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Chapter 1: How is artificial intelligence driving growth in big tech?
If you thought the AI boom was ending soon, I have bad news for you. Welcome to Motley Fool Hidden Gems Investing. Welcome in, everybody. My name is Travis Hoey. I'm joined today by Lou Whiteman and John Quast. And as much as I would like to move on from the artificial intelligence story, guys, we have to talk about one of the crazier weeks that I can remember during earnings season.
On one day, we had Alphabet, Microsoft, Amazon, and Meta report earnings, not even just a day, within about a 20-minute span. And John, the numbers were absolutely crazy. Alphabet was the one that stuck out to me. 63% growth in their cloud business. All the other companies are growing at astronomical rates as well.
We've talked about the AI spend, which is getting close to a trillion dollars per year in CapEx. The growth is phenomenal. But are we at this point where it has to be that good to justify these ever larger numbers of capex spend?
Well, I mean, perhaps the most surprising development over the past week is that I am now the most bullish AI person in this room right now. But yeah, the growth is absolutely superb and it is this good, Travis. I mean, we can talk about the money that is actually recorded as generated revenue, but that doesn't tell the whole story.
If you look at the remaining performance obligations, much of which are tied to their cloud businesses and much of that is related to AI spend, you look at Alphabet, Amazon, and Microsoft. The RPO is at $460 billion, $364 billion, and $625 billion, respectively.
So, somewhere around $1.3 trillion. And just to be clear, RPO, remaining performance obligations, is like, Anthropic signs a big contract for compute that would go into RPO. Is that right?
It could be Anthropic, it could be anybody who's going to spend money on the cloud over a certain period of time. The money that you use today, that's generating revenue, but you're going to spend more tomorrow at a locked-in contractual price or whatever. But these three companies, over just the last three months, have added $567 billion to the RPO.
In just the last three months, we're talking about nearly $200 billion a month in spending commitments for the cloud for the three largest cloud companies in the world. We can't comprehend a number such as that.
Yeah, Lou, I generally agree with John. I mean, let's talk top line first. We'll get to some of the ROI things in just a second. But it is incredible to see these companies that are the biggest companies in the world report growth numbers that you would normally associate with much smaller companies operating from much smaller revenue bases.
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Chapter 2: What are the implications of AI spending nearing $1 trillion annually?
Because the remaining performance obligations are huge. But at the same time, these are assets that could potentially, you know, we're buying land, we're building buildings, we're signing energy contracts, maybe even, you know, buying energy assets. These are assets that have long duration life cycles.
And we maybe know what the next six months to maybe two years looks like, but it's really hard to predict what the next 10 years looks like. And that's where you start to take on debt to build these things. And the calculus gets a little bit different.
Let's be clear. It's in the name, but let's be clear anyway. Operating margin is operating expenses. It does not include capex. Yes, operating margins look fine. That's an important metric. It doesn't tell the whole story, though, just so we're clear.
It would include depreciation. We're getting into the accounting world. It would include depreciation, yes, but not what you're building for tomorrow's capacity.
Right. I'll be honest, Travis, I feel like I don't get it, because I really struggle with the ROI part of this. I get the reason everyone's doing this, I get the magic of AI, I get the potential. But yeah, you said it, I mean, Hyperscale is going to spend $750 billion this year, Wall Street has them going to $1 trillion in 2027, just based on estimates.
Right now, according to Gartner, total global enterprise software spending, so just what businesses spend on all software, it's only about $1.5 trillion. Using their numbers, not mine, AI companies, they're going to have to generate $7 trillion with a T in AI revenue through 2029 to just get a really, really paltry 7% return on invested capital.
So, $7 trillion in combined sales by the end of the decade in a market that's a $1.5 trillion market right now, basically. 7%, that's not great. Alphabet, Microsoft, Amazon, they historically have aimed for 25%. I don't know how we continue to do this. I guess token prices have to go up way up, swallow a significant portion of GDP up, or we're just not going to get the payoff that we think here.
Yeah, I get the top line. I get the growth. I get the enthusiasm. I'm not sure I get the long-term win here for these companies yet.
All right, John, give us the bullish case here.
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Chapter 3: What are the market predictions for major tech companies?
It seems like there is a pressure on token prices. If John is right and agents are going to take over everything, we can't be at the price point where we are today if my computer is just going to run 24-7 doing who knows what. It seems like tokens are deflationary, but if that's the case, that's a whole different economic question.
Yeah. Look, I don't know the answer, and I don't think any of us know the answer, but I fear the answer might be that C word that has got to keep all of the CFOs for these companies up at night, commoditization. I think the reason why token prices are going down is the intense competition among these companies to get you on their stack. This is a real weird world, Travis.
You were talking about it off-air that, if anything, a lot of the components, a lot of the inputs for these things are going up now because of scarcity. That's supply and demand one-on-one. Arguably, they're getting less bang for their buck from the spending they're doing, yet they are having trouble charging for it. John's right, the pie could go up.
It could be that it just eats all of software. It could be that we begin to lay off 50%, 75% of our employees because we're spending on that too, so all of this money is freed up. We don't have to get into whether or not that's a good version of the future or not. But the other answer here, maybe it is that, yes, this is right, the SaaS apocalypse is going to happen.
But the answer could be that it's like one of those bad movie scenes, collectively, everybody's just in a race and it ends with a huge cliff.
Yeah, that's absolutely possible. John, I want to end with this, because one of the dynamics with the hyperscalers in particular, Lou mentioned it, that they've got the incentive to not be disrupted, and they've got cash flow in the most recent quarter alone, $150 billion in cash flow from the big four tech companies, Alphabet, Microsoft, Amazon, and Meta.
They're spending a majority of that now on CapEx. Likely by the end of the year, at least sometime in 2027, they as a group are going to be negative free cash flow. They're going to be taking on debt to pay for this CapEx build out.
At what point would you get concerned that maybe we don't want to use all of our cash and go from this massive cash generating businesses to now debt funded businesses?
It's a really fair question. And to your point, basically, of the Mag7, only Nvidia and Apple are expected to generate normal free cash flow this year. The other five are expected to be down or even negative, according to Goldman Sachs estimates. And it's not supposed to rebound next year. It's probably going to get worse. Yeah, exactly.
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Chapter 4: How are operating margins improving for companies like Alphabet?
Everybody makes their decisions on an individual household level, and a lot of people are still fine spending. I do think that it's inevitable that the critical mass of people who are able to do that is going to shrink because of all this pressure.
The debate, the uncertainty, the unknown is how much that critical mass shrinks and whether or not it shrinks to a point where it can't hold us up anymore. TBD, I still go back to, yeah, it's going to get worse from here, but I think hopefully we can avoid the worst of the worst.
It's going to be very interesting to watch what happens outside of the AI boom and the AI build-out. Because I would argue, eventually, these companies have got to either flatline spending or even decrease their spending and get some ROI on this investment. And there's a lot of benefits, like John said, from the economy, from all the spending that's going on right now.
So we'll see what happens in the future. When we come back, we're going to get Lou and John's thoughts on where the market goes from here. You're listening to Motley Fool Hidden Gems Investing. Welcome back, everybody. In this segment, we like to have a little bit of fun with investing in the markets.
I'm going to give an over-under to Lou and John and get an idea of where they think some stocks are going, where some quantity prices are going, get a general feel for the market. Let's start with Nvidia, guys. This has been the hottest stock in the market for quite a while now, at least since the chat GPT moment three-plus years ago. Lou, the question is,
Is NVIDIA going to be over or under a market cap of $10 trillion, currently $4.8 trillion, so a little bit more than double, on January 1st, 2030? So you have nearly four years to get there. But is NVIDIA going to be able to do it? Is this momentum going to continue or is something going to disrupt what they have going on?
I don't want to be bearish on Nvidia. I love this company. But I do think their history has been peaks and then falls, and then peaks and falls. You give me to 2030, I'm probably going to get, to be honest, it wouldn't shock me if they hit $10 trillion between now and then. But I do think that, based on our other conversation, AI spending can't continue to go up through 2030.
There's just not enough money on the planet. I do think we will be past the peak and maybe the stock will have settled and it's going to be under $10 trillion by then. Knowing them, they'll have the next big thing, robotics or something like that, and it'll be even higher than $10 trillion by 2033, but I'll take the under on that. John?
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Chapter 5: What does the term 'remaining performance obligations' mean in AI investments?
Yeah, my heart wants to say over, my head wants to say under. And I think I'll go with Lou here on under. But I think it's still going to be higher than it is today, just not over $10 trillion by 2030. And if we were having a longer time horizon, then I would feel more comfortable saying over $10 trillion. I can't believe that I'm even in a world where anything...
at any point over $10 trillion I'm somehow comfortable with mentally. But yeah, one of the things that we do need to look at is, yes, there is some constraints when it comes to the electrification of what's going on. And so I think that that's going to come to bear at some point when it comes to the build-out and how many NVIDIA products are being placed. Can we power things up fast enough?
The other question, John, is, is the competitive dynamic going to change? If we go back to the ChatGPT moment, everything was built on NVIDIA chips and CUDA. You had a little bit of TPU stuff going on inside Google, but a vast majority of the rest of the industry was building on NVIDIA chips. Now you have the ecosystem starting to be built out for other chips and other components.
You had a deal this week with OpenAI and Amazon, and they're going to be building on bedrock, just meaning that Amazon is going to kind of obfuscate away what the actual chip is running. Is it a GPU? Is it their Trinium chips, which they're investing heavily in? the customer isn't actually going to see that because they're just going to be interacting with AWS.
So does that ultimately lead to one of these potential valleys? And I also want to give this stat. NVIDIA has had negative revenue growth four years and almost six years in the past 20 years. So it is a pretty regular occurrence for them to grow a ton and then shrink a little bit for a year or two. But John, how do you think about those competitive dynamics?
I see validity on both sides of the argument. I see validity on the side that says, no, Nvidia is going to continue to dominate this market and there's no real need to worry about the competition.
But I also see the validity on the other side of the aisle as, when you look at a company that is commanding 56% net profit margins, there is incentive for these other companies to come in and say, I don't want to give them pure profit for their products, I would like to create my own products to replace some of those. I think that watching the custom Silicon players is a good idea.
So your Broadcoms, even your Arm Holdings, I think is a good one to watch from here. But I don't know. I'm torn, Travis. I can see validity for both arguments.
All right, John, I'm going to have you go first on this one. Will Alphabet, same question, $10 trillion by 2030, will Alphabet be over $10 trillion at that point?
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Chapter 6: How might economic factors impact the future of AI investments?
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Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. John, let's get to the other big earnings report from the week. This is another one of the biggest companies in the world. Apple seems to do nothing wrong at this point. Their growth for the quarter is 16.6%.
Like we saw with Google Cloud, that seems crazy given how established they are in the market, but they still are hitting on all cylinders.
Yeah. If you like growth, profits, and dominance, I reckon that you would like this report from Apple. Just a lot to like. And by the way, who says that Apple isn't an AI player? The company essentially sold out of its Mac minis and Mac studios. And it's just because
consumers are buying them up to deploy their own agentic AI systems just emerged as the preference for the general community on this whole trend. Yeah, they're selling out a ton of products. It's great. One interesting thing to watch is on the profitability side of things. Tim Cook said that they're finding ways to mitigate the memory issue.
You look at SanDisk, for example, gross margins have gone from basically 20% to 80%. That's higher than Nvidia. Tim Cook says, beyond the June quarter, we believe memory costs will drive an increasing impact on our business. So, they have ways to mitigate it now, but they're looking down the road and saying, this could get a little bit hairy for our costs.
John has most of the details here. The thing I want to focus on is China, where Apple has struggled, and there's been real questions of its Chinese preferences just moved to domestic. Revenue is up 28% to $20.5 billion in China. well ahead of the $18.9 billion expected. That is really good news if that's sustainable.
I think the big question, always the question, lots of promises, but no real details about the future products in the pipeline. We either need to answer that question or convince Wall Street to stop asking that question. But the business is solid and the business just continues to hum along.
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