Chip Design and Software Development Integration – 2 Top Stocks to Watch Right Now (AVGO & CRWD)

Chip Design and Software Development Integration – 2 Top Stocks to Watch Right Now (AVGO & CRWD)

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So this is a fantastic business. Just because this is a big business doesn't mean growth oriented investors, should ignore Mega Cap. We're in a new era. Mega Cap can most definitely outperform and provide you market beating returns. I think we can all relate to this.

We're paying for 20 different video subscription services. Wouldn't it be great if we just all had cable again? I don't know. Today we're going to be talking about Broadcom's most recent earnings, and also going to follow up on our promise of CrowdStrike, another cybersecurity company that we own. So I'm just going to start with Broadcom's most recent numbers for Q three, fiscal year 2023.

Net revenue was $8.8 billion, up 5% year over year. Earnings per share, $7 and 74 cents, which is up 8% year over year. And their free cash flow $4.6 billion, which is up 7% year over year. Nick, Let's talk a little bit about their financials before we dive into some other details. So I, I think the big thing to take away here, first and foremost Kasey, is those free cash flow profit margins.

So profitability by every metric continued to increase at a faster rate than revenue. Many people may look at Broadcom. It's a giant, it's one of the largest semiconductor businesses on the planet as measured by revenue. Surely there is no profit margin expansion potential left in this business.

But somehow, C E O Hock Tan continues to find a way to do so. Free cashflow profit margins were 51.8% last quarter. Last year we were talking about, 49, 50% free cash flow margins. We're now approaching 52% free cash flow margins. That's ridiculous. Kasey, this company it's like a free cash flow volcano in Hawaii, and it just the volcano just never stops spewing out lava.

This is a stupid illustration. I don't know where I came up with this on the fly. You get the idea here though Broadcom is the cash generating machine that never stops giving. Okay, I'm gonna shut up now. Kasey, maybe walk us through some of the broad segments of Broadcom. Man, I, where am I coming up with this nonsense this morning? It must be Tuesday morning after a long holiday weekend.

I feel like one of us needs less coffee and maybe one of us needs more coffee. We'll show you a table here that we put together of Broadcom's sales segments, and you can see in Q three networking had a 20% year over year growth, $2.8 billion, wireless, storage connectivity, broadband, all relatively flat. Broadband was up 1%, industrial, down 3% at 236 million. Infrastructure software, up 5%, 1.9 billion, and what's impressive

about these numbers is Broadcom has actually orchestrated what everyone likes to call a soft landing . Most of the industry has had year over year decline, but Broadcom has remained relatively flat, which is actually very impressive in this current market. But what we're going to focus on is this networking. How in the world did they get 20% year over year growth in this segment? And they expect another 20% year over year growth in the fourth quarter. Yeah, Kasey it is really impressive even when you strip out the key component of the networking business that we'll talk about here in just a second.

The company overall revenue was flat year over year. And remember we just talked about Marvell technology last week, if you missed that video, check that out. Marvell, we like to call baby Broadcom in year over year decline it in am, mid-teens percentage as far as revenue goes. And whereas Broadcom is still absolutely gushing cash, Marvell losing money by most profit metrics free cash flow, basically nil at the moment. So Broadcom clobbering the competition.

Even though the growth maybe looks pretty pedestrian, when you talk about everybody else being in year over year decline, this is fantastic. This is why Broadcom stock has outperformed the market and most of its peers so far this year because uh, investors have have caught wind of what's going on. What Hock Tan and Company have pieced together here is an absolute semiconductor monster. And as far as it looks for Q four, fiscal 2023, this quarter that we're currently in, that ends in October, they're going to continue to outperform the competition.

So this is a fantastic business. Just because this is a big business doesn't mean growth oriented investors, should ignore Mega Cap. We're in a new era. Mega Cap can most definitely outperform and provide you market beating returns.

Networking of course relates to the current buzzword, all the rage, AI. So how is Broadcom using AI in their business model, and how will that help propel growth going forward? Yeah, I think many investors talking heads, the pundits out there will tell you that Broadcom is riding NVIDIA's coattails here, and maybe to a certain extent that is true. So NVIDIA's selling lots of their G P U powered systems, but the networking chips are you can't just say it's all the G P U it's not just NVIDIA's GPUs doing the work here.

Whenever you have chips that are able to compute massive amounts of information to help train AI algorithms you also have to have a networking chip that is up to the task of moving all of that information. For example, from storage, from memory, to the G P U for computing. And then, back again or maybe deploying it to the end user, the customer. So networking it's not really just a case of Broadcom riding NVIDIA's coattails, these networking chips that Broadcom designs are best in class. They have a lot of what's called merchant silicon.

That's mass designed and mass produced chips that customers can buy off the shelf. They're high performance, they're ready to go. They work very well with NVIDIA's GPUs, and then they also have this custom silicon, segment.

And in particular, what Broadcom has been doing, there's been mention for many quarters now of this one customer in particular using Broadcom networking and compute chips for what's called computing offload. So maybe you have your general purpose cloud computing workload, but then you have built within that, like this application specific segment that's addressing Ai. And so the network will take the AI workload and divert it to this specialized hardware. We don't know who that is, it's a hyperscaler, so it's probably, Google Cloud, it might be Meta a k, a, Facebook, Instagram, WhatsApp. It could be Microsoft, Amazon A W S, we're not sure.

But the point here is AI networking is what's making hay for Broadcom right now, keeping the company in actual growth mode. When you strip that AI away, the business overall is basically flat. But AI a growth segment here, and that is actually going to continue well into calendar year 2024. As the rest of Broadcom's business maybe heats up again, plus this AI growth trend going on, it looks like Broadcom probably going to remain a strong business growth story well into 2024 and beyond. Two of the chips that Broadcom designs and manufactures that facilitate this AI work are the Tomahawk five, which is a switch, and the Jericho 3AI, which is a router, and this is of course a very broad category, switches and routers, Nick, so maybe you could tell us a little bit more about what these two chips actually do. Okay, so Kasey, let's use the illustration that we, like to use every time we talk about networking and think of it as a highway and freeway system.

So a switch connects different servers within a data center to each other. So maybe you have all of these Nvidia G P U powered servers like let's say H one hundreds, A switch connects clusters of those GPUs together. So that's what a switch does. It connects different servers within a data center.

That would be like the Tomahawk Five switch chip that they design. And then a router connects different networks together. So maybe it's different networks of G P U clusters within the data center. Maybe it's different data centers to other data centers.

That's what a router does that facilitates the coordination of different networks. So to use our illustration of the highway and freeway system, the switches like the Tomahawk Five switch, think of those as like the on-ramps to the highway or the freeway where cars enter the system. And then the routers are maybe the freeway interchanges where you're, you have those big loops that maybe take you from one freeway to the next freeway. That's roughly what a router does. And as the amount of data continues to increase, because these AI workloads are so big, not just the training, but also eventually the inference, once the AI algorithm is being put into use, tons of data flowing.

So you need to widen the lanes. You need to increase the speed limit in those lanes. And these switches and these routers are ultra high performance and helping facilitate more data at faster rates.

Let's talk about VMware. Broadcom has made a move to acquire this company, and the deal is supposed to close by the end of October. We'll see if that happens, That remains to be seen, but that is the plan pending, approval by a couple more countries. VMware is maybe not a company that you're familiar with, but it's actually very important to the cloud computing industry.

Of course, we talk a lot about data centers here at Chip Stock Investor, and those data centers can be either public or private where data is stored and VMware designs the software and hardware architecture that companies use to house and access their data via the cloud. We'll link an article about NVIDIA's partnership with VMware in the description, so check that out. So Kasey, we talk a lot about the need for tighter integration of hardware design and software development. In fact, the very first introductory video that we did for Chip Stock Investor in September, 2022, this was one of the key pillars driving the next bull market.

That's what we believed. So given this Broadcom, it looks like the VMware acquisition is going to go through, it's gonna be finalized here within the next month and a half, two months. What do you think? Broadcom is going to be 50% chip stock, 50% cloud software stock. Just given that information, is this like the ultimate chip stock to own for the next decade? It's looking that way. Isn't. It.

I think it's interesting just briefly to. To lightly touch on valuation here. So when the deal was announced last year, Broadcom said it was gonna be roughly half cash, half stock. VMware's now valued at 72 billion, and much of that is based on you, the stock part of that, valuation. So based on Broadcom's current stock price right now of roughly 850 bucks per share, each VMware shareholder can elect to get 0.252 shares of Broadcom stock for every

share of VMware that they own. So that's roughly $220 worth, of Broadcom stock, for every one share of VMware, I think a lot of shareholders will elect to take the stock. I think over the cash component, so that values VMware basically at over $70 billion. You might think wow, Broadcom way overpaying for this business , but I'll mention here, at the time that they announced this, they said over time they were targeting about 8.5 billion in annual, EBITDA earnings before interest,

tax, depreciation, and amortization. So this is an operating metric basically cash that Broadcom thinks it can squeeze out of VMware over time from this acquisition by basically folding VMware into the existing infrastructure software component that they already have, which was also made and built via acquisition over the last five to 10 years. Based on the price right now 70 billion valuation for VMware. This is a less than 10 year payback for Broadcom. That's pretty good in, in corporate finance when you're looking at places to allocate capital, if you think you're gonna get paid back in less than a decade, maybe eight years, based on, what the numbers look like right now.

I'm sure we're probably gonna get some updates on this. When the merger is finalized and as the integration of the two companies begins late this year and starting in 2024. It maybe it'll get even better than that, but this is a great payback period.

Broadcom overpaying for VMware, I don't think is a risk. I think Broadcom is getting a fantastic deal here and Hock Tan sort of a private equity guy with a great financial background. Has an awesome track record of making these business acquisitions and integrations and boosting the cash payout. Broadcom's, basically a chip, and now cloud software, private equity fund.

We already mentioned the 51, almost 52% free cash flow margin. This is just a fantastic business. Maybe not the highest growing business out there, but tons of cash, a shareholder friendly business, and the company continues to find ways to boost those profit margins.

Valuation right now on Broadcom stock, it's not exactly cheap. About 26, 27 times trailing 12 month earnings is the current valuation on Broadcom stock, about 21 times, trailing 12 month free cash flow. It was ridiculously cheap last autumn, so that value trade is gone. But if you're looking at something to own for the next decade, this is a pretty rock solid business.

Not one that we're inclined to add to right now. We already have a full position in Broadcom and have had a full position in it for quite some time. But if you're looking for a chip stock to own for the next decade, don't overlook Broadcom just because the business is already huge. Let's move on to cybersecurity company CrowdStrike and I will run through the numbers here for second quarter fiscal year 2024 for CrowdStrike total revenue 731.6 million, which was a 37% year over year increase. GAAP loss from operations.

15.4 million compared to 48.3 million last year. And free cash flow, 188.7 million compared to 135.8 million last year. Yeah, Kasey not a cheap cybersecurity stock. It trades for about 48 times. Times free cash flow based on a share price of $160 per share, just as of this recording on September 5th. Again, not cheap, but remember, bear in mind, cloud stocks in a bit of a slump this year is a lot of customers optimize their spend.

Basically, they're looking for ways to cut costs. And conserve cash. So that has throttled growth for a lot of cloud-based software companies, including CrowdStrike, but still growing close to 40%. Still expected to continue growing at well north of 30%.

And those profit margins, especially free cash flow, profit margins are still scaling up. Very rapidly. So premium price stock, but for very good reason. This is one that we we actually started purchasing very shortly after the I p O kind of broke my rule of waiting at least a year before buying an I P O stock with this one back in 2019. But it's paid off very well, and it's one that we continue to warm up to and think is actually a pretty good ad right now. Especially if you're looking for stocks to dollar cost average into over time.

Let's talk about why we think that this is a software as a service cloud-based stock that can continue to outperform over the next decade. And a lot of that has to do with Ai, right? The other factor that really has CrowdStrike well positioned is the tight integration between software and hardware. And Nick, we've been talking about this a lot lately because , this is what we believe to be a growth driver for the semiconductor industry and the technology industry as a whole in the coming years. So how does CrowdStrike integrate these two things so well? Let's link up a blog article that CrowdStrike wrote and released back in 2022 and some of this information obviously not updated for the latest and greatest semiconductors available on the market, but I think it still illustrates what's been going on here because as we said last year, Kasey, the cookie cutter out of the box, ready to go, software is a service, subscription model got tapped out, let's say about 2021 is when it got tapped out. Businesses migrated a lot of their workloads over to the cloud using some of this cookie cutter software services. But now we're talking about more complex IT workloads and if they want to bring those into the cloud, they're going to need a different breed of software.

Something that is, Kasey, like you just mentioned, and what we talked about with Broadcom was tighter integration with the actual hardware design and construction. Integrated very deeply with the actual software development. So here's this blog where they basically talk about their AI machine learning model training and how that's evolved very quickly. So I'll just run through a couple of tables here. They just show just one model training so maybe just to get you up to speed here, what CrowdStrike does, they have these different modules.

They started with endpoint security that's basically software security that resides on your laptop, on your smartphone or something like that. This just one single model that helps them detect data breaches and anomalies using just a MacBook Pro laptop, with 1.9 million text files took 227 hours of total training time. Now you take that very basic off the shelf piece of hardware, and now you upgrade it with some, purpose design software, used to help speed up the AI training process.

Now, speeds up the training time to 162 hours. Now let's take some G P U enabled model training with Nvidia V 100 tensor core GPUs using A W s Amazon Web Services E C two Instances. These were actually announced all the way back in 2017, so this is not new hardware, but even using these GPUs that are, six years old now at this point, you can see the acceleration here, 44 hours of total training time for one machine learning dataset. Now you take some more software optimization and apply that to those GPUs, and now the training time becomes as little as six hours. What's happening here now with the introduction of these GPUs is you're not just training one model at a time.

So not only are you cranking out these models every few minutes, you're cranking out multiple models in parallel with each other every few minutes. So you can see the explosion in software performance if you tightly integrate the hardware and the software together. So you get these very sophisticated pieces of software, you're able to expand your modules.

So CrowdStrike, not just endpoint security anymore they have a full platform for software security, which is like what Palo Alto Networks and Fortinet offer talked about them last week. And you're able to customize this software for very specific customer needs, very complex and very specific customer needs. And so whenever you hear people talking about Ai, this is really what we're talking about here. You need full system design integrated with complex pieces of software to help propel the technology forward and stay ahead of the curve. And cybersecurity is one of those areas where that's really important because you have to stay ahead of the bad guys because they're always looking to crack the code and get in and steal stuff.

So CrowdStrike you can see an ideal business that has figured out and has the resources to integrate the hardware and the software together. We've talked about vendor consolidation with many companies because It's easy to understand that it's a lot easier to pay one subscription service than to multiple companies. I think we can all relate to this.

We're paying for 20 different video subscription services. Wouldn't it be great if we just all had cable again? I don't know. But let's talk about how CrowdStrike is shaping their business, so that it can provide this consolidation. Traditionally, they have been an endpoint security company, but you can see from this visual that they provided, they are adding on more and more modules so that they can provide a full service security company. Yeah, traditionally endpoint security, but they've branched into cloud or let's call it network security, which within this also encompasses app application level security, building the security directly into the software as it's being developed.

So this is a place where Palo Alto Networks plays. They bought that company Cider Security early this year, synopsis the e D A company chip design software company also has a segment devoted to this as well. So like you said, fully fledged platform here spanning not just the endpoint, but also the cloud identity protection you name it. You said it it's not a great situation when you have to pay all these different vendors. If you can consolidate the security service you need with one company, it makes your operations easier to deal with, easier to handle and saves you money.

Vendor consolidation, you're gonna hear a lot more of this from Palo Alto Networks, from Fortinet, from CrowdStrike via the three emergent leaders, in the cybersecurity space, and we think the era of AI is upon us and that really actually helps support vendor consolidation in the next decade. So Kasey, what do you think? CrowdStrike. Is it a buy, hold, or sell for us right now? So as you mentioned earlier, Nick valuation 48 times, trailing 12 month free cash flow, growing at nearly, almost 40% year over year for revenue, I think it's the stock that we could continue to nibble on.

What do you think? I agree. Kasey. Earlier this year I was still a bit skeptical of a lot of smaller cybersecurity companies like this, but CrowdStrike seems to have gotten a handle on its expenses. Free cashflow is ballooning.

It had even faster pace than the revenue growth. Yes, it's an expensive stock, and so therefore you're going to get some wild swings and stock price as a result. So as we've said in the past, companies like this, yes, they're expensive, but if you see a path for continual growth over the next decade, stick this on your dollar cost average list. That's how we handle this. This is one that we currently, even now basically full position for us.

It's one that we nibble on about twice a year. Okay, that's a wrap here for this episode. Broadcom. CrowdStrike, we are going to talk about Dynatrace, we've been getting some comments and questions about that company, and Nick has been a investor in this company, Dynatrace, for quite some time.

So we'll discuss that later this week. And then we have to do something I really don't wanna do. We have to talk about the arm holding I P O, so , we'll make sure we have that out to you and our thoughts on that company later this week.

Whether you like it or not, We're gonna tell you about it, so make sure you hit the subscribe button. We're still trying to reach 10,000 subs. We made really great progress this weekend, but please if you can subscribe to the channel, share our channel with other investors, and if you feel like it, you can leave us a tip on Kofi. Link is in the description and in the comments.

Hope you all have a great rest of your day. See you soon.

2023-09-12 15:31

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