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- [00:00]
Podcast Host
You're listening to a brief segment from one of the Bits and BIPS episodes this week. The full show is now only available on its own dedicated Bits and Bits channels. So be sure to go to X, YouTube and your favorite podcast platform and search for bits +bits spelled B I P S and subscribe.
- [00:21]
Financial Analyst 1
So let's talk a little bit more about AI. I mean, as you mentioned, and anyone watching this I'm sure is well aware, I mean, earnings have generally been very, very good. But there are concerns and I think sort of the, like the two sides of the coin you mentioned between Meta and Microsoft, I mean, going in opposite directions, I think that's a really good sort of microcosm of sort of the different approaches. Someone can read what's happening. So maybe just expand on that a little bit, please.
- [00:47]
Financial Analyst 2
Yeah, so I listened to both the calls last night and you know what put Meta, Sorry, in the penalty box was, hey, we raised our capex spend. They didn't raise it by a lot. They raised the lower end by 5 billion, which seems like monopoly money to us.
- [01:02]
Financial Analyst 1
Right.
- [01:03]
Financial Analyst 2
But they raised it. They g. And they talked a lot. They gave us a lot of qualitative explanation, but they really. I didn't see any proof in terms of revenue growth or maybe no clarification on the timeliness of discernible roi. I didn't hear that. Now, maybe other people did. I didn't hear it. That's why the stock's down 10%. So they raised their capex guidance and Q3 revenue guide was a little below the midpoint. I know these are nitpicky things, but this is what the street reacts to.
- [01:31]
Financial Analyst 1
And from my opinion. I don't mean to interrupt you, but I mean, just given how poorly their initial LLMs were received, it seems like from my perspective, the burden is higher for them to prove that they're able to kind of catch up and overtake, especially with some of the Chinese competitors. Yeah.
- [01:46]
Financial Analyst 2
And then right after that call, I got right on Microsoft's call. Right. I can of course see all the earnings revenue versus consensus margins on and so forth. And the number one metric we're looking for with Microsoft is Azure growth. Right. Cloud growth. And that number was super strong. That was the first thing I thought, okay, that's really what we wanted to hear about Microsoft's management. The quantitative information that they gave us and the tone in which they delivered it was, you know, having listened to earnings calls for 35 years, you. You pick up on these things over time. They were confident you could Tell they maintained their capex guidance so they didn't raise it. And so that's the worry around sucking out all the free cash flow generation from these unbelievable companies here in the last six, eight months or year. Where if you and I were talking two years ago and you said, hey, do you think Microsoft, Google, Amazon and Meta are going to blow through all their free cash flow? My answer would be no way. They just did. And they're in the market borrowing more. Right. So investors have called timeout on that, Timeout on that. And you know, I'll lead you to another concept that we've been pounding on here for the last 18 months. But those were the differences to me anyway in the calls last night and why one stock is down and one stock is up.
- [03:02]
Financial Analyst 1
Yeah, it's really interesting because when we hear about these big tech companies, I mean going back to like the fang and I forget some of the other acronyms that that were there, I mean they were enormously profitable, had had very, very, very low CapEx and, and like unlimited free cash flow, a big inversion now because of how, I mean the revenues are great, but I mean like Google went to public markets for the first time in decades. I mean these companies are raising tens of billions of dollars in the debt market. I know Oracle was recently downgraded to like 1, 1 ring above, above junk status. And yeah, I mean free cash flow is all of a sudden, it's a big deal. Maybe for some of my viewers, some of my listeners that are just trying to get their hand, their arms around all this, could you maybe just talk about how from your perspective, like you think about these different buckets to sort of ascertain the health of a company because it's hard sometimes I think to distinguish between like Microsoft and Oracle and like.
- [04:02]
Financial Analyst 2
So I'll do my best in a nutshell, from a high level. So it takes, you need to consider a lot of different variables. Right. Zuckerberg, for example, last night talked about total addressable market on and on. Okay, we get that.
- [04:17]
Financial Analyst 1
Right.
- [04:17]
Financial Analyst 2
That's why the spend and then there's not nearly enough compute demand and all that. So you factor in comments like that, you look at the company's balance sheet. What I always focused on, especially as a growth manager, owning these names and liking these names over decades is how much confidence do I have in the run rate and revenue. Tell me about cogs. You know, I need to know where the margin numbers are likely to go. I don't really care about the tax rate because it doesn't move that much. But I'm trying to get my arms around all of the different things that will impact net income. Factor in buybacks, what's the earnings power going to look like. And so there are a lot of levers you can pull on an income statement, right? You can reduce expenses to boost margins. You can have an earnings beat because the tax rate was lower. There's, there's all kinds of manufacturing, right? You buy, you buy outstanding shares back and the EPS number goes up. So you can engineer earnings, you cannot engineer the statement of cash flows. Right? And so to me, maybe not so much as a growth investor, but certainly if you're a value investor, you're looking at that a lot, right? But in this case where you have the, you know, I'd argue the best run companies on the planet blowing through all of their capex, lending it to each other or backing deals in a circular fashion is a concern. I'm not saying it's not a concern. That does concern me because if this whole notion that the models are evolving by the minute, by the hour, getting stronger, can update themselves and everything that we know at the moment and therefore going to demand these data centers and all this compute power if something goes wrong there, now they're levered, right. I don't, I shouldn't talk about their, you know, interest expense ratios cause I don't know them off the top of my head. But if, when you take out the cash flow to meet obligations, that is a risk, right? So that's, that's the bear kind of argument. I guess you could make the counterargument by saying hey Chris and Steve, if they're running one of these companies, they probably wouldn't be blowing through their, their cash flow generation and investing all this money in this unless they completely believed it. And high conviction doesn't mean we're right. But I think that's what, that's what the management teams do believe.
- [06:35]
Financial Analyst 1
Yeah, yeah. I'm glad you kind of brought up the circular nature of it. I think the pejorative connotation that I've seen thrown around is sometimes a good degree of incestuousness between all these companies but at the same point like they're complementary and there's a certain level of scale you have to have to play in that arena. So like where else could they really, where else could they really go? But it does. Like if things, if this breaks, like it could be calamitous just because of how closely entwined they are to each other, like who ends up holding the bag if something goes wrong and would one bring down everyone? I know that's a question. I don't know if that's a question you get, but that's a question that I often get asked.
- [07:14]
Financial Analyst 2
Yeah, it's hard to say, but that's. You're talking about the domino effect. Once someone falls, it's kind of, you know, boom, boom, boom, boom, boom, and everybody goes down. Look, anything can happen in our business. We know that. Any stock can go to zero. We know that. I've seen that. I've owned stocks and thankfully sold them and watched them go to zero. So that can happen. Our take on this, honestly, our bottom up, fundamental take on the whole thing, the whole AI spend and where we are in baseball terms, we were talking before we got on there, you're a Phillies fan, I'm a Red Sox fan. So in baseball terms, we're probably in the second inning of this. And don't take my word for it. Go listen to earnings calls and listen to companies, all different cap sizes, all different industries, all different sectors. I promise you to the listeners, anyone can listen to an earnings call from a public company, go to their investor relations website, click on the webcast and listen. Read the transcript if you want, on every earnings call. Already this year, and this has been this quarter, sorry, but this has been true for probably the last 12 months. Every company talks about how they're using AI in their business, whether it's to improve efficiency, productivity, ultimately profitability, to make things faster and better for their customers, to improve their service levels. We've heard that for a year. I hear that in every single earnings call. So this is not going away. The use case is tangible. And now you've got large public companies talking about, hey, we're not just thinking about this, we're using it. And oh, by the way, we can demonstrate improvements in efficacy by a whole host of measures. But what we really look for is has that improved operating income? And so we're starting to hear that now. I think Microsoft did a really good job last night and they're called meta didn't. We'll see what Amazon and Apple say tonight. Right, but we're probably in the second inning of the game. The risk is there that the whole thing is a bunch of BS and it falls apart. We do not believe that. We do not believe that. We think we're in the second inning of a not any game and this is real. Now, that's okay. Conceptually that might not line up to making money in the stocks, which is a completely different different game.
- [09:32]
Podcast Host
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