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    Monday
    Apr082019

    Ulta or Nvidia?

    I am surprised at the faith intelligent people put in charts and numbers. Last week, the Chief U.S. Strategist for a big investment company said on CNBC: “$2800 (for the S&P 500) seems to be a pretty important inflection point. Even if you take it back further – really for the last few months – we’ve been in that trading range. Usually, you get some kind of pull back from a big bottom like that so…” yada yada yada. He might as well have said, “We’ve flipped a coin ten times, and we’ve had six heads in a row, so, you know, we’re due for some tails.”

    People see patterns in everything, which is why there are constellations, tea leaves, and stock charts. We enjoy talking about the patterns we see. My intelligent friends have patiently explained to me the meaning of financial charts. I have some experience with this because my father was a chartist before desktop computers. He paid me to dig weekly closing prices out of stacks of Barron’s, so that he could chart moving averages. Dad showed me the familiar patterns like double top, triple bottom, and head-and-shoulders.

    Dad once had the top two best-performing stocks for the year, which is a real feat. Later in his life, I took his theories to Commodities Corporation in Princeton and tested them against historical data. The results?  Entirely neutral. Dad used the price data as we might use tea leaves: to verify what he already believed. Fortunately, he had a strong understanding of value and potential.

    A price is one piece of data, but, like coin flips, last week’s price does not dictate this week’s price. Underlying price data are earnings data, which are also full surprises. Recently, well-paid financial analysts were surprised by earnings at iRobot (IRBT 64%), Skechers (SKX 34%), Universal Display (OLED 18%), Trex (TREX 16%), nLight (LASR 100%), Twitter (TWTR 44%) and many others.

    Even within a company, earnings are hard to forecast. They depend on how many products you can deliver (Tesla), the impact of new technology (department stores versus the Internet), the disappearance of a trend (Nvidia sales dropped when Bitcoin miners stopped buying servers), the emergence of a trend (Ulta sales increased because Kylie Jenner said so), and whether or not management is actually involved in the business.

    This last one mystifies me. Like picking stocks, people think they can run companies “by the numbers” – and without any real interest in the products or the customer experience. I have watched rooms of people pore over spreadsheets without ever asking a meaningful question like, “Do customers recommend our products?” Had he shopped in his own stores, the hedge fund manager who is now burying Sears and K-Mart might have discovered their frustrating check-out process.

    Retail is hard, but, if you think like a customer, you might succeed. Ulta (ULTA) is a chain of stores that offers makeup in every price range. I know that you can check out at Ulta because I have seen my wife and daughter do it. Since Ulta sells makeup, you might think their margins are a Zillion%, but they are only 36%. By comparison, Macy’s has 41% margins.

    Macy’s (M) also has sales of $26 billion and profits of $1.1 billion versus Ulta sales of $5.9 billion and profits of $555 million. After considering cash and debt, you could buy Macy’s for $11 billion, but you would pay $18.4 billion for Ulta, which has been the greatest stock of the last ten years. Ulta climbed from $6 in 2009 to $340 today.

    Is Ulta a perfect company? It earns 3% on its enterprise value, which is OK for a growth company. More insiders are selling than buying. The influential Jenner/Kardashian family of California lends its brand to Ulta. However, when Kylie Jenner announced that she no longer used Snapchat (SNAP), the stock dropped by 6%. What the Jenners give, they can take away. At 21, Kylie Jenner is the youngest self-made billionaire ever. Perhaps you should be reading her column.

    I would not buy Ulta for two reasons. First, I don’t know anything about makeup. Second, it seems rich. For the price of Ulta, you could buy Universal Display (OLED), the licenser of OLED technology, Trex (TREX), the maker of plastic lumber, NICE (NICE), the leader in contact center and back office software, and still have $500 million left over. Is Ulta going to double to $36 billion? I give Universal Display a better shot of doubling first.

    I prefer companies that make core technologies that may provide a better quality of life. The more complex the tool, the greater the potential value, and the less likely that the business will be copied. One of these is Nvidia (NVDA), a company that is best known for its computer graphics accelerators. It turns out that managing graphics – lighting up 8 million pixels in a high-resolution screen in real time – is more demanding than central processing – chunking ever faster through one instruction at a time. When IBM built its Watson Artificial Intelligence computer, it turned for processors not to Intel, but to Nvidia.

    If we humans are pattern-seekers, artificial intelligence (AI) is the perfection of that desire. Our memories are short and we tend to have a poor handle on probability; AI, though, can learn from human experience, and, when sufficiently trained, learn competitively by playing against another AI. It catalogs outcomes and tests new strategies faster than humanly possible. AI has applications for cars, health, defense, photography, shopping, design, and virtually anything you can imagine. We are living in the age of automating everything.

    You can get a sense for Nvidia’s breadth by visiting its developer site at developer.nvidia.com where you’ll find platforms for self-driving cars (Drive), virtual design (Designworks), embedded AI computing (Jetpack), photo-realistic gaming (Gameworks), and the Nvidia Deep Learning Institute (Computeworks). Even more important than its chips is the ecosystem that Nvidia has created, which includes 500,000 developers and 19,000 organizations. While other companies’ chips struggle to leapfrog Nvidia’s technology, Nvidia provides a complete solution in which developers have invested and which they will probably continue to support.

    I first recommended Nvidia to friends four years ago at $22, and they have often asked if they should sell it. The stock reached $281 in September 2018 and is at $169 today – up from $131 on December 1. In the last year, NVDA earned $4.1 billion or 4.3% on its Enterprise Value of $94.9 billion. Nvidia has $7.4 billion in cash. In the last quarter, insiders have purchased 91,000 more shares than they sold.

    In 2018, IBM delivered Summit, the world’s fastest super computer, to the U.S. Oak Ridge National Laboratory. Summit uses 28,000 Nvidia chips. In a test of Summit, a genomics team solved a problem in one hour that would take 30 years on a personal computer. Is the growth in AI over? It’s just getting started.

    Patterns are full of noise – up and down spikes that, from a distance, fade like mountains and valleys into the horizon. Nvidia benefited from the hysteria over Bitcoin, which has subsided, and the stock has been penalized for the loss of sales to that ephemeral activity. Many more substantial opportunities loom before Nvidia that will make the Bitcoin fall-off look like a pothole.

    If you like patterns, these two charts show the growth of the U.S. money supply and the S&P 500 between 1960 and 2016. They have a similar curve, but, in the S&P chart, you can see the hysterias of the Internet boom of the late 1990s and the real estate boom of the 2000s. To compensate for these shocks and to cover our deficits, the government increased the money supply, which tends to increase asset prices. Those assets have established the greatest fortunes in our country: Jeff Bezos (Amazon: AMZN), Bill Gates (Microsoft: MSFT), Warren Buffet (Berkshire-Hathaway: BRK-A, BRK-B), Mark Zuckerberg (Facebook: FB), and Larry Page and Sergey Brin (Alphabet: GOOG).

    The good news is that we have an opportunity to participate in the growth of future fortunes.


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