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Chapter 1: What recent changes are happening in the S&P 500 index?
There's another semiconductor stock headed for the S&P 500. You're listening to Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm Jon Quast, and I'm joined today by contributors Matt Frankel and Rachel Warren. We're going to dip into our mailbag today, not once, but twice. But first, we wanted to start with our lead story, and that is...
About once a quarter, the S&P 500 removes some companies from the index and adds other companies. This is an index that tracks roughly 500 of the largest, most profitable U.S.-based companies. There are some times where a company gets acquired or something like that, and then another company is added in between the regular rebalancings.
But we had this regular one, and Poolstock and Campbell Soup Company are out. As a shareholder of Pool and a lover of Goldfish crackers, I'm disappointed with that.
Chapter 2: What is Marvell Technology and why is it significant?
But we have a couple new ones heading in, and that is Marvell and also Flex. And so while the indexing itself isn't really something material that we foolish investors really base an investment thesis on, sometimes it is fun to bring a new stock to our attention as they get added to the large index here. And so we thought it would be fun in this episode to talk about these.
And I'm going to start here with Rachel. We want to talk about Marvell going into the index and Basically, my question here for Rachel is, what is Marvell? What does it do? And what is so interesting about the timing here is NVIDIA CEO Jensen Wang says he believes that this can be a $1 trillion company someday. So I want you to speak to that as well, Rachel.
Yeah, I do think that this could very much qualify under the moniker of a hidden gem. So Marvell Technology, for anyone who's not familiar, this is a data infrastructure powerhouse. They specialize in the high-speed optical interconnect chips and custom AI silicon that's really essential in today's day and age for transmitting data across massive server clusters.
As you noted, John, Jensen Huang recently declared Marvell the next trillion dollar company. And he said this because as AI models scale, computing has to be distributed across an entire data center. So this makes Marvell's high bandwidth connectivity a key solution to the industry's biggest physical bottleneck, which is data movement.
Now, you might be thinking a $1 trillion milestone sounds outrageous for a company that's currently valued in the $200 billion market cap range. But I think that Huang's prediction is actually a reasonable long-term thesis. It's also backed by NVIDIA's own $2 billion equity stake in Marvell. That's something that's very important to note as well.
But Marvell's path to $1 trillion, there's a few key drivers here. There's the massive dual-engine revenue expansion. Hyperscalers are using Marvell to design custom AI chips. That's a business that's projected to cross $10 billion in revenue by the company's fiscal 2029.
The optical business is growing at a 70% plus growth rate, and that's as they're linking distributed GPU clusters at the speed of light. So if Marvell stains this very robust growth trajectory in the mid-double digits, if they're able to hit that estimated $50 billion in revenue, $25 billion in EBITDA by 2031.
You could be looking at a premium of about 40 AI infrastructure multiple, but I think that you could see where there is a mathematical justification for that trillion dollar valuation. Obviously, this addition to the S&P 500 It triggers mandatory index fund buying. And I think it also cements its role in global AI architecture.
So it will be interesting to see whether the company hits this $1 trillion milestone. Whether it does or not, I think we are very much looking at a company that is playing an indispensable role in the AI infrastructure build out. And I think that's a very exciting thing to watch.
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Chapter 3: Could Marvell Technology become a trillion-dollar company?
It's a highly profitable business. It's grown its earnings at a double-digit rate for the past six years in a row. And management expects acceleration because of this AI data center part of their business in the current fiscal year, which their fiscal year runs through March. 18% revenue growth, 32% earnings per share growth is what's expected right now.
The most interesting development that I think could make this a hidden gem investment is that Flex is spinning off its cloud and power infrastructure business, the most exciting part of it. The other part of Flex's business is just electronics manufacturing, very low margin, very predictable single digit revenue growth over time. So the rapidly growing part is spinning out.
So is it a hidden gem? Maybe. The stock has more than tripled already over the past year. The forced index buying, which Rachel correctly referred to with Marvell, could give it a nice little short-term lift. But it's not going to be a long-term catalyst. The stock trades for about 35 times forward earnings. And like I said, historically, it's a low margin, modest growth business.
The spinoff is the wild card. That AI infrastructure business could command a very high multiple as a standalone business. They're expecting that part to grow by 65, 70% this year. We've seen some much crazier valuations than 35 times earnings for businesses that go into that category. Still, as it is now, it seems a little expensive for new buyers, and I probably wouldn't buy at these levels.
But if we saw the 20%, 30% pullback that we've seen in other similar businesses, I might become very interested in this.
Well, and thanks for pointing out that spinoff, because one of the things that we do look for in a hidden gem, a potential hidden gem, is something that's misunderstood by the market. And certainly a spinoff can be something that is misunderstood when you're trying to calculate that value.
However, you're alluding to the fact that perhaps you believe that this stock is overvalued going into it, and that may diminish some return potential here. So, Rachel, I want you to agree or disagree with Matt's premise here of flex stock being... Slightly overvalued, overvalued. What do you think?
I think it's possible that it's overvalued, but I think what might justify that valuation as we move forward is how the business is fitting itself into the reality of where the economy is heading. You know, it had been this kind of low margin contract manufacturer that just built electronics for other brands.
They've been really transforming and trying to rebrand themselves into this very sophisticated engineering partner for the mega cap industry. tech giants and become one of those companies that is one of the more indispensable backbones of the AI boom. I think it will be very interesting to see if and how that spinoff occurs.
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