim Gillies company, but I think the through line I would give you from NVIDIA to Best Buy here today, is this idea that companies should know what they are and investors should buy into knowing what companies are. The best by-quarter. It was perfectly decent given what this company is, they beat expectations which were low because there's, of course, the world's slowest-moving recession has been giving so much fear to people for at least the last four or six quarters now. There's of course also the long-standing general fear of Best Buy being an Amazon showroom and unnecessary in the present era of retail. They did affirm their outlook for the year, but they also mentioned that they are seeing inflation hitting household budgets by as you mentioned, buying less electronics and what-have-you. Here's the thing about Best Buy that I look at though. About a decade ago, they bought about $12 coming into 2013, and meaning they have been about a six-bagger since they bottomed a decade ago, and that's before dividends if you assumed dividend adjustments closer to eight-bagger. It bottomed because of the perceptions that we have today, that is Amazon showroom unnecessary. People, they sell commodity goods that we could buy pretty practically anywhere. Yet, Ricky, over the past decade, Best Buy has produced just over 17 billion in cumulative free cash flow. They spent about 4.6 billion of that on their annual dividend, which they have tripled the cumulative payout over the decade. The dividend per share has gone from 0.68 a year to $1.68 a year, that's a 5.2% yield today. They spent $10.3 billion in buybacks over the last decade, shrinking the share count by 36%. They spent another 1.4 billion in acquisitions, we'll assume those have been intelligent acquisitions that may or may not be reasonable. 

The rest of the cash is piled up in the balance sheet such that you have a balance sheet with nearly a billion dollars in net cash today versus the balance sheet a decade ago of with net debt of about $0.5 billion. What they do carry is relatively long-term and low-cost. What I talk about, know what companies are, and understand what they are. I look at Best Buy as basically a no-growth perpetuity like cash cow. Revenue last year was about 46 and change billion, revenue a decade ago was just under 42 billion. That's about 1% growth. I think my low-growth assertion is fairly valid. But management teams have recognized that the value for this business is as a cash cow and not as a growth engine. They've managed it as a cash cow, and that's how you've gotten market-smashing superior returns from Best Buy over the past decade out of all companies, can that continue? I believe management will probably try. I think a reasonable if you think. Again, they've done about 17 billion over the past decade in free cashflow call that averaging 1.7 billion each year. If they could do 1.5 billion a year, the current valuation is 10 times that cash flow. You're going to get your 5.2% dividend yield, and with the combination of increasing dividends. Because again, they've raised it every year practically and done a good job. 

They've grown at 18% annualized, the dividend that is over the past decade. Plus maybe taking down 3 or 4% of the shares per year, which is again, what they've been doing for the past decade. I think that probably gets you North of a 10% total return annualized from here. Now, is that good enough? Or is it just easier to go indexing? That's for investors to decide. But I will point out if I followed the Best Buy story for a while. It's because they've been owning it, look, if you were taking bets a decade ago, that Best Buy, would be a six-bagger before dividends over the next decade, I'm reasonably certain you would not have gotten many takers because again, the story was Amazon showroom, it's unnecessary. Fails to snap tests as David Gardner would say, and I hope that can still be a beautiful setup if you understand what you're buying.

Ricky Mulvey: With Best Buy too, Corie Barry pointed out in the quarter which I appreciated, is that the demand drivers are still there.

Jim Gillies: Yeah.

Ricky Mulvey: Yes, people are spending less on big-ticket items, but all of those laptops and TVs that people purchased over the pandemic, get replaced every 3-7 years, and your Best Buy showroom will be there for you.

Jim Gillies: Exactly.

Ricky Mulvey: Jim Gillies, always appreciate it. Thank you for your time and your insight.

Jim Gillies: Thank you for the invite, Ricky.

Ricky Mulvey: Before our next segment, got a heads-up for Stock Advisor members, a new episode of our premium podcast, Stock Advisor Roundtable just dropped on Spotify. Tom Gardner and the team talk about managing risk and some mid-cap companies that they believe have a bright future. Check out the show description for a link. 

Next up on this show, we've got some more, Tiktok, DigitalOcean is a Cloud services provider that focuses on developers and small to midsize businesses. But is it doing anything differently than Microsoft Azure or Amazon Web Services? Motley Fool analysts, Tim Beyers and Meilin Quinn caught up with DigitalOcean CEO Yancey Spruill to find out how it's retaining larger customers and standing out in a hyper-competitive landscape. 

Tim Beyers: Here's what I want to get to because you're certainly known for first simplicity, and that is interesting. I want to get to some of the things you're doing as you scale up. But before we get there, can we talk about how you get those larger customers? I'm just looking at the release here. What you said, let me make sure I have this right. But the percentage of customers who are spending at least $50 a month, is that now 43%? Yes, 43% of the what would you call builders and scalars, customers spending more than $50 per month, increased 43% from the first quarter of 2022, and their revenue is up 32% year over year. What are you doing to get people to stick with DigitalOcean instead of getting to a certain size, and then say, I'm ready to graduate to AWS.

Yancey Spruill: It's really important that we were built day one to serve the idea generator who wants to launch that into a business. What we've learned over time is adding features and functionalities. Layering supports customers on their journey. We've also learned some things about product. One-size-fits-all, as you said with the container, does start to run out as customers grow beyond $50 to 5,500 with the scalars. The reason we launched the premium dedicated Droplet is precisely that reason. We learned that for bandwidth-intensive use cases like media or streaming businesses. They need a different configuration than a standard amount of computing, network, and storage to the relationship that we have conventionally. We tailored that for that business, so how we've been able to scale with customers over time is we're tailoring the capabilities, we've added load balancers, we've added other bandwidth products, we've added other variants of Droplet that does flex to a scaling need, we've added databases. Once you go from X number of customers to Y, you can't use a whiteboard anymore as a start-up to talk about your customers, you need sophisticated tools to use digital tools, and so you need to manage database. Once you go from one or two engineers writing all the code to 10, 20, 30. You need different software deployment models, Kubernetes, serverless are helping with that. We've added capabilities over time so that as a two-person start-up goes to a 10 or 20 or 50 or 100, or in some cases hundreds of employees we have on our platform. As your number of employees grows, your workflow gets more complex.

The software helps to make that less complex. We have more tools that I just cited. We also have a marketplace. Then in the same with your customers, as your customers grow, you need other tools on the infrastructure side. So we've been able to scale that. We've made it such that if you looked at our largest customer today, which started as a handful of people around a computer terminal in 2014 spending 10-12 bucks a month, now that's nearly a $200 million revenue business with the hundreds of employees. Cloudways who we bought last year was a customer, started in 2014 at 10 bucks a month and grew to spending with us 1 million bucks a month with their last invoice, when we acquired them last summer. We've created this flexible model and we have support. This, I can't overstate this enough in that support and documentation, our tutorials, and our community. 

They help people, they can't call IT on the eighth floor or call DevOps on the fifth floor and say, come up here and help me with this problem. The product has to stand on its own and when it doesn't the documentation, the investment we've made there, and support, every customer gets support regardless of price point, is critically important to help them on the journey. Because we have lots of customers who come to us from one of the larger players or even smaller competitors who don't have that commitment to support. It's a differentiator for them. Because it's a force multiplier because they'd rather invest their marginal dollar and some sales and marketing or their products, their customer relationship. They don't want to invest it in core team when they can get it embedded in the product experience with us. Those are all the ingredients for how we're able to get people lift off when their idea is ready for lift-off and support them through large levels of scale on their journey to realize their aspirations to be entrepreneurs.

Meilin Quinn: One thing that's always impressed me about DigitalOcean is it's high net dollar retention rate. Just seeing that customers are spending more on the platform, I think really speaks to the value that DigitalOcean provides. I'd love to chat about new customer growth with so many companies like Microsoft, and AWS, just continuing to lower the prices of their services. I'd love to chat a little bit about the competitive landscape. Where does DigitalOcean fit into this and how does it differentiate itself from other Cloud services providers that also target small to medium-sized businesses? You've already touched on this, but I would love if you could share.

Yancey Spruill: First, the market for what we call SMB Cloud per IDC is $100 billion a year today. It's a massive market. It's not as big as the enterprise Cloud market, which several times happened. But this market is huge, it's very fragmented because there's 100 million small, medium-sized businesses in the world. It's 30 million developers collectively, those two groups spend the $100 million than Cloud spend today. It's very fragmented. How we attract people to the platform is through our tutorials. We have tens of thousands of documents online that generates 10 million or so visitors to our website a month.

We offer that for free. How do I do this on AWS? You can come to our site and get insight into that, let alone how to do things on DigitalOcean's Cloud. Many people come to our Cloud to read our tutorials and learn how to program. I've met a number of people who are running businesses on our platform today who first came to us because we had a tutorial that help them learn how to program in a certain language. Then they played with that for a few years and ultimately launched the business. We germinate people early on, foster their learning and their growth, and then we support them. That's very differentiated. The fact that we have the documentation, the support, we're an open platform. You don't have to customize your software app to our proprietary platform. We're simple, easy to use. In the time we've been here, frankly, in the first five minutes that we've been on this call, you could have been coding on our platform. In the time we've been on here now you could have read a tutorial, then signed up. It's very simple, easy to use and then it's cheap. It's really value price, which we're proud of that and we intend to maintain that differentiation. What that does is it allows us to attract people who don't yet know what they're going to do. We call them learners. They come to the platform and they just stay here. They may stay here, I think on average for four-plus years before they may or may not launch a business. That's fine for us because it's super low acquisition cost to get them here. We write their tutorials once and they're read millions of time.

It's a really low acquisition cost. The use case and the early stage ideation stage, you don't consume a lot of compute. It doesn't cost us a lot to serve them. We're going to have that compute anyway to serve the builders and scalars, which are 86% of our revenue. It's a really low-cost acquisition. I said it on the call the other day, it's the world's best lead-generation tool because they pay us to lead. Then we're getting smarter and smarter at identifying earlier and earlier who's a high-potential user and who has high intent. Then we're helping them get there sooner so that they can get above $50 as a builder or 500 bucks as a scaler. We use $50 as a marker because above 50, you are doing more than just a hobbyist or figuring things out, you actually are converging on running a business, building a business. That's how we differentiated. Is we're here for the journey?

We're not here for the million-dollar-only customer a month. We're here for come here. The average customer starts at 18 or 19 a month through self-serve. We're about identifying, and creating this place for them to figure things out. That's what we call community, huge commitment of ours. Then we help customers along the journey so that they can reach their aspirations faster and get into that builder and scalar. That's why we're feeding the builders and scalars, why we've been tailoring our disclosure over the last several quarters to talk only about them or principally because that's what's filling the business. But we need the learners. We need that large pool of people who come here don't spend a lot not sure what they're going to use, how they're going to use it, incubate them, and foster them so that when they're ready to explode and launch, we're there to serve them. Then the applications scale, you could build a billion-dollar business on this platform. That's very unique. That's how we're differentiated from everybody else in this large end of the market.

Ricky Mulvey: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy yourself stocks based solely on what you hear. I'm Ricky Mulvey. We'll see you next time.