People’s Choice Earnings Watch Party: Super Micro Red Flags, Micron’s Lofty Expectations, and More

Hey everybody, welcome in.

Yes, it's the people's choice. I love that, the people's choice earnings watch.

People are very split. We've had a lot of different votes.

Yeah, I don't think there's any multiples that I can see.

Nope.

Who saw the news on Supermicro today.

I see a hand raised.

Who knows what our rating on Supermicro has been for the last couple years? I guess we got a couple hand raises on that already. It's been suspended. Suspended rating. Mostly unattractive or very unattractive, but suspended rating. Anybody know why?

I'll refrain from answering.

Yeah, Kyle, you know the answer. I'll show you why. Weak internal controls. Going back to 2023, we just got a post today from Garrett. Who reminded us back in August of 2023, he noted that there was nondescriptive disclosure today, poor disclosure, and we've been flagging it since. Folks, so I just wanted to bring this one up because I think it's a great example of the kind of diligence we're always doing at New Constructs that you, I don't think you get anyplace else, at least not with this kind of scale. And it's not just diligence. It's not just diligence and footnotes around auditor's warnings and things like that. It's all the work that goes into getting you the truth about profitability and valuation. And I think we can see over time here, yeah, neutral and unattractive, a very short bit at attractive here, I guess, when the stock came way down, but then went right back to neutral. Neutral and unattractive. It's been one of those kind of good-looking companies, profitable, but bad stocks for a long time. So that's, that's what we got on SMCI. All right, I'm going to take One last look at the votes here, and if they're all still 100% split, which it looks like they are, I'm just gonna go— let's just go with whatever one I think is most interesting. Let's go with Micron. There's no real clear consensus. We'll put it in there. All right, so Micron. This one will be a fun one to do a reverse DCF. So the rating's suspended on this guy too because we're about to get a new Q. We think any day now. It looks like it's supposed to come in today. So we'll see a new rating on this. I wonder how much it'll change things. But this is a classic good company, bad stock. Right? Green, yellow, red, red. So it's expensive. And if we're looking through here at the rating elements, you can see economic earnings looking good. Don't like to see the share count going up. But I think all these firms are like in a position where they've got to spend in order to keep up with the AI. Situation. Return on invested capital looking good. Margins, capital turns, free cash flow—we're not—it's not so great. Pretty good one going here, though. That's a good jump in free cash flow as of the first quarter. That's a great jump considering what's been going on the last couple years. So I guess free cash flow may be turning for these guys. That's what it looks like here. And then you can see here. The price-to-economic book value really has taken off. That's a lot of expectations. So let's take a look at a reverse DCF on these guys. So when we model it out based on our default scenario, we're maxing out at around $175 a share. What is that based on? It's based on consensus revenue growth for '56, '17, '15, 12%, 10% for 5 years. And you can see them trailing down over time. Again, we're not looking to predict the future for 100 years, we're just looking to make sure We've got expectations high enough to make sense. But I think margins are a little bit low here. So let's go ahead and knock these margins up to where they are just now. And by the way, those margins look— for a long-term forecast, you got to be pretty aggressive to assume that the margin, this 33% margin, is very sustainable considering that they really haven't done it or maintained something like that for a long time. And then we're going to keep tax rates and incremental working capital about the same. So what we're going to do in this reverse DCF is really quantify what this future has to be. The difference between that blue line and the red line is the future profit growth required to justify the price. So while we can note that results in a big gap between current stock price and no growth value, and the ratio is very high between current stock price and no growth value, that's a little bit ambiguous as to, okay, what are we saying the future of this company has to be? The reverse DCF model that I'm about to share with you will show us exactly what that future has to be. So we can check out the impact of this neutral scenario we put together. And you can see if we just go neutral, we're still only getting to around $220 a share, friends. So let's see here. We got 33. Oh, there's a 26. I didn't get 33 all the way across. All right, but it's clear we got— we need to jack things up a little bit. So why don't we go— or we need to meaningfully improve something in order for the model to generate a price. required to justify in order for the model to generate a price close to the current stock price. So why don't we jack up growth rates? So let's just go 25% for 20— for 5 years, and then we'll go 15%, 15% for 10— for 15 years, and then drop it down to 10%. We'll save that off. And so the idea really was that when we first looked at the decision page, we saw about $175. We bumped the margin up and we got to $220 as a maximum price, but we're at $440. And so we really want to get a better understanding. And by the way, these prices in the past, a lot more reasonable, but we've gone from $122 to $445, $444. So what is it? What does the future have to look like to justify that? And the idea here is that when we show you what that future has to look like, now you're in a much more informed position to determine whether or not you agree with that future. And if you agree with it, then you say— then you would say the stock is fairly valued. If you want to continue to own the stock, then you need to believe in an even better future, because an even better future would be what would be required to justify price appreciation over and above where we are now. Okay, so we jacked up the neutral, and now we're looking at 15 years. So what that's showing us, 15 years of profit growth to justify the price. That's our neutral scenario. So we're getting intersection. That dot is the intersection of the reverse DCF model and the current stock price. So 15 years out, what's that saying? The company's got to grow revenue at 20% compounded annually for 15 years. That's a big number. While also seeing a dramatic improvement in profitability. You can see over the past, we've seen pretty good revenue growth rates. 5-year though is more like 8%. And you can see here return on capital versus cost of capital, barely above breakeven. So let's, let's get some more perspective on this. What does this mean for revenue? So we're gonna go from around $42 billion to $53 billion. $576 billion in the next 15 years. That's a pretty significant improvement. This is hockey stick defined, right? We can do the same thing for NOPAT. What does that look like? Okay. So, this is what it's been since 2011. What's the full history? Yeah, this is the full history. And then when we look at the implied future for NOPAT, pretty cool, right? This is what the company's done in the past. This is what the stock price says it has to do in the future. Do you believe that? Let's look at this in terms of free cash flow. Historical. Wow. Looks a lot like Notepad. Future return on invested capital. Historical. They all look the same. Future. Just straight line up. So one of the things I would say here that is particularly notable, and we're not able to totally show it, but I can show it right now, is that in terms of the extraordinarily high expectations here, is that it's one thing to see return on invested capital go up this fast. It's another thing to see return on invested capital and revenue go up at the same time. You're going to have dramatic increase in growth, dramatic increase in profitability at the same time, maintained for 15 years at a breakneck pace. And that's why it's— we get a market implied growth appreciation period of 15 years to justify $444. But that embeds a really seriously optimistic future. Who on the call today would say you think that the company is going to do better than that? Does— I'd love to get some feedback here in the chat. Does this seem like reasonable to you that the company would do this? You think they can do way better than that? What are your thoughts? Anybody have any thoughts they want to share? My opinion is that's a really high level of expectations. Coming back to this analogy here, this picture of what the difference between the current stock price is and the no-growth value. In order for the stock price to fundamentally be equal to what the stock price is, the fundamental value to equal that, the company has to achieve This future that we talked about. So what does that make you guys think? Any comments? I'm going to just leave that there and say it's pretty obvious that this is a really expensive stock, and I'd have a really hard time fundamentally owning it and expecting the future cash flows to really be any better than what the market already implies. If that's not 100% clear. Please let me know. Another great point here from James on the chat is that let's say the more we do believe they can do that. Now, everyone else in the world can see that too, and that's going to attract a lot of competition. Oh my gosh, you can grow. Let's see, what's the number here? I'm going to go to the DCF model and we're going to get for the neutral scenario. We're going to look up. And year 15, the CAGR for NOPAT. So, the profit CAGR, 22% compounded annually for 15 years. So, you don't think other people in the world are going to say, whoa, that's an opportunity. I want some of that. And by the way, I'll be happy with 15% growth. So, I'll charge a little bit less. And the next guy comes along and says, you know what? I'd be happy with 12%. I'll charge a little bit less. And it competes it away. Great point, James. That level of growth and profitability would attract a lot of competition, making it even more difficult for any one company to accomplish it. Do I know of any companies that had 15 years of that growth and profitability? Kyle has done some research before, and we have a link in some of our reports that point out that level of profitability and growth is extremely rare and has occurred very few times in the history of the world. I think amongst big companies, the only ones that have done stuff like that are maybe Google and maybe Microsoft. But you're right, very rare in the history of the world for all those reasons. Great questions, great comments. Yeah, you don't get to have this valuation and opportunity to grow for free. We live in a competitive world. If someone sees that big of a pot of gold out there for any particular business, they're not going to just say, oh, You have it. Remember that? Remember that scene in Trading Places when Dan Aykroyd's hanging out with his fiancée and, and the butler brings them the, what's that? Bananas Foster. And he spends all this time making it. And Dan Aykroyd just tells the butler, you have it. Anyway, that's not what companies do. They see a big pot of gold, potential profits, they're going after it. So they're not going to let Micron have that for free. All right, let's take another look. Moats get attacked when they are so sweet. No, exactly. When they're— that's why when they're full of that much, that much gold, they will absolutely get attacked. All right, I'm going to take another quick look at the votes and see if we've got any duplication here. Gotta move this. Nope. That's interesting. I'm seeing a little bit more on the form than I am on— what's going on here? Not many votes, folks. So you get in there, you could potentially move the needle. All right, I'm gonna go with another country, another more interesting stock. Tencent. All right. Now, I think this was— I'm glad we picked this because it's a different story. Good company, good stock. It's cheap. Benefit here, this 0.9% price to economic book value. This means the stock price implies profits will permanently decline. By 10%. So we go from Micron and the super amount of revenue growth required to justify the stock price and profit growth to Tencent, which potentially has its own issues because it's not a US company. And great comparison is a great juxtaposition. So let's do the breakdown here, right? We got good economic earnings. I like seeing shares go down. That's always great. And we got high return on capital, free cash flow from negative to positive. And then we get down here to price to economic book value. And you can see in the beginning, a big gap came down, got right, closer to right. Economic book value is moving up. And now the prices dip below that. So these are the kinds of opportunities we love. at new constructs is where we can find great businesses where the stock price implies profit decline as opposed to a relatively absurd level of profit growth. The market has already given Micron a huge moat. This moat, a 15-year moat with NOPAT growth of 22% compounded annually, that's a really big, thick, beautiful moat. That's a moat That's wide and really deep, whereas Tencent, no moat, zero moat. In fact, it's taken away the castle walls too, because the stock price implies that the company's profits will permanently decline. And so that puts us in a better situation for all kinds of things. Circling back real fast to Supermicro, we've been warning about internal control issues and things like that for a long time. And, and yeah, you can see the stock down a lot. But let's take a look at how Micron Computer has done over the last 5 days, and let's compare that to TME. Wow, Tencent really gotten crushed. So maybe let's see here, we can take a look here and see if When it was a lot higher, 10 cent. Yeah, it was neutral rated until recently. So we were probably seeing something similar. Good company, bad stock where things were expensive. Now that the stock has gotten crushed, it's looking cheap. We can see historical rating here. Tracked it back here, but down to neutral, dangerous, neutral, dangerous, back to neutral. And then as it's fallen enough now, it's gotten. to be attractive again. So depending on what you think about this business, I'm a little bit concerned about companies not located on US soil given the geopolitical tensions. But this is a completely and very different story from Micron. Great comparison. All right, DL, you got to vote in the form. There's a form in the chat that we're taking votes in, and I don't see— but, but even looking at what you voted for, It is not on the list. All right, I'm— my next one is going to go with the person who voted first, Jabil. This was a focus list stock for New Constructs for a while that did really well, and I think we're coming back to good company, bad stock here. Classic sort of layout. A lot of profits but getting expensive. Now the ratio here isn't, I think, quite as steep as it was for Micron, but you're still looking at pretty high expectations. And why don't we open a company model on these guys and do a little bit of reverse DCF on them too? But as we roll through economic and accounting earnings here, it's an interesting example. I wonder if they had a little spike in the stock price around this time and then came back to earth. But you can see economic earnings not falling for the accounting earnings head fake. Shares headed in the right direction. Return on invested capital steady. We'd love to see that. Margin steady, capital turns steady as well. Free cash flow had a really good year here, but came back down to earth. What are we looking at here? A little up and down, but consistently positive. Love to see that. And price-to-economic book value ratio. Look at this. So this is back when the time we liked it. We're like, hey, this is probably when we had it on our focus list. Do we even have—

is that listed in our So if we go to investment summary, yeah, JBL is a case study in discipline to valuation because fundamentals have always looked good, but we closed it, took it off focus list back when it got a little too more— too expensive for our liking.

Yes. Was this the first report? This is the original focus list. We first made it a long idea in April 2019. Since then, the stock is up 173%, and let's We still liked it here in 2023.

Yep. There's a link right above there. We closed it in July of '23.

We don't always let the winners run. We saw great performance and so we were out like around here and it still continued to do really well from there. That said, what is our model showing us? We took it from here to there. It's a no-brainer. And you know what? We're, I think the New Constructs, when it comes to picking stocks, we're like a hustler baseball team. We're not trying to hit home runs all the time. We're getting singles and doubles and triples. We get some home runs every now and then, don't get me wrong, but a lot of singles and doubles and triples and very few strikeouts. That's what we do. And we have the systems to do that. So, we can trust that, you know what, we got a double-triple here on Jabil. That's great. Let's take it. Let's go find something else like that, as opposed to hoping that it's going to have this big valuation run. So, let's take a look. Thank you for coming on that, Kyle. That was great feedback. Let's take a look at what we got to do. We got to see Jabil do. So interesting situation here. Margins really steady. So I don't know if we want to change those. Consensus is what it is, but let's go ahead and jack up consensus. We'll go 15%, 15% for 15 years. Let's see how that does for Jabil. Somebody changed their vote because Micron's not on here anymore. So it looks like votes are changing. No new votes, but votes are changing. I like it. All right. So if we put in 15%, Revenue growth for neutral. All right, it makes a big difference. It gets us there. So that's what we've got to see. Since that's such a wild forecast, let's, let's keep, let's make that the optimistic. This is fun, guys. I love doing this. 15%. But let's say like consensus isn't even 15%. So let's just go 15% for one year and then knock it out to 10% and see what that shows for Jabil. And by the way, this isn't a super sexy business model. This isn't like some Nvidia. This is really more of a blocking and tackling technology company. Okay. So this is going to be fun. We can compare optimistic and neutral. So neutral is when I knocked it down to 10. 10 doesn't even get you there. You really got to crank it out to 15. And so I'm going to be a little bit cute here. Let's see if we, let's, let's see if we, we just knock it, just take this one to 10 and leave the rest the same. How much of a difference that makes. So I think it's because it's really interesting to me. when we do these kinds of analysis to really get a sense of how much sensitivity there is in the valuation and the implied future cash flows to small changes in these long-term forecasts. By the way, I guess it's not really a small change. It's not small compared to people obsessing about a penny here, a penny there, or a percentage here, a percentage there in revenue growth and earnings estimates every quarter. That's part of why I say that those earnings estimates and those quarterly calls are a joke because you're obsessing over What are minuscule elements compared to the big picture for valuation of the business? So let's do default and optimistic again. And you can see, yeah, even if you take that, just that one timeframe that we had 15 going out to— what was it? We knocked it back just one. Instead of going all the way out for 11 to 15 years, we knocked it to 10. So you got 15 compounded annual for 10, and then 10% after that, and big difference. So now you're looking at 7.2% compounded annually for 38 years. That's quite a, quite a jump. It's quite a long time for profit growth. If we were to go through the exercise as we did before and looking at historical, there's revenue, looks pretty good, but it's got to get really good. Same is true for NOPAT historical. It's a good trend. It dwarfs it, right? It's, wow, okay, that's a great trend. We're getting up to like $1.2 billion in profit. It's been flat for several years here. What's the stock price say? Got to climb the mountaintop.

I was looking at revenue past decade, 5% compounded annually to give you reference on what the future might have to be.

Yeah, so we go 26 to 16, and that still looks pretty good. It's a good trend, but then compared to what it's got to do— like, if this is why I say climb the mountain. So anyway, super helpful. This is what reverse DCF analysis is about. This is why this market implied growth appreciation period rating is so valuable, because it's that kind of rigorous level of analysis that goes into it. And really happy to share this reverse DCF stuff with you all today. All right, great. Thank you for making this People's Choice Earnings Watch meeting such a good one. I had a great time being with you, and we will see you around next week or sometime very soon. Have a great weekend.