Generative Finance
In this edition of the Smart Investor newsletter, we examine the stock of a global leader in financial software. But first, let’s delve into the latest Portfolio news and updates.
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Portfolio Updates
❖ Amazon (AMZN) stock was downgraded from “Buy” to “Hold” by Wells Fargo analysts, who cited multiple headwinds that could dent the string of upward earnings revisions and weigh on further margin expansion. However, all the other top Wall Street houses remain positive on the stock, rating it a “Strong Buy” with an average price target implying an upside of over 24% in the next 12 months.
❖ OpenAI, the creator of ChatGPT, closed its latest funding round with a valuation of $157 billion – roughly the same as Goldman Sachs and more than any private company in the U.S. The world’s hottest AI startup is now worth more than 87% of S&P 500 companies. Besides OpenAI itself, one of the biggest winners of its financial success is Microsoft (MSFT), which holds a significant stake in the company, having invested nearly $13 billion. The tech giant invested an additional $750 million in OpenAI’s current funding round.
❖ Without much fanfare, Broadcom (AVGO) has surpassed Tesla in market capitalization this year, after the stock of the semiconductor and software giant surged by almost 60% year-to-date. As a result, AVGO has replaced the EV maker in the “Magnificent 7” group of the largest U.S. tech stocks. Moreover, analysts expect Broadcom’s accent to continue, thanks to its exceptional management, stellar finances, and robust operations.
❖ Arch Capital Group (ACGL) fell strongly this week, along with other insurers, as Hurricane Milton strengthened into a Category 5 storm, threatening to inflict significant damage on Florida’s Gulf Coast.
❖ Alphabet (GOOGL) saw its stock decline on news that a U.S. federal judge has ordered the company to offer alternatives to its Google Play store for downloading apps on Android smartphones and to cease all efforts to prevent other companies from developing app stores for Android.
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Portfolio Stocks Under Review
❖ Super Micro Computer (SMCI) remains under review, although we begin to observe a tentative positive change in sentiment towards the stock. We contemplated selling it last week but decided to wait for further developments as we believe that SMCI’s current difficulties are temporary, while its immense long-term potential remains intact. However, we view the stock’s extreme volatility as one of the factors that may lead to its deletion from the Portfolio.
As a reminder, SMCI underwent an extremely turbulent period, which included strong hits to investor sentiment stemming from a short-seller’s report and an SEC filing delay. The hit was exacerbated by media reports of a Department of Justice probe. Although many analysts have cut their ratings and price targets on SMCI, citing the heightened uncertainty, some remained bullish, seeing it as a major beneficiary of the rapidly accelerating investments in AI infrastructure due to its first-mover advantage in liquid-cooled rack-level solutions.
This advantage came into the spotlight on Monday when SMCI surged by almost 16% after it disclosed shipments of more than 100,000 GPUs with its liquid cooling solution system to “some of the largest AI factories ever built, as well as other cloud service providers.” The announcement underscored surging demand for Super Micro’s servers, driven by AI data center proliferation. The company’s servers are designed to reduce power and infrastructure costs in data centers.
The fact that SMCI surged amid a strong overall market decline may signal that many investors believe in the stock’s strong potential and scooped it up following news confirming robust demand for its offerings. On the other hand, we are mindful that on Tuesday SMCI gave up a large part of the previous day’s gain on the mere notion that Hewlett Packard Enterprise may begin competing with SMCI on liquid cooling, which could point to investor uneasiness regarding the stock.
All in all, we are still closely watching Super Micro, hoping for some light to be shed on its compliance questions, which could help appease investors and analysts.
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❖ We are placing Adobe (ADBE) under review for a potential sale. Adobe stock experienced a significant decline following its quarterly report on September 12th. Despite reporting strong FQ3 results that beat analyst expectations, Adobe provided weaker-than-expected guidance for FQ4 2024 (expected to be released on December 12th). Investors are concerned about signs of decelerating growth at Adobe, including projected FQ4 growth of only 9% year-over-year, which would be its lowest growth rate in nearly a decade. There are also worries about Adobe’s competitiveness in the rapidly evolving AI-powered software market. While Adobe remains a leader in its field with strong financials, these factors combined to create uncertainty about its near-term growth prospects, leading to the stock decline in recent months. Most leading Wall Street analysts are positive on the stock, with the average price target implying a potential upside of almost 26% in the next 12 months. However, ADBE seems to be stuck in a cycle of negative sentiment, with additional catalysts needed to propel it back to gains.
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Portfolio Earnings and Dividend Calendar
❖ The Q3 2024 earnings season has started, and the first Smart Portfolio company to release its quarterly results is Interactive Brokers (IBKR), reporting on October 15th.
❖ The ex-dividend date for Oracle (ORCL) and Verizon (VZ) is October 10th, while for General Dynamics (GD) it is October 11th and for EMCOR Group (EME) it is October 15th.
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New Buy: Intuit (INTU)
Intuit, Inc. is a financial software company that provides financial management, compliance, and marketing products and services for small and medium enterprises (SMEs), accountants, and individuals.
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From Startup to “Microsoft of Fintech”
The company was founded in 1983 and introduced its first personal finance software in 1984. Within five years, sales of Intuit’s software climbed to $55 million, driven in large part by the company’s exceptional emphasis on customer service. By 1992, the program dominated the personal finance software market, propelling Intuit into the ranks of market leaders.
Intuit gradually broadened its scope, offering programs for SME payroll processing, bookkeeping, and other uses. After establishing its dominance in the market for stand-alone personal and small-business financial software, Intuit made strategic acquisitions in fields complementing its offerings and struck various partnerships with financial institutions.
With the advance of worldwide connectivity, Intuit transformed itself into a fast-moving Internet company through internal transformation, divestitures of non-core businesses, and acquisitions. In fact, throughout its history, the company’s consistent delivery of high growth rates was driven by its highly agile business model, which embraced ongoing business transformation as a permanent modus operandi.
This year Intuit has begun another transformative overhaul, this time to fully capture the potential of the artificial intelligence (AI) advance. Although Intuit has already made significant strides in integrating machine learning (ML) and AI across its product suite, it now strives to transform itself into an AI-driven expert platform by refocusing resources on generative AI initiatives.
Intuit went public in 1993 with a valuation of under $2 billion. Today, with a market cap of $169 billion and annual revenues of $16.3 billion, Intuit is one of the top financial software providers in the world. It occupies #297 in the Fortune 500 list and ranks #7 among global U.S.-listed software companies in terms of revenue.
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AI-Driven All-In-One SaaS Platform
Intuit has established itself as a leader in financial software and services, with popular products like financial management platform QuickBooks, tax preparation application TurboTax, credit monitoring and personal accounting service Credit Karma, and email marketing platform Mailchimp. The company serves approximately 100 million customers worldwide, although the lion’s share of its revenues is from the U.S.
Intuit has long implemented the Software-as-a-Service (SaaS) model as a cornerstone of its business organization. By providing cloud-based solutions, Intuit offers its clients cost savings and an optimized client experience, while enjoying stability and visibility of recurring revenues and low-cost scalability. The company generates a significant portion of its revenue from subscription fees for its cloud-based solutions, but also earns transaction fees from its payment processing services integrated within QuickBooks, as well as commissions on loans facilitated through the platform. During tax-filing periods, Intuit enjoys seasonal spikes in revenues, particularly from TurboTax sales.
Meanwhile, its decade-long focus on ML-based and AI-driven solutions has positioned Intuit for continued growth in the fintech sector. Intuit enjoys a first-mover advantage in implementing AI in its industry thanks to its aggressive investments in AI capabilities, which began long before its competitors realized the importance of AI implementation.
By 2023, Intuit was facilitating 810 million AI-driven customer interactions annually. The company generates over 65 billion ML predictions per day, enhancing its ability to understand and predict user behavior. Intuit Assist, the GenAI-powered assistant, was officially launched in 2023, offering contextual financial advice and automating tasks across all product lines. Intuit began integrating AI and GenAI into products like TurboTax in 2023, offering personalized recommendations, automating tasks, and improving the overall user experience. Intuit has also built its proprietary GenOS (Generative AI Operating System), which includes custom-trained financial large language models (LLMs). The company has integrated AI across its product suite, enhancing customer experience and operational efficiency. Intuit’s AI capabilities have positioned it to deliver unparalleled speed and accuracy in financial decision-making for its customers, helping create a sticky customer base.
Intuit also constantly strives to expand its total addressable market (TAM) with new initiatives. Thus, in September, the company introduced Intuit Enterprise Suite, a configurable integrated financial platform designed to scale and enhance productivity and profitability for businesses as they grow. This platform is intended for larger and more complex businesses and could help Intuit capture a larger share of the $89 billion TAM of mid-market businesses in the U.S.
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Many Years of Growth Ahead
Intuit boasts stellar finances, with a meager net debt-to-equity ratio of 11%. Its debt is more than well-covered by operating cash flow, while interest payments on its debt are covered by EBIT many times over. In addition, the company’s fundamental strength is displayed in its high ROE, ROA, and ROIC, placing it in the top 25% of its industry. Its gross and net profit margins come in the top 20%, while its operating and FCF margins make the top 10%.
Intuit has shown strong growth over the past five years, with revenue more than doubling and earnings-per-share increasing by over 50%. The company’s revenue growth has been particularly impressive, with a CAGR of 21%, outpacing its EPS CAGR of 11%. EPS growth lagged that of revenue due to several factors related to the company’s prioritization of long-term sustainable growth, such as investments in R&D and product mix diversification and expansion. In addition, Intuit made significant acquisitions during this period, such as Mailchimp and Credit Karma, which have diluted earnings in the short term while contributing to revenue growth.
On August 22nd, the company reported the results of its fiscal Q4 and full fiscal year 2024, which ended July 31st, 2024. In the quarter, revenue grew by 17% year-over-year, with three out of four reporting segments displaying double-digit expansion. In fiscal 2024, revenue rose by 13%, operating income by 16%, and EPS by 18%. For fiscal year 2025, the company said it expects revenue growth of 12-13% and EPS growth of 13-14%.
The provided guidance was above analyst estimates, despite the ongoing investment in AI transformation, which is expected to continue throughout fiscal 2025. This includes workforce restructuring, as the company said it will let go about 10% of its workforce, including executive roles in order to refocus resources on generative AI initiatives. Intuit said it will hire about the same number of workers in fiscal 2025, who will help it harness AI similar to how it utilized the Internet two decades ago. In addition, the company laid out its plans to increase investments in generative AI and to expand into new markets such as the U.K. and Australia, which would significantly add to its growth potential.
Despite its great size and reach, Intuit can continue growing at a double-digit pace for many more years, as it still has many market opportunities to exploit, as well as the expertise and market position to harness additional niches. These include opportunities for expansion with larger companies, a potential for advancement in the field of tax assistance, and more aggressive international expansion. Analysts project Intuit’s long-term EPS CAGR of over 16%.
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Total Return in Focus
Intuit’s stock has risen by just ~14% in the past 12 months, strongly underperforming the S&P 500 due to this year’s volatile sideways trend. Some investors were nervous about the company’s large-scale investment and restructuring plans centered around AI, with no clear outlook as to when these efforts would translate into faster earnings growth.
As a result, while INTU continues to carry a notable premium over the IT sector’s average, it now trades significantly below its historical valuations. The comparison to competitors is borderline meaningless, as it competes with very different companies in its spheres of operations – from slow-growth dividend companies like Automatic Data Processing to agile giants like Salesforce (which is also in the Smart Portfolio). On the other hand, based on its future cash flows, Intuit appears to be about 35% undervalued.
Intuit’s market dominance is based on its ability to come prepared for every major technological change, with its track record confirming analyst optimism about the stock. Leading Wall Street brokerages foresee an average upside of over 20% for INTU in the next 12 months.
Intuit is a dividend-paying company, which has distributed and increased its payouts consistently over the past 12 years. While the company’s current yield of 0.61% is low, the dividend has been growing at a fast rate and is expected to continue increasing at a double-digit pace for years to come. The latest dividend increase of 16% was announced in August and is effective for the coming payout to shareholders of record as of October 10th.
In addition, Intuit performs aggressive buybacks. In fiscal 2024, the company repurchased $2 billion of stock. In August, Intuit’s Board of Directors approved a new $3 billion repurchase authorization in addition to the previous one which hasn’t been completed, giving the company a total authorization of roughly $5 billion to repurchase shares.
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Investing Takeaway
Intuit stands as a dominant force in the financial software space, leveraging a robust recurring revenue model through its comprehensive SaaS platform. Its leadership in AI-powered financial management and tax preparation software has consistently driven revenue and margin expansion. Intuit’s aggressive push into generative AI further strengthens its position, with new initiatives expanding its addressable market. Despite recent stock volatility, Intuit offers a compelling combination of stability and growth potential, making it an attractive long-term investment for those seeking both innovation and strong financial fundamentals, as well as a valuable addition to the Smart Investor Portfolio.
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New Sell 1: Vertex Pharmaceuticals (VRTX)
Vertex Pharmaceuticals, Inc. is a global biotechnology company engaged in the development and commercializing of therapies for the treatment of cystic fibrosis, infectious diseases, bacterial infections, autoimmune diseases, and neurological disorders.
Vertex has stellar financial health and outstanding capital efficiency and profitability metrics. It has a robust portfolio of therapies, including a world-leading cystic fibrosis treatment, and a promising pipeline with some of its drugs under development having the potential to become blockbusters.
Despite all these positives, the company’s stock has been under pressure since its last earnings report on August 1st, which featured a wider earnings-per-share loss than was expected. The negative EPS was a one-time event brought on by expenses associated with an acquisition of Alpine Immune Sciences, as well as increased investments to support launches of new therapies. Vertex raised its full-year product revenue guidance, citing growth in sales of its cystic fibrosis (CF) treatment and the soon-to-launch gene therapy Casgevy.
The stock of the biopharma giant fell from its all-time high following Q2 underperformance, though not by a large percentage. Vertex’s stellar finances and cash-producing capabilities, along with its strong portfolio of existing and prospective treatments, provide a strong argument in favor of the company. The main negative factor was VRTX’s high valuation, which could limit its near-term upside. Analysts from top Wall Street houses are conflicted on the stock, with many citing a modestly favorable risk-reward profile due to the uncertainty of the efficacy outcome of its experimental pain treatment, which is currently undergoing Phase 2 trials. The average analyst price target on VRTX currently reflects a potential upside of less than 5% in the next 12 months.
While our view of Vertex’s robust long-term potential remains intact, we believe that in the near term, the stock’s upside potential from a successful trial is priced in, while lack of success may bring notable declines. We may revisit this financially stellar biotech giant in the future, but for now we see it as prudent to lock in gains and sell the stock.
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New Sell 2: Lam Research (LRCX)
Lam Research is a global leader in the design and manufacturing of essential semiconductor fabrication tools with a primary focus on etching, deposition, and cleaning tools used in semiconductor manufacturing. The company reported a strong previous quarter and issued an upbeat outlook for the current one. However, LRCX stock has been under pressure lately, with several top Wall Street brokerages reducing their price targets for the next 12 months.
Lam derives about 40% of revenues from etch and deposition equipment for various memory solutions, with the rest coming from products for advanced chip foundries and logic/integrated manufacturing. Memory tends to be a highly volatile end market with extensive price fluctuations, which impact the company’s revenues in the short term.
Analyst forecasts at the time of LRCX purchase for the Smart Portfolio foresaw a significant rebound in memory demand in the near term, but these now seem overly positive. Thus, Citi lowered its estimate for wafer fab equipment spending, basing its outlook on weak consumer demand for PCs, smartphones, and autos, weighing on producers of chips for those industries, including LRCX. Mizuho analysts also lowered their price target on Lam Research as a result of their cutting of estimated wafer fab equipment spending growth this and next year to near flat, citing concerns about Intel’s recent spending cuts and headwinds in China.
China stands as the main selling reason for LRCX due to the company’s high exposure to the Chinese market. While this has driven growth, it also presents significant risks due to potential market fluctuations and geopolitical factors. In recent quarters, Lam has seen declines in some aspects of memory equipment sales to China due to one of its largest customers being slapped with U.S. sanctions.
Although the average analyst price target for Lam’s stock still envisions an upside of almost 28% in the next 12 months, the slew of downgrades has materially harmed investor sentiment. The fact that the 10-to-1 stock split, enacted on October 3rd, failed to produce a positive sentiment infusion, may reflect further on this trend.
We may revisit this wafer-fab champion in the future when we gain some clarity on the pending investment cycle in memory semiconductor capex and China orders. Meanwhile, we believe it is prudent to sell the stock.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
The stock markets have been volatile lately, and our exclusive club has lost one member – Pentair (PNR). However, with a gain of 29.75% since its purchase on June 26th, it hasn’t fallen far below the threshold, and we expect it to return to the ranks soon. Additionally, we are selling one of the Winners Club members, Vertex (VRTX).
As a result, our list of Winners now includes 15 stocks: GE, AVGO, ANET, ORCL, EME, TSM, SMCI, TPL, PH, HWM, CHKP, ITT, AMAT, GD, and APH.
Besides PNR, the next in line to join the lucrative club is still PYPL with a 27.95% gain since its purchase date. Will it close the gap, or will another stock outrun it to the finish line?
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
