Asit Sharma (2:58)

So they're not really in opposition. If you think of this from Nvidia's perspective, when the call came to supply this type of answer for consumers and Nvidia went from being sort of a test and research development phase company alongside those companies that were building the models to. To just jumping into this wide world where suddenly everyone can pay for inference. Nvidia was talking a lot about scaling laws. The fact that after you trained a model, it required a lot of compute to keep serving up inference. So the scaling law of inference was much talked about at the time. Now as we've emerged into bigger and badder models, Ricky, the training actually doesn't stop once a model is released. So now we're into things phase is called post training, where a model keeps learning after it's released to the public. And that really triggers this second law of scaling. And Jensen Huang talked about three laws of scaling last night on the call. That second is the post training scaling law. That means you have to have a lot more compute as you post train a model. So Nvidia is starting to win on volume. As you can see, the models emerge, they get better and, and more compute is required. Now there's this third law which you sort of alluded to, which is when you ask a model to reason, to think in steps, that requires a lot more compute than just answering it one question and waiting for that simple answer to a simple query. This is the third law that Jensen was referring to in the call, the inference time scaling law. You ask a model to think, to reason, to take steps, take its own time. Have you tried the latest ChatGPT models that really think? Sometimes that model takes five minutes to return an answer. As these laws keep evolving, really what's happening is that Nvidia is winning on volume, as I sort of hinted at before. So the cost of compute can go down. And to complete this virtuous cycle, what Nvidia is doing is architecting for more compute that will handle more and more of these scaling laws. And it has to drive down the cost for its customers to want to keep playing. And the customers want to keep playing because they're showing cost savings with each successive, more complex round of GPUs that it throws at the market.

Ricky Mulvey (5:21)

What's happening with Nvidia's networking revenue. We talked about how this is a data center business. So for the newer listeners, how is the networking business different from the data center business? Because we're going to talk about it. This is one rare area where revenue is actually declining for Nvidia.

Asit Sharma (5:37)

Sure. So networking is such a fun thing to think about because none of us really understand it unless we happen to be in this industry. The way I think about it, Ricky is slinging data throughout a physical space in a way that's efficient, given whatever that end demand is. So in this case, AI, Nvidia bought a company called Mellanox a few years ago which had a competing standard to the Ethernet standard, which we probably all remember from years ago. And that has proven to be pretty good for moving data through AI networks a little bit faster in some cases than the Ethernet standard. Now, Nvidia has kept innovating on this technology and it's trying to compete with companies like Cisco, with Juniper Networks, with Arista Networks in some ways. But moreover than that, it's trying to make its own data centers, the ones that it builds in prototype. It actually builds prototype factories to make them more efficient so it can sell more of its GPUs. They've gotten pretty good at this. And what happened this quarter is that a standard that Nvidia had put into place now is merging over, integrating to a new standard. So the old standard, which is still quite robust, is shifting to something called NVLink72 and they are combining that with a technology that they call Spectrum X. With Nvidia, there's always so many new products, product names. The gist of this is that they have a transition quarter as they make their networking more capable for the next generations of Blackwell GPUs, they're going to see like a slight drop off in this networking revenue. But the company expects that it's going to pick up in the very near future.

Ricky Mulvey (7:25)

And anytime you listen to an Nvidia earnings call, you always get bold visions of the future from CEO Jensen Huang. And I'm hoping you can translate this vision for our listeners. Quote, the next wave is coming. Agentic AI for enterprise, physical AI for robotics and sovereign AI, as different regions build out their AI for their own ecosystems. And so each one of these are barely off the ground and we can see them, end quote. What is that vision? Asit?

Asit Sharma (7:50)

That vision is a vision in which the three most important customers to Nvidia, those enterprise businesses that I mentioned, then companies that are going to merge in the future from doing stuff that's Online and in cloud data centers. They're going to move that into the physical world. So think the manufacturing community, the automobile autonomous driving community, and third, the only entity left on the planet that has enough pockets to keep Nvidia growing. If they exhaust the spending of these big hyperscalers and companies and manufacturing companies in the future, that group is the sovereign government. So let's quickly break down what this means. Agentic AI for enterprise is the, the ability for big companies to spin up their own AI agents throughout their companies and make your work and my work theoretically more easy so that you and I can be more productive and potentially keep our jobs. I mean, this is the future that everyone is questioning. Second, physical AI for robots is, it's sort of interesting. From its founding, Nvidia has been fascinated with the physics of how things work, from the physics of visualization. So how they became a leader in the gaming space with their virtual reality machine learning, and also the way they present graphics on their graphics cards, that's always been something they've wanted to explore and they've moved that into the physical world. So they take what's something that limits a large language model, so the text modality, and they've expanded that into a lot of video and other modalities. And what this means is that they're gathering enormous amounts of data so that the robots can understand physically how things work. They're training robots for the real world. So instead of a robot going out and moving things with its hands before that ever happens, they have thousands and millions and billions of simulations based on video data or prior other data, some of it text, so that the robot already knows how to do it pretty well. And they have a platform called Cosmos which is promoting this, which has millions and millions, actually, I think it's in the trillions of tokens of training already under its belt. And then finally that sovereign AI piece, foreign governments want to catch up in a world where AI can be a level playing field or make things a level playing field. So Nvidia's positioning itself as sort of the first end to end customer. And they're pitching that to really European countries, countries from the Middle east, all over the globe to say, we can come in and give you the technology that's needed, that can be in house, so you don't have to go outside of your, your own country and put stuff on other people's servers. And we can make you as competitive as say China or the United States, because you'll be using our latest technology. And it's a Big market for them. It's. It's a market that if it materializes, could be the transition market outside of these few big names that everyone knows. Alphabet, Microsoft, Amazon, who are the main props right now of the Nvidia story.

Ricky Mulvey (10:59)

All right, I'm going to ask you maybe an unfair question. This is a stock that I have unfortunately been watching from afar for a few years now. And in my brain I was like, you know, there's going to be a dip. Right now Nvidia is at about 28 times forward earnings. It's flirted with 50 times forward earnings just a few months ago. This is for a stock that leapfrogs the market cap of McDonald's on certain days, which it has done before. 28 times forward earnings seems awfully mature. Yes, it's a multi trillion dollar business, but is this a dip worth buying? Asit?

Asit Sharma (11:36)

It is a tough question. I wake up some mornings. On the mornings I'm thinking about Nvidia and wonder if all that growth isn't in the rearview mirror. It seems awfully hard for a company this size to grow at a rate that could be in the teens or the low 20s. That would justify a person buying today who feels like maybe it could be an even cheaper company. I bought it 28 times earnings today, but as the growth sputters out, maybe it trades for 15 times earnings in the future. The other argument, or way to look at it, is that this company has exhibited an uncanny knack for understanding what the future looks like. Proof of this case is this latest Blackwell chip. If you've ever driven by a piece of land and seen the sign Build to suit, meaning thereby that the owner of the land will build what you want for you based on your specs, say a warehouse or a restaurant. Nvidia is the planet's best build to suit manufacturing company because it works so closely with all the key players. The people that are building the large language models, the people that are building data centers, the hyperscalers, the end customers for its GPUs. It has such a bead on what the future looks like, forget its own great technology. So it already has a keen understanding of where things could go that it's almost unerringly correct at developing in advance the technology that has a lot of demand attached to it. So even if this phase slows, Ricky, at least based on its track record, I wouldn't be surprised if a dormant company that people don't get excited about anymore, called Nvidia sometime in 2032, surprises the market again. And Takes off.

C (13:26)

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Ricky Mulvey (14:02)

I want to move on to the next story and this is about Applovin, which kind of quietly was the most successful tech company in the stock market of 2024. Asset not Palantir, it was Applovin. But right now, Applovin is facing the shorts. So for those unfamiliar, Applovin sells ads for mobile games. If you're a fool, you can think of this as the trade desk, but for mobile gaming. And before we get to the allegations, this is. It's been a tremendous rise for the company. Why have investors previously at least been so bullish on Applovin?

Asit Sharma (14:35)

Applovin operates in a pretty difficult market. This is digital programmatic advertising. If you're familiar with the Trade desk, it's a little bit like that. An ad platform that's served up automatically, but it's confined mostly to the mobile gaming market, which is treacherous. It's a market that it's just difficult to make good money in. There's a company called Unity Software which is extremely capable. It's having a relatively good year. But that's a case study of the stumbles and problems with trying to compete in a market where ad impressions are hard to come by and it's hard to actually have unit economic value here. Applovn has seemed to do this quite easily with a management change and some new technology. They call it Axon 2. It's a model that is continually enhanced to optimize their monetization strategy. And the stock has really taken off with the success of this platform. That's the quick story behind why Applovin has garnered a lot of attention from the business community, the analyst community, and also just retail investors who want in on a company that can prove it can really juice the earnings and revenue growth in such a tough market.

Ricky Mulvey (15:51)

There's quite a few allegations in the short reports that one of them came from Fuzzy Panda. So a few of them include basically, one is essentially COP Meta's homework on their users to track their customers, and they think Meta would be very upset about that. Another allegation is that a lot of app lovin ads use sort of nefarious tricks to drive downloads that could include, you know, placing a little X above a game where you think you're closing out of the ad, but really you end up opening the app store to download the game. And then additionally there's some fairly serious allegations on on tracking children within these mobile gaming segments. When you were working your way through the short report Osit, was there anything that just wowed and shocked and awed you as these short sellers would like to do?

Asit Sharma (16:39)

I like to read short reports of companies that aren't recommended in services that I work on here at the Motley fool or that I own personally for the reason that sometimes a short report can have a kernel of truth that you need to follow and understand more. I've read my share of reports, Ricky, where I just went through everything and felt like nothing here has any potential to even stick and it just sounds over the top. So I guess what caught my attention was what you mentioned, the allegations of sort of harm towards younger consumers and that seemed like something that is a typical hook for short sellers when they have a report. So we have to just explain here. Short sellers provide a service to the investment community in that they can point out what they think or allege is misunderstood by investors, but they also have a financial interest in investors getting scared and selling out of a company. That interest is often brought to your attention by the hook. So I think that's what sort of leapt out at me as a little like maybe too much because I think it's probably going to be easily refuted by the company. In fact, was a blog Post from the CEO of AppLovin responding to this and I think he pretty squarely deflected sort of any kind of harm that could come to younger users. But I know we have a lot more to to talk about, so let's keep moving.

Ricky Mulvey (18:11)

Yeah, this is definitely a question of who do you believe the short sellers would say that this, that app love and ads where if you're playing a mobile game, you see another ad for a mobile game that there's direct downloading that you are tricked into as a user? The CEO of AppLovin, Adam Farogi, says every download results from an explicit user choice. These are statements in direct opposition to each other and it's up to the, I guess the investors to decide who they believe.

Asit Sharma (18:40)

Osit the blog post itself is pretty interesting, Ricky, because it's short and this is one of the statements, you know, you've isolated that makes me think I want to study this a little bit more. I haven't made any kind of firm decision on whether these allegations are spot on or just way off. But when an executive puts it in this way, what he's doing is putting the onus of any kind of technical engineering up for subjective interpretation. So in other words, you explicitly use or wanted to play this game, so you clicked here. Now what you've also brought up here is if that triggers some installs that the customer doesn't understand or know about, they're disclaiming responsibility, but it doesn't mean they couldn't be culpable in that respect. And we should point out here that Applovin, while they clearly explained how their value is created, they say it's not created by just mere impressions or clicks. Their revenue is based on the value that they drive for those using their service. Well, actually it's partly install based, so the more installs they show, the more revenue they generate. So that question doesn't exactly address this. The other thing that the blog post doesn't head on address is this allegation that you've brought up. Not that you've brought up, Ricky, you and I aren't in the business of writing these short reports, but you've relayed from the reports that maybe this company is sort of reverse engineering important data from Meta. So what's happening here allegedly is that Applovin has sort of a view into Meta's advertising and from that it's getting access to important first party data. So Meta ads will include first party data that maybe the customer doesn't want anyone else to see a Meta platform customer and be served up ads from. So the allegations are that they're sort of looking at all this stream of information and then engineering advertising that makes their ads more successful, which is not kosher for the major platforms from Meta to Apple to Alphabet.

Ricky Mulvey (21:00)

And anytime I read a short report, in this case I'm reading a short report and I'm reading management's response. Osita, my, my eyebrows raise in both cases because you have, you have two players with tremendous benefit to tell a certain narrative. And in the case of Applovin, as you've mentioned, I've been served mobile ads for games that feel a little fishy. So I understand where they're coming from on that. On the other side, for these short sellers, they're basically saying that once Meta finds this out, they're gonna shut down Applovin. And we know this because of a whistleblower who, who found this with 13 standard deviations. It couldn't possibly be coincidence. And oh, by the way, we can't really publish that because they sold that information to a hedge fund. There's some weirdness going on and it makes me wonder, couldn't Meta just shut down Applovin? And why is a short research firm figuring this out before Meta?

Asit Sharma (21:56)

So my wife, who has a degree in information science and is really great at reasoning and is often calling me out at the dinner table for stuff I don't understand, she would say that's the kind of question you should ask if you're reading a short report. This is the crux of it. Why wouldn't Meta figure this out on its own? Why couldn't they? Why haven't they, why wouldn't they pull the plug? So I think this is for investors, just a great question to ponder and to keep us from jumping to a conclusion and getting scared into a response or, you know, and perhaps being tricked into response. We just don't know. But I think we'll find out in the coming quarters. If next quarter we see a big drop in revenue and they say, oh, by the way, if certain unnamed platform is sort of clamped down on us, we'll, we'll understand what happened.

Ricky Mulvey (22:41)

So I would encourage the investors listening. It's okay to just look at this, take the information in. It doesn't mean you have to take action on it right now. Asa Sharma, thanks for being here. Appreciate your time in your insight.

Asit Sharma (22:51)

Thanks a lot, Ricky.

Ricky Mulvey (22:57)

As always. People on the program may have interests in the stocks they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. While personal finance content follows Motley fool editorial standards and are not approved by advertisers, Motley fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.