This is a teaser pitch that we solved about six weeks ago, but I think the solution got lost inside a longer article because folks continue to ask about it… so I’ve pulled it out to talk about for you here today in your bonus Friday article, partly because it also plays off of the same themes we talked about in yesterday’s article.
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 a think tank, of course, 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.”
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… 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 year and a half 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.
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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 bottom line: 5G is a very, very big deal. Essentially, whoever controls 5G is anticipated to control the internet several years from now. So, the long-term investment potential is huge.
“However, instead of one company that needs 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 probably 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?
Well, the numbers are getting a bit stale because they haven’t reported their March quarter yet (that’s expected on May 29), but analysts so far are penciling in a good growth year this year (22% earnings growth), followed by about 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 and the next couple years, that’s about a 15% annual growth rate. A forward PE of twice that, or 30, would get you to about $120 (or $84, if you use GAAP numbers, which most analysts don’t). That makes the current price of $82 look perhaps rational, though not most people’s idea of “cheap.”
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 expertise from folks like Keysight.
Does that mean they’ll win? I have no idea… but it’s a reasonable story that holds up, conceptually, and it’s been a solidly run company that makes reasonable acquisitions and appears to be well-positioned.
At the time I originally wrote the words above I did not own Keysight shares, but I bought some after the earnings call in late May — here’s an excerpt from what I wrote to the Irregulars at that time (on May 31):
Keysight (KEYS) earnings came out on Wednesday… I was interested in this one following the drop a couple weeks ago but decided to wait until their update to see if the business is still on track and what their reactions are to the current trade imbroglio. And, well, sometimes waiting until earnings means you miss out on a good price. Keysight posted a strong “beat and raise” quarter and the stock recovered a bit of the dip we saw earlier this month.
The numbers were indeed impressive — the revenue was only a little better than had been expected, but the earnings popped considerably… KEYS had provided guidance for 96 cents in earnings per share, and they actually posted $1.22 (all that is adjusted/non-GAAP, not actual earnings). For the current quarter they’ve guided to $1.04 billion in revenue and non-GAAP earnings per share of $0.97-$1.05, which is almost exactly a match for what analysts are now estimating (average of $1.02 is the estimate now, before the guidance was given it had been 97 cents). They did say that the tariffs and the Huawei ban will cut into revenues, with a small impact of about $25 million in the next quarter and then a more substantial impact in the fourth quarter, but given the $4 billion annual revenue run rate no one is expecting a huge shakeup.
Keysight’s Investor Day presentation is now 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 (from Agilent, which itself was spun out of HP 20 years ago), 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).
So it seems likely that we’ll see both continued growth and some shareholder-friendly leverage that may help to boost returns over the next couple years, and the stock is certainly not cheap but I’d say it’s fairly valued on non-GAAP earnings — 24X trailing earnings and 17X 2020 earnings estimates. That’s a very slight premium to the overall market, and I think KEYS is a more-than-slightly above-average company. 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.
That’s enough to reassure me that the next 3-5 years should be very strong for Keysight, and this 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 a pretty low bar, even for a company that is already large ($15 billion market cap, $4 billion in revenue) and there’s a decent chance they could do better than that. I’ve added about a 1.5% position in KEYS to the Real Money Portfolio — and I’d like to grow that position if we get opportunities to add in the future. This is a growth stock, and is pretty fully valued, but I’ve started with a somewhat larger position than usual because I don’t think it’s nearly as risky as the nosebleed-valuation cloud stocks (TTD, OKTA, etc.) or the hugely cyclical semiconductors (NVDA, XLNX).
I certainly don’t know where KEYS is going in the short term, of course, but the share price dipping after a post-earnings surge made it a reasonable buy for me in the mid-$70s — I’d be willing to add a bit more if we see it continue to dip back down during what seem to be pretty weak-sentiment days as we head into Summer, but I’m not in a hurry. This is a good start in building a position that I think could be a strong if relatively unexciting grower for at least the next 3-5 years.
So where is this whole 5G and data center spending curve going to turn in the next couple quarters? 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.
There was a good quote from a MarketWatch column by Jeremy Owens a few weeks ago (NVIDIA tells the truth, and tempers a potential rally for chip stocks) that caught my eye — I don’t know his work in general, but this bit summed up the sentiment pretty well:
“The reality is that this could be a temporary slowdown that will end by the time 2020 rolls around, or it could be the beginning of the end for the massive cloud data-center build-out that has supported the tech boom even as the mobile-phone market has stagnated and personal-computer sales continue to struggle. Executives continue to rely on the first option and refuse to acknowledge that the second even exists, but at least they are being more honest about how little they can reliably predict in this environment.”
We as investors do tend to get too wrapped up in whatever the popular narrative is, though, 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, they just paused some of their ordering and stopped buying some things for some of their data centers for at least a little while. They’re still expecting to grow — as, for example, we saw CoreSite (COR) lease out “hyperscale” space to one of its big customers in April for another expansion to its Santa Clara data center campus… that’s “pre-leasing” for something that’s under construction, their eighth center on that campus, so about 2/3 of that space is now pre-leased and construction is expected to finish up by the end of the year, and they are confident enough in growing demand that they also bought some property on which they can add a ninth center in Santa Clara.
That doesn’t mean everything is being built and all is rosy again, it just serves as one anecdotal reminder that 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.
And, of course, in the interim few weeks we’ve seen a bit of a surge in the market as the “Trade Deal” optimism increased (on some days) and, more importantly, as we all started to believe the the Federal Reserve will cut rates and make us all happy again. .. so KEYS shares are a little higher, though still within the realm of “rational” when it comes to valuation (and for what it’s worth, it is still a “strong buy” stock with an “A” grade in Navellier’s portfolio grader system).
So… there’s a hodgepodge of comments about the tech sector, some from a few weeks ago and some added today, and your teaser solution for a couple 5G/AI stocks that folks have been asking for… feel free to share your thoughts on the topic with a comment below, and thanks for reading!
Disclosure: Of the stocks mentioned above I own shares of Keysight, NVIDIA, CoreSite, The Trade Desk, Okta, Xilinx, 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.