Profits and cash still matter

good morning. Did someone say credit cockroach? The Wall Street Journal reported that BlackRock and a group of other financial institutions lost $500 million in a “breathtaking” accounts receivable fraud. This came just days after BNP Paribas reported a €190 million “credit incident” that also involved fraud. Email us with the name of a good pest control company: unhedged@ft.com

And don’t forget. The New York edition of Alphaville’s Pub Quiz is November 11th. Along with every other self-respecting financial nerd in our great city, Unhedged will be there too! It’ll be fun! Click here for details.

technology revenue

Three months ago, during the last Big Tech earnings season, Unhedged attempted to explain the differences in performance among major technology companies (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla). We concluded that the situation is quite simple. The market wants increased revenue. “When sales grow…stock prices rise. Sometimes the market can be a pretty simple beast,” I wrote. This is the view that despite their unimaginable size, big tech companies still trade like startups. Investors want world domination (revenue growth is a proxy for that) and can worry about profits later.

Now I think that’s a mistake. That’s right, Nvidia, a monster of sales growth, has performed the best, while Tesla, with almost no growth, has performed the worst in recent years. But when you remove these two extremes, the picture becomes even murkier. A recent vivid example is the difference in market reactions to Alphabet and Meta’s third-quarter results.

Alphabet announced strong increases in sales and earnings per share, and management warned that investments in artificial intelligence would lead to significant increases in operating and capital expenses next quarter and next year. The company’s stock price rose 3% on the news. Meta announced much the same thing, and its stock fell 11% on the news. News reports focused on Google’s growth and Meta’s spending, but the numbers didn’t change much. In fact, Meta’s sales exceeded Alphabet’s sales both in absolute terms and compared to expected values. Nevertheless, after Alphabet’s stock rally, the company is now trading at a 20% premium to Meta on a price-to-earnings basis (and Meta, at 20 times forward earnings, is arguably the lowest priced among Big Tech stocks).

Looking a little deeper, there were some important differences in the earnings per share results. Alphabet’s growth accelerated and shattered expectations, while Meta’s growth, while strong, slowed and only slightly exceeded historical expectations.

If you widen your lens a little, the point becomes clearer. Below are the revenue growth rates for the past four quarters for five large tech companies, as well as analysts’ expectations for revenue growth over the next four quarters.

Meta’s revenue has been growing faster than Alphabet’s and is expected to continue growing. And generally, all companies are expected to maintain steady revenue growth over the next year. When it comes to revenue, it’s a completely different story.

Revenues for all five companies are expected to slow significantly next year. Part of the reason for this is that the past year has been very cyclical, and (for all companies except Apple) heavy spending on AI. At Meta and Amazon, profits are expected to fall to near zero (although next year’s forecasts are likely to rise following Amazon’s third-quarter earnings report released last night; Alphabet’s forecast may also be raised soon). However, Meta is in a different class when you look at its capex and free cash flow estimates for this year and next.

Meta is expected to increase investment much more than its peers on both a dollar and percentage basis, and is the only company among the five whose free cash flow is expected to decline correspondingly next year. The market does not give “AI hyperscalers” the freedom to spend the money they need on data centers. Meta is the only company that is increasing expenses faster than free cash flow is increasing, and the market is punishing it accordingly.

This may seem pretty obvious, but the market is understandably focused on earnings and free cash flow. But the story of the AI ​​boom has been one of unbridled competition for computing power and AI market share, regardless of profits. This is absolutely not true. Meta’s divergent performance shows that the market has set guardrails for big tech companies, and most of them respect them.

(Armstrong)

President Trump’s China deal

After all the excitement leading up to the US-China meeting at the Asia-Pacific Economic Cooperation Conference in South Korea, the US and China reached an agreement that the market had no interest in. The economic and financial impact of this agreement was so small that it was completely overshadowed in the stock market by the profits of high-tech companies.

Several horses were traded. President Trump announced that China would buy “huge amounts” of soybeans (12 million tons this year and at least 25 million tons a year for the next three years, according to Treasury Secretary Scott Bessent). China has postponed rare earth regulations announced earlier this month. Both countries suspended measures targeting each other’s shipbuilding industries. The United States has postponed extending high-tech export restrictions and halving fentanyl tariffs on China to 10%.

Tariff reductions are a bit of a relief for China. However, the benefits will be small. Louise Lu of Oxford Economics expects China’s growth rate to increase by just 0.1 to 0.2 percentage points next year. Soybean purchases have only returned to last year’s levels.

In short, this agreement is more of a temporary détente than an agreement. “The four ‘T’s” remained largely untouched: Taiwan, transshipment, TikTok, and chip technology,” Lu points out. “All of the big economic and non-economic issues that President Trump and past American presidents have complained about were never even on the table,” said Bill Reinsch of CSIS.

“There’s not much trading. There’s a pause,” said Alan Wolfe of the Peterson Institute for International Economics. Cornell University’s Eswar Prasad agrees:

This is not an agreement, but a framework, or even an outline of a framework, so the uncertainties are not resolved in any substantive way. . . If you think about the huge strides the United States has made compared to just a few weeks ago, there has certainly been progress. But if you go back to January, before President Trump took office. . . It’s hard to see how much the US has gained

This week saw another, more interesting and less direct development in U.S.-China trade relations in the form of U.S. trade deals with Cambodia, Malaysia, Vietnam, and Thailand. These agreements specifically call for the enforcement of measures to counter transhipment attempts to avoid US obligations, but these agreements do not directly address them. Malaysia’s agreement with Cambodia also includes a clause that threatens to reimpose “Liberation Day”-level tariffs if the two countries enter into new bilateral free trade agreements or “preferential economic agreements with countries that jeopardize the essential interests of the United States.”

Although some of the pressure from trade relations between the United States and China has been lifted, the two countries remain deeply hostile.

(Kim)

A book I read often

CDMX dream

This newsletter was amended after initial publication to correct the number in the first paragraph to $500 million.

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