We’ve Seen This Movie Before

This week brought NVDA earnings, which again showed phenomenal growth in sales and earnings, with similarly impressive margins, all attributed to the global scramble to gain position in the AI movement. This has been driven in large part by the large hyperscalers (AMZN, MSFT, AAPL, GOO and TSLA) ordering massive amounts of chips from NVDA. Yet with the earnings release came a decline in the stock from the $129 area to close at $119.37 on Friday.

Why? As a discounting mechanism for future growth, the market seems to be sending a message that the price of the stock is fully reflective of the expected growth as well as reflecting a concern about the potential for disappointment in both the outsized growth and the astronomical profit margins.

Marc Weiss, CIO of Open Field Capital, and the co-portfolio manager on the Palumbo Emerging Growth Portfolio, has seen a similar movie play out in technology investing. Marc, unlike many of his peers today, was around in technology money management during the 1990’s when Cisco (CSCO), the major hardware play on the rapid growth of the Internet, rocked the tech world.

He explains: “As major technology changes come in, the infrastructure hardware providers are the first focus. But in the end, the focus shifts to the software providers, who put the apps together to take advantage of the new hardware.”

He feels the hardware represented by NVDA maybe has been overdone here, and that the explosive growth in ongoing revenue and growth will begin to shift to the software and app providers. At this point, while NVDA has ushered in the AI hardware capability first, now much smaller follow-on hardware competitors are arriving at substantively lower valuations to offer cost-effective alternatives.

After the CSCO boom, an example of the start-up hardware company was Arista Networks (ANET), a start-up that came in following CSCO with a new and better network structure and has enabled Arista to generate substantive investment value for investors since their introduction.

Cisco from the beginning has grown nicely, but the big valuation bump in the late 1990’s was the result of drawing investors in as the marketplace rushed to CSCO network tools.  But the stock price was way ahead of itself.  The company grew, but the stock price during that bump was substantially over valued in hindsight. While we are not predicting anything similar to the CSCO experience for NVDA, we feel it is prudent for investors to review their exposures, remain nimble and be prepared to diversify their AI investment exposures.

Fast forward to 2022-2024. AI, like the Internet, becomes the next wave in technology! To get the AI wave going, the biggest players need the hardware. The Magnificent 7 are seeing this AI wave, and they jump on accumulating the hardware infrastructure NOW! And they all see the massive size of the future game, and they all want to be (and feel they need to be) in it, NOW! The hyperscalers see underspending as a risk to their future market position. What happened? The hyperscalers controlled much of the production, drove up the prices of GPUs and placed them on allocation. Now it appears the shortage is being alleviated, partially by new production and by upstart competition.

NVIDIA Investors: Prepare to Be More Nimble

What is the next phase in the AI Wave? In Marc Weiss’ opinion, using his deep experience in the mid-to late 1990s, it is the application/software/service providers, who map their tools to the new hardware, and the upstart hardware providers who have created better products that improve the cost-effectiveness and performance of the new AI infrastructure hardware.

This shift in focus from only AI hardware investments to a much broader list of software players could have significant ramifications over time. After such significant dominance, we believe investors with significant tech exposure should continue to monitor NVDA, as part of the MAG 7, and the entire MAG 7 concentration within the indices and portfolios should be reviewed and watched carefully.

If, in fact, the market performance across the technology sector broadens from the Mag 7, and the extreme focus on NVDA begins to broaden out, we feel these investors should at a minimum review their portfolio and their sector and individual stock exposure to reflect a possible change in expectations.

Some analysts following the NVDA call expressed disappointment about the NVDA CEO avoiding clear answers regarding both what the customer’s ROI was along with any specific mention of any potentially formidable competition surfacing. Offered as questions during the earnings call, it appeared to listeners that the answers might have been evasive. One AI analysis service monitoring the call confirmed the answers were defensive in nature.

In fact, viable competition to NVDA is beginning to surface in both AI training as well as AI inference. However, the emerging competition is made up of small private companies, and thus less well known. While small relative to NVIDIA, they are beginning to get traction with AI users, and as a group could possibly serve to lower NVIDIA’s growth rates and profit margins going forward.

Investors Should Review their Tech Portfolio Exposures

At Palumbo, we see great investment potential surfacing across both emerging opportunities in technology and biotechnology over the next decade. To help our clients participate in these emerging technologies, earlier this year we developed the Palumbo Emerging Growth Portfolio, a portfolio of publicly listed technology and biotechnology-focused companies. The objective of the portfolio is to provide clients’ access to a more direct investment exposure to these innovative and disruptive technologies with the hope of higher growth than the mega-cap companies in both sectors.

Taking a longer-term view, we did not chase the trend to concentrate portfolios around the Mag 7, and as such are not surprised that it may be waning, starting with NVDA. We have full confidence our portfolio exposure and asset allocation will enable our clients to achieve their investment objectives over time and continue to focus on achieving our client’s long-term objectives through diversified investing with long-term holdings.

In summary, we suggest continuing to review portfolio strategy and allocations along with individual exposures in the technology sector. It is fast-moving with continual innovation, and a “set-it and forget it” approach we feel could be sub-optimal. The arrival of the response to the NVDA earnings is of no surprise to us, as we have been commenting about it previously in this column.

Palumbo Wealth Management along with Marc Weiss, CIO of Open Field Capital stand ready to address any questions you may have regarding your portfolio or formulating a strategy to capture the continued unfolding of AI over the next decade.

We look forward to hearing from you with your questions and thoughts.

Philip Palumbo

Founder and CIO

Palumbo Wealth Management

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

 The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

 Past performance is no guarantee of future returns.

Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that the future performance of any specific investment or investment strategy will be profitable.

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By: Adam