The purpose of this weekly is to sharpen my thinking by sharing thoughts about industries and companies that fit into powerful long-term investment themes. It is also a place to share insights into decision making, takeaways from the past week, and random thoughts that arise. Thank you for reading this piece! Feedback is welcomed.

This week:

• AI: Prosperity on the Way, Part 2, Semiconductors
• Lululemon: Long Term Value Creation
• Random Thoughts, Digital Age Reflection

AI: Prosperity on the Way, Part 2 – Semiconductors

Nvidia had a monster year in 2023.

• Nvidia started 2023 as a company with $27 billion in revenue and a valuation of $408 billion.
• The company grew revenue during the year at a pace of 119% to an estimated $59 billion and its valuation grew to an astounding $1.2 trillion! That’s almost a 200% increase…!
• In the quarter just reported, Q3 2024, the Nvidia’s data center revenue (80% of total revenue) increased 279% year-on-year to $14.5 billion.

  This level of growth coming from such a high level of revenue is unprecedented. As a result, Nvidia is now largely considered the bell weather for AI spending.

  Is this real or is it hype? How can one tell?

  I think it is important to separate what Nvidia’s results are saying from the hype that is out there for AI, as there is hype and will be for some time.

  Nvidia’s inflection can be explained mostly by the fact that there is not enough infrastructure built today to train and run the LLM models. The larger players, such as Big Tech, are spending a lot of cap ex dollars to try and establish market

leadership in the LLM race. At the same time, there is demand that has been in place for some time for infrastructure to manage customer data in the cloud, outside of the LLM models.

The piece that is harder to parse out is what the real demand is and for how long. AI driven adjustments that Big Tech, the corporations that are demanding AI solutions, and startups flush with cash all need GPUs. Nvidia cannot meet demand right now, so amazingly, their results could have been even better! But the way that buyer behavior works for long lead time products like semiconductors, customers will over order in the hopes of getting more chips sooner.

This is the hardest part of the intermediate term outlook for Nvidia. There is likely some overordering (or double ordering) at the customer level, this always happens for goods in short supply. There is also demand that is not being met today. While it could prove to be difficult to predict each quarter’s results and stock price reaction, the growth trajectory is very favorable. Whoever wins the battle for the Processing Unit battle (GPUs, CPUs, combined) will be a massive company with an eye-popping market value. More to come on this in future weeklies.

The short to intermediate term outlook for semiconductor companies that have exposure to AI and that enable lower process technologies, is more favorable with the Nvidia news. Some companies are already reporting an increase in demand coincident with Nvidia’s results. Some are not seeing it yet but are seeing a slowdown in economic activity affecting their revenue.

One lesson from the 1990s was the value creation that occurred around some basic themes. One of those was as PCs became more ubiquitous, more semiconductors were needed. Not every semiconductor company did very well (although many did) but the ones that were direct beneficiaries created a lot of value for investors.

This time, it appears that direct AI beneficiaries will create value, and companies positioned to provide smaller chips and smaller die sizes should do very well too. As we go through 2024, I am anticipating more good news from these players and most likely a cyclical bump up for the non-AI beneficiaries as well. In total, the group seems poised for a good 2024 and into 2025.

Note to readers: Arrowside Capital has a position in Nvidia.

Long Term Value Creation: Lululemon

I wrote last week about Lululemon, the company. This week, I wanted to tie in the long-term value creation for shareholders that has been created by building this business over the years.

There are many ways to invest, and there are many ways to view and characterize a company’s stock. What has been proven time and time again is that if a company does a great job of growing for a long period of time and prudently expands and invests for future growth, the result over time will be an increase in value for shareholders. I wrote this last week:

Great businesses have these characteristics:

• They grow revenue and grow it consistently.
• They earn a margin above similar products or services.
• They preserve financial flexibility and invest for future growth.
• They repeat this behavior.

In my experience, long-term value creation has the following elements:

1. Gradually build a bigger and bigger revenue base.
2. Earn a margin to generate a profit.
3. Invest effectively to enable future growth and potentially more incremental profit through the benefits of scale.

Sort of easy to say, very hard to do. Each of these elements are difficult in and of themselves. Long-term value creation is about duration as much as it is the elements. Doing these things is hard and doing them for many years is reserved for the very few.

Lululemon has done this for a long time, now 17 years as a public company. I talked about the growth last week, 22% compounded annual growth in revenue over that period. In preparation for this passage, a few things stood out.

• The compounded return of the stock (market value) was outstanding from almost any starting point beginning in 2007-2019.
  • If you had bought and held at the end of the year from 2007 through 2019, on average you would have compounded 22% for the period held.

• The company managed to generate a strong operating margin and Cash Flow Returns on Capital (CFROIC) during that entire period.
• As one would expect, when the stock traded for a higher multiple, the next 3 year forward return compounded at a lower rate (more like that of the market). Conversely, when the valuation was more attractive, the forward 3- year return was better than the average of 22% CAGR.
• The revenue growth rate of the company did not climb at the same rate, but it was still positive all the way through. The more you extend the duration, the more consistent it appears.

In conclusion, a few things that Lululemon reinforces for long-term value creation.

• An extended period of growth will result in a strong compounding of stock returns.
• Second, investors often fear that they “missed it.”
  • Buying at almost any point over the 12-year period of 2007-2019 would have resulted in better performance than the overall market, by a lot!
• The mix of revenue growth and profitability produces very powerful long- term results, and the exact amount of growth and the exact amount of profit at any given time are less important than the direction and time frame. Note to readers: Arrowside Capital has a position in Lululemon.

Random Thoughts

What are the best advances we have seen in the digital age? Here are my favorites so far:

1. Amazon – it’s incredible how much time is saved!
2. Uber – can anyone remember how bad getting a cab was. Or a black car?
3. Food delivery – Instacart, Door Dash, etc. – another amazing time savings!

There may be more because of AI, can’t wait to see what comes next…

My story

I am an investor and entrepreneur, having started two investment companies. I am

the Founder and CIO of Arrowside Capital (http://www.arrowside.com), based in Boston, MA. I have more than 30 years of experience in the investment business, investing in companies geared toward innovation and growth. The blog is named The Zen Innovation Investor because I believe it is so important to remain calm and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought provoking.

Disclosures

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