Welcome back today on the Joseph Carlson Show.
The major indices have performed well this year with the S&P 500
and the QQQ making major gains. But these gains are being led by
a handful of companies. We can see the overall map here
of the S&P 500 year to date. We have some of the bigger names
like Microsoft, Apple, Google, Meta, Amazon, Costco, Eli Lilly,
Broadcom, all making huge gains year to date.
But there's one company that really stands out that's already
a large company. That is NVIDIA, which is up 160%
year to date. That is an astronomical return
for a company the size of NVIDIA.
NVIDIA alone has accounted for roughly 1/3 of the S&P 500 gains
year to date, meaning that if you took away this company from
the S&P 500, the S&P 500 would have returned around 11% instead
of 17%. That's how big of an impact
NVIDIA alone has had. It's really been breathtaking.
It's been astronomical. Anytime a company has this large
of an influence, this much attention and this much
momentum, I think it's important to look at it from a value
investor perspective and that's what I plan to do in this video.
I'm going to go out on a limb a bit.
I'll be giving the bear case for NVIDIA and why I personally
believe this is an incredibly risky company to invest in
today. Now we also, of course, have
some other news to get to. Ed Yardini from Yardini Research
gives his opinion on the market melt up.
Boeing just agreed to plead guilty to the 737 Max criminal
case. We'll be observing more of the
downfall of Boeing and the collapse of their company's
culture. And Paramount Global and
Skydance finally formally agreed to a merger.
We'll be looking at how that impacts Paramount stock.
Now, I first want to start off by giving my bear case on
NVIDIA. And I want to start off by first
prefacing this bear case. Anytime I give a bear case on
any popular stock, one like NVIDIA, there's a lot of risk to
it. The risk of course is that the
stock races up after you release your bear case.
Now, I don't have any position in NVIDIA.
I'm not short NVIDIA. I have no options or no position
whatsoever on NVIDIA, so there's no financial risk with being
bearish on NVIDIA for me. In fact, if NVIDIA stock races
upwards tomorrow after releasing this video, I'm not out
anything. I haven't really lost anything.
I own a high quality portfolio full of companies that are doing
fantastic. My performance has been great
over the past couple of years, so I don't have any issue if
NVIDIA continues to do well. And that's not my motivation
behind making this video. The reason that I come out with
bear cases on popular stocks is because I see a lot of retail
investors investing in the market and they throw their
money into whatever is doing best at the moment.
There's a post on Reddit just today saying my dad invested
$200,000 into NVIDIA last week and he's saying he could hold it
for the next three years. What are your thoughts?
Good investment. These are the type of posts
we're seeing now with NVIDIA. People's dads throwing $200,000
into the stock just to hold it for a couple years and see how
things go. And this type of thing is to be
expected. Nvidia's phenomenal performance
this year brings a lot of attention to the stock, which
increases the chance of retail investors pouring money into
this company, for better or worse.
A lot of this is due to recency bias.
Recency bias is a normal thing. Most of us have this.
It just means that we give more attention to recent events over
historical events, and recently the best stock in the market is
NVIDIA by far. This also seems to follow
another pattern. Investors clamor into stocks
that have recently had incredible outperformance and
then they go on for years having underperformance.
One of the best examples of this is Tesla, a stock that has been
flat for over 3 1/2 years to this day.
Even after this recent rally, Tesla stocks still trades below
where it was in 2020 and well below where it was at the price
point in early 20/21. I made similar videos on Tesla
at the time calling out the insanity of Arc Invest $3000
price target for Tesla. In that video, I argued that
Apple is a much better opportunity than Tesla given the
valuation and the fundamentals. Since that video, Tesla is still
under the price point that it traded at 3 1/2 years ago.
When I released that video, Apple has increased by over 80%.
Now I didn't come out with that video because I hate Tesla and
want it to fail. I came out with a video to
highlight a stock that was incredibly popular, being
promoted by many popular figures, saying that the demand
for Tesla's was unlimited, it would go on forever.
Saying that they were selling every vehicle they made and
their margins were going to March higher and higher and
higher, and they weren't going to run into any problems with
their Moat or competition. All of these things being said
about Tesla, how the company could not fail, and how the
stock justified the extreme valuations made me increasingly
nervous about the company. Another very popular retail
stock that I've given a bear case on is Palantir.
Three years ago, during peak bullishness for Palantir, at a
time point where Palantir was doing incredibly well, I had a
poor cold water on the situation.
I released a video called Why I'm Not Buying Palantir.
I went over the business fundamentals, the growth
prospects, and the valuation, expressing my concern that
Palantir traded at an incredibly high valuation.
That video was released February 19th, 2021.
The stock price at the time was $29.00 per share and even 3 1/2
years later, Palantir still does not to this day trade above that
price. Now again, Tesla and Palantir
are both great companies. I'm not against what they're
doing or the companies themselves.
In fact, I could see myself investing in them with the right
situation. But both of these stocks got
into situations where good companies made poor investments.
So the purpose of making these bear case videos is not to bet
against these companies or profit from their demise.
It's to give a different perspective for retail investors
that see these as fantastic investments.
In many cases, great companies can make poor investments if you
invest in the company at the wrong time.
And with NVIDIA, I think it's very questionable.
In fact, I think it's very risky to invest in it at this time.
The first thing that we can point to is how NVIDIA makes
money. Simply put, where do they get
their revenue from? As I've gone over previously on
this channel, they get their revenue from data centers.
That is where the majority of their revenue and growth is
coming from. It's not coming from gaming,
professional visualization, or automotive.
These are nice parts of the company.
I guess they're meaningful to some degree, but as you can see,
all three of these combined are still less in revenue than they
were in 2021. O The growth is not coming from
these three segments. It's all coming from data
centers. NVIDIA is in the business of
providing chips for data centers.
These chips are massive. In fact, they're more like
entire server racks instead of chips.
And these chips are expensive, some of them being $30,000 and
upwards for a single chip. NVIDIA has dominated the data
center chip business, growing it exponentially over the past year
from $4 billion in revenue up to above $20 billion in revenue,
and it's still growing. And while the revenue has grown
and the margins have expanded, the free Cash Cash flow has also
exponentially expanded. Here's the free cash flow of
NVIDIA since 1999. You can barely see the amount of
free cash flow made-up until 2021.
You see a little bit right here. It was doing good in 2021.
And then you have the explosive growth, earning $15 billion in
free cash flow in a single quarter.
This puts it on track to earn $60 billion in free cash flow
this year. The returns on capital employed,
a measurement of how effectively a company can reinvest its cash
that it earns, is also increasing exponentially.
This is a metric that was not reliable historically for
NVIDIA. It had it in the 5% range, which
is on par with companies like Ford or GM, and then it went up
into the 15% range, which that's getting closer to companies like
Costco. Very reliable and predictable
companies. But then it ebbed and flowed
over time. Now over the past year, the
returns on capital employed have surged upwards of 27%.
This is a 5X of their returns on capital employed.
Gross margins are expanding, but more importantly, operating
margins have doubled their historical average over the past
five years, racing up to 65%. Profit margins are now around
57%. Whatever metric you look at, you
can tell that business is good for NVIDIA and specifically the
data centers. But that raises the question of
duration. How long can NVIDIA sustain
these type of metrics and this type of growth?
Sequoia Capital released research looking into this
question. They call it AI $200 billion
question. The generative AI wave which
began last summer has gone into hyper speed.
The cattles for this double acceleration was NVIDIA Q2
earnings guide and and subsequent beat the signal to
the market the insatiable level of demand for GPU's and AI
training. Before Nvidia's announcement,
consumer launches like ChatGPT, Mid Journey and Stable Diffusion
had raised AI into the public consciousness.
With Nvidia's results, founders and investors were delivered
empirical evidence that AI can generate billions of dollars in
net new revenue. This has shifted the category
into its highest gear yet. We've seen all of this over the
past two years. ChatGPT and Nvidia's quarters
leading to incredible gains by the company, the stock price
going up 10X over the past couple of years.
While investors have extrapolated much of Nvidia's
results and AI investments are now happening at a torrid pace
and at record valuations. A big open question remains.
What are all these GPUs being used for?
Who is the customer's customer? How much value needs to be
generated for this rapid rate of investment to pay off?
How is all of this spending being justified?
Consider the following. For every $1.00 spent on GPUs,
roughly $1.00 needs to be spent on energy cost to run the GPU in
a data centre. So if NVIDIA sells $50 billion
in run rate GPU revenue by the end of the year, a conservative
estimate based on analyst forecast, that implies
approximately $100 billion in data centre expenditures.
The end user of the GPU, for example, Starbucks X, Tesla,
GitHub Copilot and other new start-ups need to earn a margin
too. Let's assume that they need to
earn 50% margins. This implies that for each year
of current GPU CapEx, $200 billion of lifetime revenue
would need to be generated by the GPUs to pay back the upfront
capital investment. This does not include any margin
for cloud vendors. For them to earn a positive
return, the total revenue requirement would be even
higher. So the argument that Sequoia is
making here is basically for NVIDIA to be selling $22 billion
worth of data center chips and GPUs, someone needs to be making
money on those sales. It can't just be the cloud
companies buying these chips that need to make money.
The cloud company's customers also need to make money in the
process. Based on public filings, much of
the incremental data center build out is coming from big
tech companies. Google, Microsoft and Meta, for
example, have reported an increase in data center CapEx.
Reports indicate that Bident, Tencent, Alibaba are big NVIDIA
customers as well. On a go forward basis, companies
like Amazon, Oracle, Apple, Tesla should also be important
contributors. The important question to be
asking is how much of this CapEx build out is linked to true end
customer demand and how much of it is being built out in
anticipation of end customer demand.
This is a $200 billion question. If you add up the different
companies and how much they're expecting to generate in AI
revenue, you have open AI generating $1 billion in
revenue. You have Microsoft saying that
they're going to generate around $10 billion with Microsoft
Copilot. We can assume that Google will
generate around similar amounts of revenue from their AI
products. Met and Apple each generate $10
billion in revenues from AI. And let's use $5 billion as a
placeholder from Oracle by Dance, Alibaba, Tencent X, and
Tesla. These are all dummy assumptions,
but the point is that even if you assume these extremely
generous gains from AI, there's still a $125 billion hole that
needs to be filled for each year of CapEx at today's level.
Sequoia goes on to argue that this leaves a huge gap to be
filled, and that gap will be filled by start up companies.
Start up companies will benefit from the overbuilt ecosystem of
AI. They'll leverage cloud companies
and their huge infrastructure to be able to offer AI products to
their customers at very low expense.
They note that during historical technology cycles, overbuilding
of infrastructure has often incinerated capital.
Bringing down the marginal cost of AI is good for start up
companies. But where does that leave
NVIDIA? NVIDIA is benefiting directly
from being the leader in AI chips during a time where
there's this insatiable demand for AI chips.
But as we've seen and as they note, in many cases, that leads
to it being overbuilt, meaning that too many companies race to
become the AI leaders. They buy too many chips and then
they're left over building their infrastructure.
In this case, the estimates are somewhere around $125 billion,
even from optimistic assumptions from their biggest customers.
If smaller startup companies are not able to fill in those gaps,
then NVIDIA could be left with a glut and demand.
A glut and demand would affect every meaningful fundamental of
the company. So my first major concern with
NVIDIA right now is the possibility of an overbuilt AI
infrastructure. If that takes place and they
eventually have a glut and demand, that glut and demand
will lead to declining or decelerating fundamental
metrics. And that leads us to concern #2
there's two different setups to a stock, one that I consider to
be the perfect situation and one that I consider to be the worst
situation. I always try to find companies
that lean more to this left side, more to the perfect
situation, because it leads to outperformance.
Of course, the worst situation often leads to underperformance.
So let's go ahead and go through this under the perfect ideal
situation for the setup of a stock.
You want a company that has accelerating revenue growth.
Now, accelerating revenue growth does not mean a company that's
growing revenue. A company may grow revenue 10%
year over year over year. That company does not have
accelerating revenue growth. A company that has accelerating
revenue growth means the rate of growth is increasing year over
year. So one year it's growing 5% and
then suddenly it's growing 10% or 15% or 20%.
It's great for companies to have continually growing revenue, but
it's incredible if a company can have accelerating revenue
growth, especially when it's unexpected.
Now, we also have the same thing here with earnings growth.
We have accelerating earnings growth.
Again, this doesn't mean that they're earning the same amount
every year. It means that they're earning at
an increased rate every year. These type of companies
typically lead to outperformance.
We also have expanding margins. If the company has accelerating
revenue growth, accelerating earnings per share growth and
expanding margins at the same time, that is a win, win, win.
That is a situation where your stock is going to go up almost
definitely. In fact, every situation that
I've seen this with the stock, the stock price goes up.
And then finally, to cap this off, the perfect situation in my
opinion is when you get accelerating revenue growth,
earnings growth and margin expansion tied together with a
low starting valuation, an undemanding valuation to start
things off, leading to multiple expansion over time.
A company that fit this situation was Netflix two years
ago. At one point, investors were so
bearish on Netflix that they traded the stock down to around
$170 per share, right below $200.00 per share for a couple
of months. During this time period, Netflix
had a 15 Forward PE ratio. It was a lower multiple than the
market. Netflix had a low starting
valuation leading to multiple expansion.
Netflix went from a 15 Ford PE ratio now back up to a 36 Ford
PE ratio during this time period.
Two years ago, Netflix had accelerating revenue growth.
Netflix's flat revenue in 2021 is what caused the 70% sell off
in the stock. Many investors thought the
company was done for because the revenue was going down, but then
we had a re acceleration in revenue that reignited investors
bullishness on the stock. Accelerating revenue caused the
multiple to expand. All of these factors of
accelerating revenue growth, earnings margin expansion, and a
low starting multiple led to an incredible return for this
stock. From this point, Netflix is up
267%. This incredible return is a
result of this perfect situation.
But then we move on to the worst situation.
We have decelerating revenue growth.
We have decelerating earnings per share growth.
We have margin compression with margins going down.
We have a high starting valuation with very high
expectations from investors leading to multiple compression
over time. The worst situation is the exact
opposite of the perfect situation.
And if we ask the important question here, which situation
does NVIDIA stock appropriately fit into right now?
I think we can take a look at that.
The first question is regarding revenue.
NVIDIA has benefited dramatically from accelerating
revenue growth. We've seen that over the past
year, but that is not going to happen over the next year.
Nvidia's revenue growth is going to decelerate quickly.
Nvidia's revenue growth is going from rates of 97% down to 30%
and from 30%. It's only going to decelerate
more and more. So we have decelerating revenue
growth. What about their earnings
growth? The earnings per share has gone
up 631% over the past year. It is impossible for NVIDIA to
keep these earnings growth rates up.
It is going to decelerate dramatically over the next year.
Margins is another big question and there's a lot of debate
about margins with NVIDIA. We know that NVIDIA stock has
dramatically benefited from rising margins over the past
year, but the question now is whether or not those margins are
likely to continue going up or more likely to go down.
If I have to take a guess here, with margins at 65% for
something that every company is now trying to build out because
of how profitable it is, I think the margins are more likely to
go down over the next three years than up.
There is a chance they could go up.
Maybe NVIDIA can protect their Moat completely, but I have to
believe there's more of a chance of margins going down than up.
And then finally, the current valuation of the stock, is it a
low valuation that will lead to multiple expansion or high
starting valuation leading to multiple compression?
NVIDIA currently has a 54 PE ratio and a 40 price to sales.
This is a pretty high valuation. And if I'm looking at this stock
right now, I think there's far more chance that it's going to
have multiple compression over the next five years than
multiple expansion. Maybe the PE ratio could go to
60 or 70. Maybe the price to sales could
go to 50, but overall I see far more downside with their
multiples than upside. So it's priced at a price right
now with a high starting valuation and very high
expectations from investors. When I look over the situation
overall, I see a company that is likely to have decelerating
revenue growth, decelerating earnings growth, margin
compression, and it's at a pretty high valuation.
Now, that doesn't mean that the stock is doomed and video could
do just fine, but it has a lot of factors working against it.
It has a far more uphill battle than when it was in the
situation two years ago where everything was accelerating,
everything was expanding, and the valuation was lower again.
It's impossible to see the future.
Maybe NVIDIA will continue to trade upwards with incredible
demand, especially in the short term.
But over the next three to five years, I have to look at this
from the perspective of a value investor with the fundamentals,
the valuation and the future growth prospects of the company.
And right now, I see a lot of reasons to be a little bit
concerned about this company more than to be extremely
bullish on it. I consider it right now an
incredibly risky proposition to invest in NVIDIA.
The final point I'll make is something that I think is
interesting to look at and that is that overall insiders are
selling shares of their stock, not just their compensation
through their stock based comp, but they're actually unloading
some of their position. Especially over the past month.
NVIDIA insiders have been selling around 1% of their stake
in the company just in the past month alone, which is not a huge
deal. In fact, I don't consider this
overall that big of a deal in and of itself and I'd never make
a bear case on a company centered around insiders taking
some gains. So in and of itself, I don't
think that this is too big of a problem.
When I'm looking overall at the stock in the situation right
now, I think it's just another thing to throw in, another thing
to mention. Because we do see insiders
overall taking a bit of the gains here.
I don't see any buys coming through with insiders.
So there's my overall concerns about NVIDIA and a different
perspective on a stock that has been incredibly popular.
Now let's go ahead and move on to some news here.
We know the market has been going up over the past couple of
weeks, seemingly every day, inching up inch by inch.
And Ed Yardeni, who has a lot of information on the market, he
publishes a lot of charts, says that this is a slow motion
market melt up. I think the way I would describe
things as we're in a slow motion melt up the market just for the
past few weeks has just continued to March higher to new
record highs. And it's done it on
disappointing economic indicators.
Because I think investors have concluded that let's not worry
too much about the the economy slowing or even a recession,
because if that were to even become a significant risk, the
Fed will move pretty quickly to lower interest rates.
I don't think the Fed needs to lower interest rates, but the
the Fed looks like they're ready to lower them if necessary.
Ed argues that the reason the market continues to go upwards
despite weak economic data is because investors realize that
the Fed is on their side and the Fed will lower interest rates if
the economy ever runs into trouble.
I don't agree with him here. I don't think that's the reason
that most investors continue to buy.
I believe most investors buy stocks repeatedly and
continually and put money into their four O 1 KS and retirement
accounts because they're long term investors, because they've
been told their entire life to buy the stock market and not
worry if there's a recession, eventually it will recover.
Most investors understand throughout history that we've
gone through recessions. Most investors in America
investing into the retirement accounts aren't trying to time
the ebbs and flows of the market.
So I think overall, the reason the market continues to go up,
the reason that investors continue to buy, is because
these companies are doing well. Investors want to own them, and
they're not concerned about the temporary question of a
recession. Now moving on, Ed gets to his
projections of what he thinks the earnings per share will be
for the S&P 500 in 2024. Yeah, I, I think we're going to
do $250 a share this year. That's up from $225.00 a share
last year. I think next year we're going to
do 270 dollars a share than $300.00 a share.
By the end of the decade, I think we could be looking at
$400.00 a share. Ed's forecast is for the SP500
to earn 250 by the end of the year.
Tom Lee's was 285. So he's not quite as bullish as
Tom Lee, but he still thinks that the earnings are going to
be higher than the previous year's.
Now moving on, we have news that Boeing agrees to plead guilty in
the 737 Max criminal case. Boeing will formally acknowledge
the guilt and accept fresh punishment over its dealings
with the Federal Aviation Administration before 2737 Max
crashes that killed 346 people. As part of the plea to one count
of conspiracy to defraud the US, prosecutors asked the company to
pay a second $244 million criminal fine and spend $455
million over the next three years to improve its compliance
and safety programs. Boeing also must hire
independent monitors for three years to oversee these
improvements. Pleading guilty creates business
challenges for Boeing. Companies with felony
convictions can be suspended or barred as defense contractors.
Boeing is expected to seek a waiver for that consequence.
The company was awarded Defense Department contracts last year
valued at 22.8 billion. Also, as part of this plea
agreement, Boeing board of directors agreed to meet with
victims families. Now when I look over this
consequence for what Boeing did, I think they got a slap on the
wrist. I think this is way below what
their punishment should have been.
Boeing didn't just get things wrong, they didn't just make an
honest mistake. They intentionally and willfully
put dangerous planes on the tarmac with passengers in it.
They didn't do any proper checks before the 2nd crash after they
knew that something was dramatically wrong with the
first one. This is what led to 346 people
dying. Around half of those people
still could be alive if they properly identified the problem
after the first plane crash. And not only did they not do the
checks, but they also blame the pilots.
After the crash. The CEO of the company went in a
press conference and said that it was pilot error and that as
far as they could tell, Boeing did nothing wrong.
So they were victim blaming after this crash which killed
346 people when their planes and the faulty design of the M cast
system was the reason for the crash.
The fact that Boeing is having to pay less than $1 billion, you
have 244 million and then 455,000,000 over the next three
years is a complete miscarriage of justice here.
That is a slap on the wrist for a company that made huge
mistakes. Last year, Boeing made $4.4
billion in free cash flow. So that's not even 1/4 of one
year free cash flow over the next three years.
And this is the big penalty that Boeing's given.
The plea deal falls short of what families of the Max crash
victims had wanted. They asked federal prosecutors
to seek fines as high as around 25 billion.
Now $25 billion I think is a is a lot of money.
I could see them coming down from that number.
But even having around $5 billion of fines would be a nice
hefty punishment for Boeing. The fact that they brought it
down all the way to around 600,000,600 seven 100,000,000 /
3 years doesn't really send the message that I think the victims
once sent, the companies are being held accountable and
they're given real fines and penalties for this type of
damage. What Boeing did was cause an
incredible amount of destruction, killing 346 people,
damaging the reputation of a great company and making it so
that people don't have confidence flying in their
planes. That is an incredible amount of
both immediate damage to the families involved and the brand
damage of the company. And I think the penalty for this
should have been much bigger. Now, finally, we also got news
that the rumors are true. Paramount Global and Skydance
agreed to the merger. It's finally official.
The rumors were fairly accurate. Skydance and its investors have
agreed to spend more than $8 billion to acquire National
Amusements. That is the family parent
company that controls Paramount. Paramount stock is down 4% on
the day. Not much has changed here.
I believe the thesis for investing in Paramount has not
changed since this acquisition. Now that's it for this episode.
If you like this type of content and you want to see additional
content, you can check out the Patreon membership that also
includes access to qualtrum.com. Other than that, I'll see you
next time.