Bill Gates recently said he's only been as excited about a technology leap like today's artificial intelligence revolution one other time -- the graphical user interface, first introduced all the way back in 1980.
Just as the graphical interface allowed everyone to use computers for the first time, AI is likely to enable everyday people to access superhuman intelligence and capabilities, from software coding, to generating text, images, and sounds, and a myriad of other activities.
While the tech sector has done quite well in 2023 thus far, some AI leaders still trade at reasonable valuations, especially after the interest rate scare over the past three months.
With the market so obsessed with near-term results, the recent earnings season has provided opportunities to scoop up these two AI winners for the long-term after their post-earnings swoons.
Image source: Getty Images.
Alphabet
It was a bit confusing that Alphabet (GOOG -3.33%) (GOOGL -3.37%) sold off so hard following its late October report. After all, the company grew revenue 11% to $76.7 billion, with earnings per share up 46% to $1.55, handily beating expectations.
Even though Alphabet's core Google Search and YouTube digital advertising results surprised to the upside, investors appeared to focus on its Cloud unit, which grew "only" 22%. While normally that would indicate strong growth, it was a deceleration from last quarter's 28% growth. That was somewhat concerning, as cloud rival Microsoft was able to reaccelerate its cloud growth, and even the much larger Amazon Web Services was able to maintain its growth rate.
Some may have interpreted that as Alphabet losing market share or falling behind on key capabilities. But that's not exactly clear either. The entire cloud industry slowed down in a big way last year, and clients across the board have sought to cut their cloud computing costs amid a retrenchment.
The pace of slowdown, bottoming, and reacceleration can vary based on customer mix, the degree of discounting, and types of services offered. So, it's a little bit difficult to say one platform or another is winning based on a single quarter.
Because of some unique capabilities, Google Cloud attracts a lot of start-ups, which have been feeling the pain over the past few years. However, CEO Sundar Pichai also noted that more than half of all generative AI start-ups are Google Cloud customers. Moreover, Pichai said the number of generative AI projects on Google Cloud's Vertex AI platform went up 7 times just between the second quarter to the third. So Google Cloud is still attracting AI companies.
It's true, Microsoft may be gaining share in the near-term, thanks to its early AI lead and investment in OpenAI. But soon, Google will unveil its own multimodal generative AI model, called Gemini, which is anticipated to be released either at the end of 2023 or early 2024.
On the conference call, Pichai said of Gemini:
I'm very excited at the progress there and as we're working through getting the model ready. ... To me, more importantly, we are just really laying the foundation of what I think of as the next generation series of models we'll be launching throughout 2024. The pace of innovation is extraordinarily impressive to see. We are creating it from the ground-up to be multimodal, highly efficient tool and API integrations and more importantly, laying the platform to enable future innovations as well. And we are developing Gemini in a way that it is going to be available at various sizes and capabilities, and we'll be using it immediately across all our products internally as well as bringing it out to both developers and cloud customers through Vertex.
The artificial intelligence race is just starting, and it will be a marathon, not a sprint. With the release of Gemini, look for Google Cloud to get a potential boost next year and beyond. That makes the stock's recent sell-off an opportunity.
Super Micro Computer
Another head-scratching reaction came after the earnings release of server-maker Super Micro Computer (SMCI 3.84%). Super Micro's innovative "building block" approach and focus on energy-efficient computing has made it a leading player in the sale of artificial intelligence servers.
Given that many tech executives now anticipate a 50% annualized growth rate in AI chips through 2027, that means AI server revenue should grow at a similar rate. No wonder Super Micro, while still about 30% below its highs, has still tripled year-to-date.
Strikingly, the company still trades at a quite reasonable 23 times trailing earnings. This is in spite of the company's forecast to grow over 40% in the current fiscal year ending next June.
So, why did Super Micro have a muted reaction to its latest earnings report? It's hard to say. After all, Super Micro did beat revenue and adjusted (non-GAAP) earnings expectations, while also lifting its full fiscal year guidance and guiding for the December quarter above analyst expectations.
One wrinkle could be that despite solid revenue growth, the company's margins compressed relative to last year, with gross margins falling to 17% relative to the year-ago quarter's 18.8%. Moreover, on a GAAP basis, operating income actually fell in dollar terms, as operating margins compressed from 12.1% to 8.1%.
However, there are two big reasons for the margin compression, which will likely reverse in the quarters ahead. First, Super Micro was still supply constrained in the quarter, with design wins and orders exceeding its ability to secure Nvidia GPUs. So, the company will see revenue grow as more supply becomes available.
This is a known problem, and management was correct not to penny-pinch on operating expense growth. The AI space is competitive, and Super Micro should absolutely keep investing in employees and R&D to capture the massive opportunity. And while the company did see a big jump in GAAP operating expenses, that was mostly stock compensation for key new technology employees. But after last quarter's big jump in operating expenses, Super Micro guided for more moderate operating expense growth next quarter. That should coincide with more revenue and therefore operating leverage.
Second, management has brought on new low-cost capacity in Taiwan, with another plant coming soon in Malaysia. Management noted Super Micro only utilized 60% of its existing capacity last quarter, so as units increase with growth, Super Micro should see leverage and higher margins. Moreover, the new Malaysia plant will have lower costs than both Super Micro's U.S. and Taiwan campuses, so that should also lower costs of goods sold as that plant starts producing later this year.
As long as Super Micro continues to grow with more GPU supply, margins should expand. Meanwhile, on the conference call, CEO Charles Liang noted that even this year's guide for 40%-plus growth was "conservative":
So at this moment, $2.7 billion to $2.9 billion for December should be a very conservative number. And for our whole fiscal year, $10 billion to $11 billion, again, should be a conservative number. So I feel very optimistic to continue to grow quickly.
Expect more upside from this emerging AI leader.
