This is a teaser pitch that we solved back in May, but folks continue to ask about it… and our older article is getting pretty stale, so we’re digging in for an updated look today.
The headline of the ad pretty much says it all:
“The little-known Washington D.C. financial “think tank” that recommended Intel at 46 cents… Apple at 56 cents… and Google before anyone else, makes a SHOCKING new discovery…
“THE MOST DISRUPTIVE INNOVATION WE’VE SEEN IN 45 YEARS!”
Investorplace Media is not really a “think tank,” of course (when an ad copywriter puts a term in quotes, that means “this part is made up”), but it is a publisher that has built up a decent-sized business over the years, much of it on the back of Louis Navellier’s longstanding stature as an early “quant” in the world of investing punditry and advice. They’re selling the idea of this next breakthrough…
“Recently, Google’s billionaire CEO said it’s ‘more important than fire or electricity.’
“Robin Li, the CEO of Baidu, one of China’s biggest companies, predicted this new breakthrough ‘will have a much bigger impact on society than the internet.’
“And the MIT Technology Review says its ‘changing the world and doing it at breakneck speed.’
“This technology even has the full faith and backing of the U.S. government…
“Just recently, President Trump signed an executive order that calls for his administration to ‘devote the full resources of the federal government’ to help fuel this new breakthrough.”Are you getting our free Daily Update
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Those are all references, broadly speaking, to artificial intelligence, or AI — which is really just the evolution of computing, and, depending on your definition, has been in use for a long time (Google’s search results use AI, so does your robotic vacuum cleaner, and the auto-driving assist features in your car as computers “learn”… it’s just that we’re not particularly close to the “Terminator” robot phase where machines “think” and act independently).
Then the hinting gets more specific:
“… just recently we uncovered an “off the radar” Silicon Valley company we’re calling the “Artificial Intelligence Master Key.”
“The Tiny Device That Will Unlock the AI Revolution
“It’s a company that’s created THE essential AI component…
“What insiders are already calling the ‘secret weapon’ in the AI race.
“In short, it’s the ‘brain’ that all AI software platforms need to function, analyze, and interpret data. It’s known as the “Volta Chip”—and without it, the AI revolution simply would not be possible.
“You see, for AI to work, the technology needs to sort through and analyze TRILLIONS of data points, in fractions of seconds…
“Then make a ‘decision’ in that extremely narrow window of time.”
And that seems clearly to be a pitch for NVIDIA (NVDA), since NVIDIA’s latest GPU architecture, Volta is their next advancement over the prior Pascal architecture. And Navellier has teased NVIDIA as a “master key” stock before, though last time it was hinted at as the “Master Key for Cryptocurrency” (that was a couple years ago).
That’s kind of surprising as a teased stock now, since NVDA shares get a “Sell” grade of “D” in Navellier’s Portfolio Grader service currently — as they should, since that system is primarily about prioritizing analyst upgrades and estimate increases and similar upward momentum indicators, and NVDA doesn’t have any strong momentum indicators at the moment.
But, of course, selling a newsletter sometimes means using the best story that the copywriter can craft into a compelling sales pitch, not using the stock that is actually favored at that moment by the newsletter editor.
It’s no big news that NVDA is the most often teased AI stock, though, what I was really interested in Navellier’s latest pitch was his 5G stock — since that didn’t look like it was one of the ones we’ve seen pitched over and over (Nokia, Xilinx, tower REITs, the filter companies, etc.) What’s the 5G “Master Key” they’re pitching?
More from their ad:
“Although the ‘AI Master Key’ is the ONLY investment you need to make a fortune in the AI revolution…
“We’ve uncovered another opportunity to make many times your money from the rise of AI…
“To help you capture this opportunity as well, I have an additional report I’d like to include….
“The second report is called ‘The #1 Investment for the Coming 5G Revolution.'”
5G is certainly connected to the rise of artificial intelligence, if only because the processing power required for AI is so great that it’s much more efficiently done by massive “supercomputers” in data centers — and that only works for real-time work (like, say, self-driving cars) if the communication networks those systems use to talk back and forth to the “brain” in the data center are much faster than is possible now… which, of course, is the promise of 5G: Fast networks, extremely low latency (“latency” is the “waiting for an answer” period… think of the modern equivalent of sitting and listening to your modem connect with AOL. Your self-driving car needs to have an NVIDIA supercomputer in it unless it can get millisecond-fast instructions over the air, and it’s more efficient to have the supercomputer be in a datacenter than to require one in every car, and the same is true, to a lesser extent, for all of the smaller “AI” installations across the Internet of Things and mobile devices).
What else do we get by way of hints for this 5G stock?
“5G is a unifying digital fabric that will enable billions of devices to connect and communicate with one another, all the time…
“Making the “Internet of Things” possible.
“This gives you another rare chance to make a LOT of money as the AI and Internet of Things revolutions unfold.
“And I’ve identified a little-known company at the center of it all.
“It has the technology that will help connect billions of “Internet of Things” devices to the new 5G network.
“Becoming one of the biggest beneficiaries of the coming 5G revolution.
“This is a secret AI play practically NO ONE in the mainstream financial community is paying attention to…
“And I believe it could easily help make at least five times your money over the next few years.”
That’s not much, right? Thankfully, in the email introducing the ad Navellier dropped a couple other hints:
“The whole industry is shifting to 5G, and soon Apple will be along for the ride — but I don’t view AAPL as the right way to play 5G now. Apple has a history of making more money from services (like AppleCare and Apple Music) than from the devices themselves. And, anyway, it won’t deliver 5G phones until September 2020.
“Samsung and Huawei are further ahead on 5G — but instead of the companies that need 5G technology, I think more money can be made in the one that’s involved in the creation of 5G. That will be the stock that lets us cash in on that whole meteoric rise of the 5G market.
“In Growth Investor, we own a little-known electronics company — that is helping some high-profile clients move to 5G. Its customers include the top 25 telecoms…the top 25 tech companies…and 78 of the Fortune 100 companies.”
So what is it? If all of those clues are referencing the same stock, as seems likely, then Navellier is very likely touting Keysight Technologies (KEYS).
No, we can’t call that a 100% match… but KEYS cites just those numbers in its marketing materials — this is from their home page:
Keysight was spun out of Agilent Technologies about five years ago, and they specialize in testing and electronic measurement equipment — an area that has already seen substantial growth because of 5G investment and will, they think, continue to grow, though commercial communications solutions are still only about a third of their revenue. They set out a goal with their first investor day, in 2015, to be “first in 5G wireless”, and they think they’ve done that and that they are “well-positioned” to capitalize on their early lead.
Their investor presentation describes their addressable market as about $15.5 billion, growing at 3-5% a year, and they think that they can expand their market share (which is currently estimated at 22%). That leads them to believe, as of last year at least, that they think they have a sustainable compound average growth rate on the top line (revenues) of 4-5%, which is not that dramatic, but they also think that their operating margin can improve, and that their earnings per share growth rate for the long term will be better than 10% annually.
So without knowing a lot about the dynamics of each of their business segments, or how much they might be lowballing those expectations (if any), what does that tell us about the current opportunity?
Analysts had to increase their estimates for the year after Keysight had a “beat and raise” quarter a couple weeks ago, so they now see earnings growth of 40% for 2019, followed by 8-10% growth in 2020 and 2021… so if you’re just going from the PE ratio and penciling in numbers, it’s not a bad shorthand to start with a maximum valuation of about twice the growth rate for a “hot” sector.
If we average out that earnings growth for this year (which is huge, 40% growth) and the next couple years, that’s about a 20% annual growth rate. A forward PE of twice that, or 40, would get you to about $194 (or $148, if you use GAAP numbers, which most analysts don’t). That makes the current price of $95 look eminently rational, though 20 times forward earnings is certainly not most people’s idea of “cheap,” and the growth is widely expected to slow down dramatically after this year so using the expected 8-10% growth rate is probably more conservative. Using forward estimates and ignoring this year’s huge growth surge, I would say $90-95 is a pretty decent “max buy” price for the shares for a relatively conservative investor who does want a taste of growth.
I’d like to put my money where my mouth is, since such statements are not terribly meaningful (“I just bought” is a far more honest expression of sentiment than “it’s a good buy here”), but I just wrote about Keysight on Friday so I’m barred from trading in the shares for a few more days. If it stays in the low $90s or dips further, I’m likely to add to my position… though, of course, now I’ve written about it again so I can’t buy the stock for another 72 hours. I’ll let the Irregulars know if (and when) I do change my position, as always.
Keysight has acquired other companies to grow their business over the past few years, and thinks that they are going to be able to begin returning cash to shareholders in earnest in the next year or two, probably mostly through share buybacks, so that could provide some boost to earnings.
Probably the biggest argument in favor of Keysight, at least story-wise, is that the world is getting far more complex — as we saw with the Boeing debacle, testing and assessing equipment vulnerabilities is increasingly difficult and critical, and everything I read about 5G reinforces the notion that these MIMO networks that operate on a variety of frequencies and with lots of wave-shaping and targeting are going to be far more complex than previous wireless networks… which, again should require a lot more testing equipment and software and expertise from folks like Keysight both in setting up those networks and in maintaining them.
Does that mean they’ll win? I don’t know for sure, but I’m betting they’ll continue to do well and maintain their leadershipo… it’s a reasonable story that holds up, conceptually, and it’s been a solidly run company that makes reasonable acquisitions and appears to me to be well-positioned.
Keysight’s Investor Day presentation is up on their website, and it’s worth watching some of the video and checking out the presentation slideshow if you’re interested in this one. What might stick out for investors is the fact that they made a plan for KEYS to build into a growing company when they went public as a spinoff in late 2014, and they’re on track — they expected to use their cash for acquisitions to build the growth potential over 3-4 years, and they did that, but they are now moving into the “value creation” phase where they use appropriate leverage to help return capital to shareholders… and they did bump up their buyback authorization with an announcement that they have a stock repurchase plan now of $500 million (they had bought back about $200 million under their previous $350 million authorization).
If the market crashes, KEYS will almost certainly crash with it — but I am very impressed with the discipline they’ve shown in restructuring and building the company over the past few years, and with their exposure to some of the most important end markets and trends in the world… those who are pushing the envelope to build 5G networks, next-wave 400G data centers, and self-driving cars are going to need increasingly complex and effective test equipment to build those systems, and Keysight is getting more closely aligned with their customers, pushing R&D to meet specific customer needs, and, they say, taking share in most of those markets. And 5G specifically is indeed a substantial driver, this is a diversified business but their communications division accounts for more than 60% of revenue, and is growing faster than their other divisions (13% revenue growth last quarter), mostly because of 5G investment by telecom companies and other customers.
That’s enough to reassure me that the next 3-5 years should be very strong for Keysight, and this last quarter and the conference call took away some of the concern that the trade war talk will meaningfully bite into their financial performance (it will hurt, but KEYS is so diversified across essentially all large technology businesses that it will be muted).
Their long-term goal is to have sustainable core revenue growth of 4-5%, improving margins, and earnings per share growth of at least 10%. Given the tailwinds of current large-scale technological changes coming through, including 5G network building, I think that’s actually a pretty low bar, even for a company that is already large ($18 billion market cap, $4 billion in revenue), and there’s a decent chance they could do substantially better than that… they only provide guidance for the next quarter, so analysts are really just penciling in “10% earnings growth” for the next couple years until they’re told to do something different, and I’ll be surprised if the earnings forecasts for 2020 don’t soon climb above the current expectation (right now, the forecast that I’d argue is probably too conservative is $4.86 for FY 2020 earnings per share, after 2019’s guidance from the company to expect $4.57 this year — analysts have added a penny to that, so they’re looking for $4.58 in the fiscal year that ends on September 30).
I don’t know where KEYS is going in the short term, of course, or whether the forecast they give next quarter (expected around November 20) will be above or below current expectations, but I think analysts are being too conservative right now… and even if they aren’t, the valuation is rational. The share price dipping after a post-earnings surge made it a reasonable buy for me at the end of May in the mid-$70s, and given their strong operational performance this year, despite the trade tumult, I’d like to buy more below $95 if I get the opportunity after this latest post-earnings surge. Preferably much below if we get another market shock in the next few weeks, but I won’t let the perfect be the enemy of the good — I think I have a good start in building a position that could be a strong if relatively unexciting grower for at least the next 3-5 years.
For what it’s worth, Keysight is graded much higher by Navellier’s own Portfolio Grader service than is NVIDIA — KEYS gets a “strong buy” A grade versus NVIDIA’s “sell” D grade.
So where is this whole 5G and data center spending curve going to turn in the next couple quarters? Will that impact NVDA and KEYS? That’s what we were all panicking over before the trade war and the Huawei fight, and the pace of that spending is still pretty uncertain, especially quarter to quarter.
We as investors tend to get too wrapped up in whatever the popular narrative is, and that tends to make things seem far more binary than they actually are. Google, Facebook and Microsoft didn’t stop spending suddenly in mid-March… China didn’t stop buying from Keysight when Huawei got banned. Big companies paused some of their ordering and stopped buying some things for some of their data centers for at least a little while, arguably because they had gotten ahead of themselves and built up too much inventory… and Keysight is still seeing growing sales in China, including a little bit that is still allowed to Huawei and also plenty of sales to non-Huawei customers (Huawei has historically accounted for about 3% of Keysight revenues, and they see that dropping to 1-2% next year… so it’s meaningful, and political shifts will make a difference, but it’s not overwhelming).
So the trade war continues, data center growth may or may not pick up to previous levels at the end of the year… but activity is still taking place — tech stocks tend to turn on a dime, and to all react to the same shifting stories that we tell to explain (and oversimplify) what’s happening, but the business is never 100% positive or 100% negative, some of coping with that means just riding the waves… and ignoring the financial news is probably one of the better ways to do that, if you value your sanity.
Disclosure: Of the stocks mentioned above I own shares of Keysight, NVIDIA, Facebook, and Google owner Alphabet. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.