- We’re joined by Alex King from Growth Investor Pro (Cestrian Capital Research.).
- Alex shares with us stocks he has rated as accumulate. Including one extremely controversial stock that the market dumped after their recent earnings call.
- We also cover Microsoft’s earnings, and a few cybersecurity names as well.
Editor’s Note: This is the transcript version of the previously recorded show. Due to time and audio constraints, transcription may not be perfect.
Find more of Alex King’s research at Growth Investor Pro.
This episode was recorded on February 1st, 2023.
Daniel Snyder: Welcome back to Investing Experts Podcast. I’m Daniel Snyder. In this episode, we’re back with audience favorite, Alex King, from Growth Investor Pro, to get his views on some recent earnings and stocks that he is rating as accumulate. And honestly, one of these stocks peaked my interest since their recent earnings were not exactly welcome by the market. Also, Alex explains his method of how he utilizes both fundamental and technical analysis within his investing strategy.
Just a reminder, anything you hear on this podcast should not be considered investment advice. At times myself, or the guest, might own positions in the securities mentioned, but this is for entertainment purposes only and should seek advice from a licensed professional before investing.
If you enjoyed this episode, please do us a favor, share it with a friend, leave a rating or review on your favorite podcasting app. And now let’s get into the conversation.
Alex, I just – for the people that don’t know who you are, let’s just start at the very top. Do you have, like, a one- to two-minute background of how you got into investing in your background and where you are now?
Alex King: Yeah, sure. Of course. So I have a background in institutional investing. I started my career as a venture capitalist, moved into leverage buyouts. And then when I finished, I was investing my own money in public stocks.
I started writing stuff down because I figured that if I didn’t write it down, then I’d probably just spray money around and make a terrible job of it. And I figured if I wrote it down, that would make me do good work. And then I thought what would be really good way to force myself to do good work is to write stuff down and then publish it.
So I’ve known Seeking Alpha for a long time, 10-plus years before I started publishing on it. And so I thought, “Okay, well, I’ll write some stuff and put it up on there.” And it was never meant to be a business, to be honest, but it took off. It was a really big hit, quite quickly. I came across the Seeking Alpha Marketplace platform, and I’d subscribe to a couple of people there. I still do and really like that.
And I thought, “Okay, well, I wonder if we could do that, and we did it. Set the company up. It’s our first service in Seeking Alpha. We’ve done a bunch of other stuff as well now, but it’s still a big part of our business. And yeah, we run a pure-play investment research business. We’re a grown-up company. We’re SEC regulated. We have – there’s me, I’m a fellow or independent director.
We have many, many authors now writing on everything from equities to options to credit to rates to, you name it. We cover investing, we cover trading, all sorts of stuff, all of which came from basically not wanting to mess up investing my own money. So it’s been a slightly unpredictable ride, but big success. Companies growing all the way through ‘22, which has been a delight in the surprise. And, yeah, it all starts with Seeking Alpha, so we’re really grateful for the opportunity.
Daniel Snyder: Why don’t we just dive right in? Dynatrace (DT) is a company that you follow that just reported earnings. Wanted to see what’s your overall thought just top level about Dynatrace?
Alex King: Yeah. So Dynatrace reported today before the open. It’s unusual like software stocks sitting at reports before the open. The stock’s up. I see the market has died for a bit last couple of minutes, but it was up somewhere between 10% and 13%, 14% around the open today.
Dynatrace is a really boring business in many respects, right? The thing it does is incredibly boring unless you’re a software person It’s software that spends all of its time watching other software. That’s the way it does. It’s called the observability category. All large companies, all enterprise customers, have observability software. They buy it from Dynatrace. They buy it from Datadog, that’s (DDOG). They buy it from Splunk, (SPLK); New Relic, (NEWR), kind of adjacency; PagerDuty, (PD).
Dynatrace, along with Datadog, are the newer members of the category. Datadog’s high-growth, Dynatrace is an older business, but it’s run like a machine. It’s a thing of beauty. So the business IPOs 2019, from memory, and it came to market with 4 times leverage, 4 times trailing 12 months EBITDA worth of debt. It’s now in a net cash position. It’s redeemed $1 billion of leverage loans in four years from its cash flow. And at the same time, it’s grown at 25% to 30% a year. That’s what it looks like in fundamentals.
The important thing this quarter was, it’s the first software stock which reported, at least in our universe, and we cover most things. That showed accelerated revenue growth. So revenue growth this quarter versus the December quarter in 2021 was a higher rate of revenue growth than was the September quarter versus its prior year. That’s really important in tech and software. People look for accelerating stories. And it’s the first story to accelerate.
Now the charts look bullish for a while, we’ve had it accumulate rating for some time. I found a low toward the end of last year, like many of the tech names that it’s been moving up, but this, I think, can really propel it up. So Dynatrace, we’re still accumulate on. We’re bullish on the stock. I own i personally for this closure. And I think that can be a real winner. If the market even stays flat for this year, no doubt that Dynatrace can win. If there’s any tailwind with the market, so it can be a big success, I think.
Daniel Snyder: So I want to ask you though. So I’m looking here on Seeking Alpha about Dynatrace; ticker symbol, (DT). And Seeking Alpha authors have a buy. Wall Street analysts have a buy. The Quant System’s currently a hold. But under the Factor Grades, the valuation is an F grade, and it looks a little bit overvalued. So is the story here that this company is going to grow into the valuation?
Alex King: Find me a software stock that isn’t always overvalued, right? So the Seeking Alpha Quant system is super. It’s really, really good. But you have to read it through your own lens, okay? So what you have to know is the best growth stocks always look too expensive through that lens. And so you have to apply your own filter, okay?
So if you’re looking for low-valuation stocks, then you’ll find it with basically relatively low growth, very high accounting earnings, high EPS, high earnings per share, accounting earnings. What those systems don’t generally pick up is super high rates of recurring contracted revenue growth, big rates of cash flow margin, and big deferred revenue and big remaining performance obligation.
And we talked about these last time, which is use remaining performance obligations, as your guide. You’ve got a big fat order book, it’s growing quickly. It’s a big multiple of trailing 12-month revenues. That’s a great software stock to own. And so those Factor Grades just don’t look at those things. So in their own way, it’s a great system, but you won’t find opportunities like this just through those quantitative metrics. So you got to pick the tool that works.
Daniel Snyder: Yeah, completely. Just had to ask you that a little clarification on that. So talking about software stocks, let’s talk about one of the behemoths that you also follow that just announced earnings, and that’s Microsoft (MSFT). And we know Microsoft is bigger than just software. But what did you take away from their quarterly earnings in regards to the overall company, I mean, and the guidance, the AI side of everything, what did you think?
Alex King: Yeah. I thought the numbers are awful, but the market didn’t care. So I took that as a big bullish sign for the market, right? And we said that in our coverage. So I’ve got the numbers right here. So we had 2% revenue growth in the quarter, 10% on our trailing 12-month basis. Cash flow margins were terrible, 37% on a trailing 12-month basis, that’s low for Microsoft. Dreadful numbers. Didn’t matter. Stock went up anyway.
And so I think that what that tells you is a number of things. One, as always, the market looks forward not back. So I hate the phrase priced in, but what the market will always do is bottom out before fundamentals bottom out. And as everyone knows, because if they didn’t know before, they do know now monetrary policy is prime, prime, prime driver of equity valuations, more important than any individual stock earnings performance.
And so I think the stock – the market reaction to Microsoft was basically, okay, it’s not great, but we’re expecting a monetary easing coming, and so we’ll hold the stock up on that basis. Plus, which if you look on the technical side of Microsoft, yeah, normally, Microsoft is a really resilient stock. It doesn’t sell off much when the market dumps, but it sold off a lot in ‘22.
So in technical terms, put in a low around the 61.8% Fib retracement off of its 2021 highs. That’s a big drop from Microsoft. Not normal for the stock. And so I think the stock, the market reaction was really, okay, numbers aren’t great and probably improve, and the selling is done again even in a flat market. Of course, the market can dive tomorrow, who knows, but in a flat market, probably Microsoft’s hit a low.
And so again, it’s stock we rate to accumulate. I only personally for disclosure, and we would expect it to move up in the course of this year. Again, absent some fed apocalypse or something, we really expected to move up this year.
Daniel Snyder: Do you have any opinion or thoughts about the Activision (ATVI) acquisition that Microsoft is trying to do?
Alex King: Kind of. I mean, we don’t cover Activision. I don’t much know the company, read the headlines like everybody else. I would say two things. It’s the first I would say regulatory misstep that the CEO Nadella has made. So one of the things that’s marked in Nadella’s tenure from the prior CEOs get, it’s born and so on, that’s been an incredibly good lobbying effort.
Microsoft’s monopoly or quasi monopoly in many segments as we all know. And yet, regulators have left it alone for a decade, and that’s not an accident. That’s because Nadella has been better occurring in favor in DC and with the EU than the previous CEOs. Previous CEOs have kind of bull in a China shop method, which is, well, I don’t care. We’re the big guy. And governments don’t tend to react well to that.
Going after Activision, given Microsoft’s other strength in gaming, they’ve attracted that regulatory attention that’s unusual for them. So I’d view it, I mean, we will see. I mean, if they hit problems with that, I think it’s Nadella’s first major strategic mistake, to be honest. Personally, from a Microsoft stock perspective, it don’t have a strong view on whether it does or does not complete. I’m not sure it’s desperately relevant to the stock going forward.
I think if markets recover in ‘23, Microsoft’s going up. If you look at Microsoft stock chart, it’s basically the stock chart of the NASDAQ, it’s the same thing. If you look from the 2018 lows through to the 2019 highs, COVID crisis lows, 21-highs, 22-lows, it’s the exact chart of the NASDAQ. I mean, just the same chart.
And so Activision will or won’t close. There’ll be a whole lot of noise available one way or the other. I’m not sure it’s that pertinent to Microsoft’s overall stock trajectory. That’s it. No kind of expert on Activision, so others may well have a better view on that.
Daniel Snyder: What about their angle with AI? We know that they’ve been putting a lot of money towards Open AI. They’re going to end up with 49%, I think, share in the company. Is that going to be one of your big catalysts that you think will propel it?
Alex King: I think so. Again, if you look at, I mean, Nadella has been a genius CEO. I mean, up there with Lisa Su just taking on an old established business and just dragging it up, that’s right. And the same as Lisa Su. He’s achieved it because he’s an engineer, a software developer, in his case, a silicon engineer in Lisa Su case at AMD (AMD).
And you have to give them great credit for dragging Microsoft into the cloud here. Now Microsoft is synonymous with cloud, right? Everyone uses Office 365 or some version of it. Everyone knows about the Azure cloud product. But when Nadella took over, Microsoft still had that error of resisting the Internet. I’m trying to process everything on a device in the enterprise or the consumers’ home and just reflecting that whole gates’ former reluctance to engage. And he’s changed that completely. And that’s what’s propelled Microsoft up from the mid-60s to where it is today.
And the next leg I’m sure is, as you say, is open AI. AI, more generally, but I think they’ve picked a good candidate with OpenAI. They invested early. As you know, they’re talking about, she just mentioned a new investment right now. They also get it for the coverage I’ve seen, it’s a preferred investment, so they get priority returns on a number of other investors.
And over and above the financial benefit, and I would be confident that they will integrate the technology well into their own. And so, yeah, I would see AI, unlike Activision, as a big driver of the next, not just this year for a tad longer than that, but the next whole growth leg from Microsoft.
And again, you got to put that credit, to the door, the CEO. And he probably wasn’t his personal idea. I’m sure he has many attempts reporting to us. But as the gatekeeper, what money gets spent on and what doesn’t, it’s a really good allocation of capital. These things, to your point about valuation earlier, these things always look ridiculously expensive when they happen.
If you remember Meta (META) platforms Facebook ads was bought Instagram for $1 billion, ridiculous, right? No revenue. $1 billion complete nonsense, ridiculous. WhatsApp $19 billion, ridiculous. No revenue. Turned out actually both fabulous acquisitions because of that technical vision of the founder. And I think OpenAI will be the same Microsoft. Yeah. So I agree.
Daniel Snyder: Now you just mentioned in that last answer about AMD, and, of course, AMD released earnings and we can talk about Lisa Su and everything else. But you had this great article that you put up about Intel (NASDAQ:INTC). And with Intel’s earnings and kind of just a quick background for everybody is you say this is possibly the worst quarter of any company we have reviewed since you started your service. That is a bold statement, sir. So I got to ask you, I mean, why?
Alex King: Well, let me just run these through. I’m just looking at my other screen this, I mean, Intel numbers. Okay. So this is a company, Intel, which supposedly is the bedrock of the semiconductor industry, right? So until quite recently, if you wanted a good desktop or laptop computer, you chose an Intel processor until quite recently.
Until quite recently, they were absolutely dominant in the server market. They missed mobile, as everybody knows, got late into Apple. But nonetheless their home territories were holding up. But this company in a GDP plus 3% environment, right? Everyone’s talking about recession, not in a recession, right? We talked about this last time. really, you had me on last time.
And I said there isn’t a recession. We just – since then, we’ve come on U.S. GDP plus 2.9%. The economy is good, right? People are buying more stuff. Okay. In that environment, Intel managed to shrink its revenues by 32% this quarter. It managed to take its gross margins down from a peak of 58% in the June ‘20 quarter down to 43% now. And its cash flow margins were even more spectacularly bad, which for a company that used to be just a cash machine is bizarre.
The company is in a tailspin. I mean, all results from a decade-plus of underinvestment in manufacturing process technology, design technology, management teams run by accountants, not by engineers, it is a carbon copy in my view, a silicon copy, I guess, of Boeing (BA), right, which is the stuff we also cover. We cover growth names. We also cover value names in Boeing. We’ve been covering for some time and we’ve rated it accumulate for quite some time now. And it has been a rocket ride of a stock based on awful fundamentals.
I mean, the only company with worst fundamentals we cover at Intel is Boeing. And Boeing, if it wasn’t called Boeing, would be bankrupt because nobody would lend it a $1. But because it’s called Boeing, 13 banks got together when the thing couldn’t generate $0.02 of cash to bail it out. Wasn’t called a bail out. It didn’t see a Fed guarantee written anywhere, federal government guarantee anywhere, but it was there quietly.
And Boeing has been recovering fantastically off the lows. It’s up again today on the basis that the second Chinese carrier is restarting 737 MAX operations. Intel, we think forgetting numbers, doesn’t matter, right? What matters about Intel is U.S. semiconductor policy. The U.S., as we all know, is in a trade war with China. It started out as a really noisy trade war under the previous administration, and it’s developed into a very quiet trade war. There’s less treating.
But actually, the actions are tough as tough or tougher. And very specifically, in semiconductor, the U. S. is reshoring semiconductor manufacturing. So for a decade, two decades-plus, it’s been a gradual shift semiconductor manufacturing eastwards. Yeah. Taiwan Semiconductor (TSM), is the biggest merchant provider, but SMSC Chinese manufacturing – merchant manufacturing business has grown tremendously.
And the strategy was that U.S. fabless semiconductor companies would share design IP and manufacturing IP with Chinese and other Asian manufacturing partners in order to basically get preferred contracts with those partners and the partners got some IP benefit. That’s come under policy review. It’s been determined that that’s capital be bad, national security risk, blah, blah, blah, you can argue about the merits of that, but that’s the decision that the administration has come to.
And so this reshoring exercise is in full flight now. That means heavy, heavy, heavy semiconductor CapEx and manufacturing plants all across the U.S. You’ve seen TSM benefit from that. Just another stock that we rate accumulate in a big pharma. I only personally – even Warren Buffett, who hates tech, he’s a big owner of TSM, right?
Intel, kind of has to succeed if the U.S. reshoring of semiconductor manufacturing is to succeed. Intel kind of has to assist with it. And so I would expect Intel’s stock to be the beneficiary of basically federal funds flows, bank guarantees of all kinds, capital funding of all kinds coming from all different quarters. We expect the stock to benefit from that. Not quickly, not in a way that anybody likes, no one is going to get excited about Intel products anytime soon. But if you believe that the chip sector is called the reshoring, it’s going to continue that Intel is likely to be a beneficiary.
So we rate Intel accumulated for entirely different reasons, so AMD, right? AMD, great product. Financial is great. Growth – everything you want to see in a growth stock, Intel, just a disaster when you look at the numbers. But I think the stock grew up anyway.
Daniel Snyder: It’s really interesting that you give it an accumulate even though the fundamentals have been deteriorating. And as of today, today is Wednesday, February 1st when we’re recording this, we heard the earnings from Lisa Su in AMD. And they’re talking about how data centers is really a good growth driver for them. They’re seeing the weakness in gaming, in the client side. Kind of just throwing this hypothesis out there, is there any reason to believe that Intel might eventually just become a foundry company with how they’re kind of seeming to fall behind on the client side of things as well?
Alex King: Logically, every reason. And I think if you were doing this as a business school class, we all sat around and said, well, all the management team at Intel, which is they just walked out the door. We’re a business school that just bought Intel. But how are we going to do with it? And I think a good strategy will be exactly like you say, which is just can design sell off older beauty. So we don’t forget they’ve got a big position in Mobileye (MBLY), they just IPOed, which probably should generate some benefits and moved to manufacturing.
There’s two problems with that. The first, which is they’re not very good at manufacturing, right? That’s the number one problem. And they’ve had the big change in Intel’s fortunes came a couple of years back when they made a really rocky move to the 10-nanometer process node, which was a really smooth move at TSM and others. And that really set them back.
And again, just like Boeing’s engine, it’s just – I hate the labor analogy. It’s a really good analogy. Boeing’s problems didn’t start because they had accidents with 737 MAXs. They started because they under invested in engineering a long time ago, and that led to upgrading our plane way beyond its capability, trying to use software to compensate for more really hardware problems.
And intel, and as a result of basically underinvesting. And financially, the management team for that, enough engineering infom, Intel same thing. So the problem is if you just said today, okay, we’re going to be a merchant foundry business. They don’t have a good enough foundry business yet.
So I think probably what you would be doing if you’re on the Board of Intel right now is saying where we need to move to is number one, improve the manufacturing technology. Number two, start to catch up on the design front with AMD and others. And see how that goes.
The second point is that corporate DNA and emotional attachments to lines of business really matters. The reason that business school solutions are almost never implemented is emotion. So if you went around the Intel ordering right now and said, I tell you what, in five years, we’re not going to make CPUs. We’re not going to make GPUs. We’re not going to make any – we’re not going to design anything. We’re just going to make other people stuff.
You would find horror on the faces, because that isn’t the origin of the business, and it’s still not the DNA of the business. In their minds, they’re a fantastic integrated device manufacturer that’s just hit a couple of snacks. and it’s upstart AMD is making a lot of noise, but hey, they’re still and also around. ATI, they disappeared a long time ago. This is a temporary blip. in their hearts, that’s what they think. There are, of course, but that’s what they think.
And so I think the idea of moving to purely merchant manufacturing is a really good one, but it’s probably not one of the companies emotionally capable of doing even if they were to improve their manufacturing talent. So I agree with you, but I don’t think it’s going to happen.
Daniel Snyder: I just had to ask because I know how much they’re putting into CapEx. And as you’re talking about with the politics and things that are going on here in the U.S.
I want to go ahead and move forward though into another sector kind of get away from, I mean, I’m sure we’ll revisit tech here in a second because we want to talk about some cyber security names.
But I want to ask you about this defense name. Specifically, L3Harris(LHX), they announced earnings. You put out a really good recap article. You mentioned the backlog is increasing 5% over year. Revenue is up 5.24% year-over-year for this company, beating by $220 million. Defense, the world, the war in the Ukraine, I mean, NATO alliance, they’re all pushing more purchasing orders. I mean, is this a strong accumulate for you? Is this an accumulate? Is this a hold? What’s going on with this one?
Alex King: If anyone’s watching this, then you read our stuff. You know, that most of our chart shows so-called Elliot Wave and Fibonacci. And there’s any number of technical methods that can work and we just happen to like those.
LHX is – has been at what’s called a wave for low. So basically, if you think about stocks get happy and 4 waves up, right, 1 up, 2 down, 3 up, 4 down, 5 up. And way four is the last sell off before a final sort of move up before the whole thing resets. And LHX is around a way forward right now.
And so what that means is we think it can run up. At some point, it will roll over probably in the next year they seem like something like that, and it will start to move down. And when it starts to move down and probably move down for a while in our opinion. But for now, yeah, we think there’s good story of upside. It is a dividend payer. It does share buybacks, it does all of those things.
And why we like LHX is because it’s not an old line defense contractor where all the revenue is based off of – where you better get the next generation of fighter plane out quickly or the strategic missile review, better go your way or it’s a much more diversified business. It’s basically a technology business. It was built around the old Harris Radio business, and it’s been gone through serial M&A, both acquisitions and disposals. And it’s run essentially as a holding company.
Financials are a little bit hard to follow from a distance because there’s been so many acquisitions and disposals. But if you just take a snapshot, it’s nicely cash generative, balance sheet safe, buybacks continue at pace, very financially focused management team, which we’ve talked about, has its downsides. But for basically an acquisition play, pretty where you want. And they’ve set themselves at a stall of being what they call the sixth prime, okay?
So their goal is we want to get up there with Northrop Grumman(NOC), Lockheed Martin(LMT), Boeing, all these names. And it’s getting there. And the smart thing they did is they said, right? Space is going to be our thing. Okay. So if you look at their line of business in space, if you look at their satellite and satellite tracking business, it’s doing really well. And they did a smart thing recently, which is they are in the process of acquiring a company called Aerojet Rocketdyne, (AJRD), which we’ve covered for a long time.
So Lockheed tried to buy it a couple of years ago, and it was blocked by the FTC on vertical integration grounds. So the argument goes. There’s too much vertical integration, in their case, hypersonic and something. There’s not really any regulatory hazard with this deal as far as I can see now. It was mentioned by Senator Warner in D. C. The other day as well as this shouldn’t happen. There will be no doubt be a lot of lobbying by various characters that say, this deal shouldn’t happen.
But on a spreadsheet, the deal should go through. And what that would mean is that they become basically a duopoly provider of solid rocket motors alongside Northrop Grumman. That’s a really important sector. If you’re going to build hypersonic missiles, which is next generation missile, you have to have solid rocket propulsion systems.
The next generation of nuclear missiles, which is currently under development primed by Northrop Grumman, huge $90 billion contract. You need solid rocket motors for those things. And although Northrop owns the other provider, they are contractually obliged to use aerojet motors. And so there’s big growth ahead for that sector. And LHX has been smart in basically moving to where the park is going to be.
So it’s a solid business, good financials. I’m not sure there’s life changing returns, I’m not sure if you’re going long at this point, but there’s good solid returns. Again, it would be paid a modest dividend I think up the yield is, there’s nothing dramatically. It does pay dividend. So amongst the defense names, it’s probably the best risk reward for us at this point. The others, your lock key is not for growing to the rest of it, look to us to have rolled over already, right? So the backlogs are climbing.
If you look at fundamentals, sure, you can get excited. But if you look at what’s been priced in already, they look probably to have topped for this cycle. Boeing, different. Boeing’s, I think, going to keep going up. But that’s primarily because of the civilian aerospace side. The LHX, again, we rate it accumulate. I own it the disclosure. I think it’s got a solid future, but we’re not talking 2, 3 times you’re running the next 12 or 18 months. It’s more modest than that.
Daniel Snyder: I’m looking here on Seeking Alpha, it says the dividend yield is 2.09% for those that are wondering about that. So I think it’s pretty interesting how your – you respond your answer with that one. You started with technicals, and then you kind of wrap up with the story and the fundamentals.
So for those people that are listening that might not know about the service that you’re running, how much do you put weight onto technicals versus fundamentals when you’re deciding what’s accumulated with so?
Alex King: Case-by-case, I would say. I mean, to stay at the obvious, what you really want to see is fantastic fundamentals that are improving. Last time I was on, we talked about using that sort of little time machine window of remaining performance obligation or backlog in the case of defense companies.
And so the perfect by setup for us for going long is fundamentals improving, no one has noticed. That happens more often than you would think because people don’t know where to look, right? People aren’t trained. Wall Street won’t help you because they don’t want you to know. CNBC won’t help you because they don’t know what they’re talking about, and or they’re giving you disinformation.
So – but people don’t know where to look. And so if you can find a company that has improving fundamentals that the market hasn’t gotten onto yet, and you can find the stock at a major technical low, that’s a great setup for us because obviously you can always be wrong with the direction of stock. But if you’re a major technical low, then you can place a stop loss, not very far away from where the stock is today, and that should give you a good risk reward.
The stop loss is, as everyone knows, is if you place them – if you think, well, I don’t want to stop loss to trip, so I’m going to place it a mile away from where the stock is today, that will never trip. Because when it does, it blows a huge hole in your account. But if you can buy these names near a technical low, where hopefully the stock has bumps and starting to move up a little bit, then your stop loss can be 5%, 10% away, 20% at the most for big volatile names, but you’ve got some good upside. And you’ve seen that a lot in tech stocks right now, a lot, lot.
So we talked about Dynatrace earlier, first, stocking our coverage to see accelerating revenue growth. Cybersecurity, everyone has forgotten about cybersecurity, right? And I think it’s because there’s an actual war happening, right? So before there were actually bombs and missiles raining down on civilians in Europe, I think people were really worried about all the damage the cybersecurity could do. And it was top of mind in the media. They’ve gone worried about their own computer, all of that.
I know people see what an actual war is like. A little bit less worried about it. Correct me probably. But enterprise is still spending on this stuff. And so companies like Zscaler (ZS), Cloudflare (NET), all these companies have great fundamentals, but they’re at major, major technical lows.
Cloudflare. If you look at the chart, it’s retraced to right around the 78.6% Fibonacci retracement of the whole move up from its post-IPO lows, basically. That’s in – translate into English, that is a closely huge massive self-off. But what’s important is it’s fair and support at that level. That’s not an accident. That’s just algorithmic trading going well, stop us, double that far, usually find support around this food level, and it started to move up, okay, anything can happen tomorrow. But you have great fundamentals and a stock that’s absolutely been dumped thrown in a dumpster and set on fire. And so that’s a great setup for us.
Zscaler. That’s another example. Same thing, great fundamentals, really sold off hard, looks like it started to move up. Everyone’s forgotten about Cybersecurity. If GDP is growing at 2.9%, enterprises are going to keep spending on this stuff. So the fundamentals for these businesses are going to hold up and or improve. And there the stocks ought to follow suit in a flat market.
So technicals versus fundamentals, you need both. And you need to think about the wider picture. So everyone now is a macro investing expert that all fits into it. Now it’s all about macro investing there, right? So we all know now how important monetary policy is, that’s a new thing. It wasn’t important to anyone apparently, but it is important there. And you also need to know about the policy impact on companies we’ve been talking about Intel.
So technical fundamentals, yeah, all those things. In the short-term, technicals probably always matter more. And over the very long-term, multiple years, fundamentals at least as important. But to be honest, even over months and years, technicals matter as much. And the reason for that is the behavior of large institutional accounts, right?
Large institutional accounts manage so much money that they have to be able to create returns from nowhere. And so this accumulate marker distribute markdown cycle that we like to use. That’s just trying to spot that pattern at work in large account trading. And then follow a little bit behind. And so, yeah, the reason that sometimes stocks move up and down inexplicably is simply that big money’s moving around. Because if you don’t move them around, you can’t generate returns.
Now the tricky course is just follow behind big money a little bit,. You can spot what they’re doing if you’re cute and you’re careful and just follow that. So technical fundamentals, yeah, both in different measures per stock. But – yeah, I’d – you can’t – I don’t believe you can’t successfully invest in public stocks without having a really good understanding of both.
Daniel Snyder: So I want to go back a second to you were talking about Cybersecurity, right? Specifically, Zscaler and Cloudflare. Zscaler earnings come up on February 23rd and Cloudflare is on February 9th. But both of these slides I was looking here on the Seeking Alpha symbol pages, they were both down, like, 50% over the last year in share price. So is it just kind of, like, this kind of just yells exhaustion to you and you’re expecting earnings be top and bottom line from both of these companies?
Alex King: The reason these two names are important is because in cybersecurity, the market’s moving ought the end market, the enterprise buyer is moving away from endpoint protection, which is a fancy name for protecting the stuff that’s on computers, be there use – end user devices or data center devices, and towards in network security.
Now it’s not either all, you need both. But more of the spend we think is going to gravitate towards in network security. And that’s because it scales better. That’s like why do you do cloud computing at all? Answer because it’s cheaper for any given CPU cycle. It’s cheaper to do essentially and distribute the outcome and to do it on a distributor basis.
Well, security is the same. So if you can basically protect everything, all the resources that are within the network, at network level and then treat any onboarding device computer, phone, whatever it might be as a potential threat and then clarify whether it is or it’s not a threat, and then admit it if it’s not, that probably what people call a Zero Trust network environment. That’s a cheaper way to do it than trying to protect the device itself and stop all bad stuff getting on for the device.
The two leading providers of Zero Trust Network, so Zscaler, which is the leader; and Cloudflare, which is a catching up. So Cloudflare didn’t come from security, came from Network acceleration, but it’s moved towards security quite well. So this is a category that spend is just going to keep coming, and it’s going to gain overall security spend from the likes of CrowdStrike, [indiscernible] and so forth.
The stocks have beaten up because in both cases, they had exceptionally high valuations. And to be honest, they still do. If you look at any valuation metric on either of those names, it’s – on a fundamental basis, it’s still a big valuation. And that will put many people off and there’s no argument that just did a big valuation.
They’re also beaten up because they both get treated as unprofitable tech. That’s not quite true. If you look to an EPS perspective, yeah, they’re both disaster areas. But Zscaler is incredibly cash generative. It’s EPS negative because of the heavy stock-based comp. Stock-based comp normally doesn’t cause us any sweat. Zscaler is pretty egregious. It’s so bad that their executive comp plan almost didn’t get passed at the last shareholders meeting. And it was something like, I don’t know, exact numbers, but it was less than 60% [indiscernible]. It’s pretty remarkable. I’m assuming like it. But it does generate a lot, lot of cash.
Cloudflare needs to learn how to generate cash. So far, it’s treated cash. It’s completely expendable. They have a big heavy CapEx bill. It’s around 19% of revenue last quarter, I think, on a trailing 12-month basis. They have not at all learned a trick of generating cash from working capital. So Cloudflare has adopted as a tactic, well, you pass later. And they’ve done that, yeah, for good reasons, which is it helps them win market share from Cisco and other incumbents because you’ve got to give a reason why you want to buy the surgeon.
But it’s kind of time that change because once a company moves their network, the security onto one of those providers, you’re really not going to move it off unless something bad happens, you have a series of bad outages or something. We’ll support truly awful for two years. You’re going to keep it there. And so Cloudflare needs to learn to charge more upfront to get paid more, upfront, less in arrears and turn their cash flow around from heavily negative to initially neutral and positive.
So I think as an outside, if you look at these two stocks, there’s plenty to put you off, to be honest. What will put you off with Zscaler, as you go, the stock-based comp makes my eyes blink. And again, this stuff doesn’t normally bother me, but it is big. And that that’s toxic to many people.
Cloudflare, a bit ago, how about collecting some cash? It’s pretty simple reasons. You’re in business to make money, so why don’t you try? And those are fundamental problems for the business. I personally have all the view that the stocks more than reflect that. They both have hit technical reversal points and a fan support.
Now we’ll see what happens with the rates decisions this week. Sure, they could sell off more. Anything can happen. But long-term, I would be surprised if these two names didn’t start to move up pretty considerably. And once everyone remembers how important the category of Cybersecurity is, I would expect the revenue growth to accelerate once more and the stocks to do really well.
You do kind of have to hold as a bit when you’re buying these around now. But if you’ve been around tech long enough, you know that with these sorts of companies, you always have to partly know it’s when only buying them because it never feels good at the time. But in retrospect, if you don’t buy them, you’re looking to go, well, it’s obvious. Why didn’t I? Yeah, look at the show. Of course, it’s obvious. I’m an idiot. And if you do buy them and it goes to anything, oh, I’m an idiot. Yeah, how could I pay 15 times revenue in this environment?
So how do you solve for that? Well, either though by them, if it’s too scary and volatile, it’s understandable, or solve for position size, solve for it with stops trading, stops if it moves up risk management. But a house view, Cybersecurity is not at all participated in rally off of the Q4 ‘22 lows and that’s over to you, I think, and I would be surprised if it didn’t happen in ‘23.
Daniel Snyder: Excellent conversation today, Alex. I really appreciate all the insights. I mean, we went through so much in this episode. I want to give you the opportunity. I mean, if people want to follow-up with your research, again, contact with you, where can they reach out to you and follow you?
Alex King: Yeah. If you look at those two places, Seeking Alpha profile is the best place to go for Seeking Alpha content. We run super, super, super low cost newsletter. You can sign up for $49 a year just to get a flavor of what we do. It’s got timed entries and exits, great places to start with our stuff. We run a premium service, Growth Investor Pro, It’s a really bad name for a great service. So it covers growth value, individual stocks, ETFs, investing trend anyway.
We’ve got a half of offer on that right now until middle of the month. So it’s 999 a year, rack rates 2,000 a year. So have a look at that. And for our other stuff, check our website, cestriancapitalresearch.com, but go to our Seeking Alpha profile first. That’s got all of our Seeking Alpha content to mind.
Daniel Snyder: Yeah. And I just got to reiterate. I mean, I was just looking at the Dynatrace, which is why we started off the episode with it. I mean, you are on top of the earning calls, and provide the viewpoint almost immediately afterwards. I think that’ll wrap it up for this episode. Anything else you want to say before we get out of here?
Alex King: Just a big thank you. Love doing these sessions. Love watching your other episodes. So appreciate it, and happy to come back anytime soon. So great work you guys do.
Daniel Snyder: Well, like I said earlier, you are a fan favorite. We’ve heard so much good feedback about the previous episode we have with you. We’ll definitely have you back again. I know everybody loves it.
Alex King: Thanks a lot.
Daniel Snyder: Just a reminder, everyone, if you enjoyed this episode, leave a rating or a review on your favorite podcasting app, and we’ll see you again next week with a new episode and a new guest.
Find more of Alex King’s research at Growth Investor Pro.