Big tech stocks have driven the markets to record highs, but with plenty of concerns about whether the run can continue, what are we hearing from the companies? Evan Chen, Associate, Portfolio Research with TD Asset Management discusses with MoneyTalk’s Greg Bonnell.

Transcript

Greg Bonnell – The big tech names have been driving the markets to new highs, but with plenty of concerns about whether the run can continue. What are we actually hearing from those tech companies? Joining us now to discuss is Evan Chen, associate for Portfolio Research with TD Asset Management. Welcome back to the show, Evan.

Evan Chen – Thanks, I feel like it’s a regular appearance now.

Greg Bonnell – Let’s get you on here on a regular basis. Of course, technology has been a hot topic for investors. We are seeing a bit of caution. We know there’s some big stakes with Nvidia (NVDA). But earnings so far– we’ve heard from the other big tech names. What are they telling us?

Evan Chen – Yeah, so you ever have a tough boss, one that you can never do well by? You can never seem to please you can never do well by. Well, imagine this. Your coworkers submit a report a day early. And your boss says, why not two days early? Your other coworker says, I automated this task that’s taking up an hour of our time.

And your boss says, why didn’t you do it earlier? But not you. You’re the best employee they’ve ever had. You put your head down. You work hard, and you do it all. So I want to liken those first two employees to Google (GOOGL, GOOG) and Microsoft (MSFT, MSFT:CA), and you are Meta (META, META:CA).

So let’s dive into the earnings. Google earnings were good. They beat expectations everywhere, except for YouTube. Margins were also near all-time highs, and they managed to cut headcount for the second quarter in a row. So what did that get them? A minus 6% day as we had worries over YouTube and margin compression in the second half.

Microsoft earnings were good as well. They beat expectations everywhere, except in the core segment of Azure, the cloud platform. So growth was 30% instead of the expected 31.5%. So what’d that get them? Minus 7%, which mostly recovered the next day. But it just goes to show you how skittish the market was.

Now, finally, Meta. Meta earnings were very good. They beat expectations everywhere, driven by upside and ad pricing as advertisers saw more returns on spend. On the call, Mark mostly spent his time outlining his AI strategy and some tangible examples there. The stock was up 8% the next day and has continued since.

Let’s go over the financials now. So all three companies are growing earnings at around 15%, 50% higher than the S&P 500. Margins are strong. We continue to see operating leverage. However, margin expansion is probably at its end as we get higher charges from the capex coming into the income statement from the spending. So all this still leads to double-digit earnings growth at around a market multiple, so still pretty attractive.

Greg Bonnell – When you were talking about Meta there and Mark Zuckerberg talking about AI, you used the word that stood out for me, tangible benefits. Is this what’s becoming key now as we go through these companies and say– everyone likes to throw the phrase around– are you tangibly finding a way to capitalize on this opportunity?

Evan Chen – Yeah, so the big theme of the quarter, I think, was the debate around AI-related spend and capex. So last time I was on the show, we were seeing that capex, for the hyperscalers, was increasing 30% to 40% this year. And early estimates of next year are around the same. So that’s a lot of money, maybe $200 billion. It can buy a lot of things. And what is it actually getting you?

So Google and Meta, and even Microsoft, have come out saying that the risk of underinvestment is greater than the risk of overinvestment when it comes to AI. So investors got kind of spooked by that, and they got spooked by that because they took that statement to mean that we’ve over invested and we don’t have returns. So that’s pretty scary.

I would take the opposite side of this argument. I think we’re beginning to see AI-related returns in cloud on the hyperscalers and engagement in Meta. So the cycle from money into the ground, capex, to revenue will take at least 18 to 24 months. These data centers don’t appear overnight. It takes a long time.

They’re physically capped. So you got to build them. You got to put everything in. You got to test them, all of that for them to come on. So we haven’t seen a lot of returns yet because they’re still building the thing that will get the returns.

Greg Bonnell – So people will ask of the run that we’ve seen in the markets and in tech if they had missed the boat. It sounds like you’re setting up an argument saying, it’s still an interesting time to look into the space because we’re in the early innings.

Evan Chen – Yeah, I have some examples, too, of how AI is relating to some of these companies. So the first is a lot of the features around AI for consumer-facing and B2B are just better summarization and search. That’s not super exciting, but it’s a start. And I think it’s going to broaden over time.

So, to put some numbers behind it, Microsoft– the run rate in Azure for AI-related benefits is maybe $3.9 billion. That’s not nothing. Amazon has said they have multi-billion-dollar Cloud AI-related benefits. Same with Google, multi-billion-dollar AI-related benefits in their cloud platform. And Copilot is at a $1.2 billion run rate. So it’s still early days, but we’re beginning to see billions of dollars sloshing around with some of this spending.

The second is that, while you may not have these consumer-facing products that are really obviously, like, wow, it’s doing everything for me–

Greg Bonnell – The killer app, right?

Evan Chen – Yeah, the killer app.

Greg Bonnell – Search has been around forever. I want my search to be better. But where’s the killer app?

Evan Chen – Where’s the killer app? But I think you’re seeing in small fits and starts. So among Fortune 500 companies, a lot of them on the calls are saying that they are seeing tangible benefits from AI. So, for example, Amazon (AMZN, AMZN:CA) has said that AI has saved them, I think, 4,500 developer years in work. So that’s a lot of years, $260 million annualized.

Microsoft has said that they’ve saved hundreds of millions of dollars in customer support using AI. And Goldman Sachs (GS), a bank, has said that developer efficiency has increased by at least 20% using Microsoft Copilot. So these are benefits that exist, and we’re just at the start. I think the technology is just going to get better.

Greg Bonnell – When I think of the stage were at right now, I think of data centers, right? These processors to do the heavy lifting, the heavy thinking. There is an interest in the space. How is it looking?

Evan Chen – Yeah, so that trade has rolled off a little bit since the last time we’ve come on. It’s actually funny. We came on maybe at the peak of that, and it’s come down a little bit. So we have Nvidia tomorrow. We’re going to see what they say. But I think just these stocks are taking a breather.

Some of them are up more than 100%, so 20% drawdown. I’m not too worried. I think that long-term trend is still there. And I think we’re going to see more data centers being built out just because the risk of underinvestment is greater than the risk of– sorry, the risk of underinvestment is greater than the risk of overinvestment, like these companies have said. So they’re not going to pull back, I don’t think so, anytime soon.

Greg Bonnell – The last time you were on, too, I think we were talking about the fact, with all the spotlight on the hardware plays, the data centers, the brains to run AI, some of the software plays have been overlooked. What’s that space looking like?

Evan Chen – Yeah, so the stocks have been underperforming in software, so only up 6.5% year to date, which is underperforming the broader market. But are these businesses really impaired? I would argue, no. I think this is an interesting time to look at some of the software.

Growth hasn’t fallen off a cliff. So growth has decelerated for sure. In 2021, things were growing 30-plus percent on the top line. Now, maybe one or two companies are doing that, but it’s not like they’re going into negative comms. You still have double-digit growth numbers.

We had a little bit of a head fake in Q1, coming off of strong numbers at the end of last year. But a lot of the stocks with unique stories were better than expected and have performed as such. So while there are fears in the market, there’s obviously still demand in certain spots that are attractive. Companies such as ServiceNow, SAP, these companies have unique value propositions. And they’re still doing well.

Greg Bonnell – If we put it all together, you get investors thinking about the technology space. They’ve seen a nice run. They’re thinking about the path forward. What do they need to keep in mind?

Evan Chen – I think valuation is something to keep in mind. It’s kind of boring. But what I would say now is that valuation is fair for a lot of these internet giants. You’re not paying too much more than a market multiple for some of these stocks that are growing 50% higher. So that sounds pretty attractive to me.

But of course, you need to be aware that you’re on this AI trend. You could spend too much and eat up all your profits. So it’s a balance there. But I think we’re in an OK spot to have some pretty good forward returns.

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