Earnings season is upon us, and once again, it will be all about AI.
We're almost 17 months into the generative artificial intelligence revolution, if you set the starting line as the launch of OpenAI's ChatGPT in November 2022. So far, most of the benefits have gone to the picks-and-shovels plays, chip companies like Nvidia, Advanced Micro Devices, and Micron Technology, cloud providers like Amazon Web Services and Microsoft Azure, and hardware vendors like Dell Technologies and Super Micro Computer.
In the long run, though, AI can't just be about capital spending. Someone has to use the stuff. That's why this quarter, the focus shifts to software companies. All of them have been frantically writing new code and revamping to join the AI wave.
Investors have bid up software shares, anticipating an eventual AI profit afterburner. At some point, they'll have to deliver. Sooner would be better than later.
Wedbush analyst Dan Ives, ever the optimist, says his "myriad of field checks" gives him high confidence that the AI revolution "has begun to hit its next gear of growth," passing the baton to software from semiconductors. Ives thinks first-quarter results "will be a major catalyst" for tech shares, with a potential 15% rally by the end of 2024. He says AI related outlays will be 8% to 10% of 2024 IT budgets, up from under 1% in 2023. We'll see.
Here are things to consider ahead of the tech earnings deluge:
Boffo? Netflix will raise the curtain on big tech earnings on Thursday. As in recent quarters, the focus will be on progress signing up subscribers to its ad-supported subscription tier, and the ongoing password sharing crackdown. The key metric: subscriber growth. Consensus calls for 4.5 million net new subs; Citi's Jason Bazinet thinks the total will be closer to seven million, but he says investors are looking for eight million. The stock has rallied 27% year to date, tripling over two years; even a slight miss could trigger profit-taking. I've seen stranger things.
Ask Bing. One portfolio manager told me the data point that matters most this earnings season will be uptake of Microsoft's AI Copilot software, for which the company is charging $30 per user a month. Microsoft isn't likely to provide a lot of specifics, but expect upbeat color. Also in the spotlight: the Azure Cloud business, which is expected to grow 28%, in line with the December quarter. "We've moved from talking about AI to applying AI at scale," CEO Satya Nadella said one quarter ago. Morgan Stanley says AI could help Microsoft's per share profits double by fiscal 2029.
Crab Apple. So far, 2024 has been rough on Apple shareholders thanks to the new antitrust lawsuit from the Department of Justice, difficult competitive conditions in China, a paucity of AI news, and a general lack of growth. In fact, Wall Street is anticipating March quarter sales will fall 4% from the year earlier. Apple will make a flurry of AI-related announcements at its June developers conference, but the stock is stuck in a rut and earnings seem unlikely to change the trajectory.
Like Button. Meta Platform's stock has rallied 47% this year, as the company gets traction from using AI to better target ads and content on Facebook and Instagram. Dan Niles, founder of Niles Investment Management, thinks the stock is still reasonably priced, with a mid-20s forward price/earnings ratio and revenue growth in the mid-teens. Meanwhile, Meta is still reaping benefits from its 2023 "Year of Efficiency" initiative which spurred it to cut staff by more than 20%. But higher costs for AI engineers drawing seven-figure pay packages and bigger outlays for AI hardware will crimp margins. If CEO Mark Zuckerberg wants to drive another up leg for the stock, he could shutter the Reality Labs metaverse unit, which is losing well over $10 billion a year.
Search Me. One of the toughest calls right now is Alphabet, parent of Google and YouTube. The company missed estimates for both segments in the December quarter. The stock is up 12% this year, but there's still concern about whether Google will be impacted by competition in internet search from chatbots, including its own Gemini (nee Bard), which currently has no ads. But like Meta, Google should see strong ad demand this year, with the Olympics and elections just ahead.
Buy Now. Niles also likes the outlook for Amazon.com, where growth at the Amazon Web Services cloud unit seems to have bottomed after a multi-quarter slide. The Wall Street consensus calls for 14.9% AWS growth in the quarter, up from 13.2% in December and 12.3% in September. AI should continue to boost demand. Niles also likes the outlook for the core retail business. Jefferies analyst Brent Thill wrote in a recent research note that with under 20% of global retail sales online, and 85% of global IT spending still in corporate data centers, there is "a long runway for growth."
Big Iron. Both Dell Technologies and Hewlett Packard Enterprise pointed to surging AI server demand in their last quarterly reports. Meanwhile, amid the increased adoption of AI, there are signs that some companies are moving workloads back to their data centers from the cloud, where the costs of running AI are cheaper and data can be better protected. That bodes well for hardware providers like Dell and data networkers like Arista Networks. Endurance Capital fund manager David Readerman sees Dell as a cheap play on AI hardware. As Readerman points out, fund managers can't put all of their money in Nvidia.