We're talking earnings and investor questions on Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime contributors Matt Frankel and John Quast. So today we're getting lots of questions from members, and we thought this would be a really good time to combine some listener questions as well as earnings reports that we've seen coming out in the past couple of days. It's a little bit of a marriage of good ideas. And so we're going to talk about Cisco's earnings. We're going to talk about Lumentum's earnings. And also we'll get into, hey, maybe we should talk about non-AI things for a little bit from our investor mailbag. But as I said, we're going to start with Cisco. And we got a question a little while ago from one of our listeners. I hope I get the name right. Ahilash Shankar. And was asking about Cisco and one of our thoughts on it. And I thought it would be a great time to start the conversation today because Cisco reported earnings and the stock is up 13.8% as we were recording because numbers were pretty good. Revenue growth was up about 12% for the year. Earnings was up and obviously guidance was looking pretty good. John, why don't you run us through the numbers and what you guys saw in this particular earnings that I would say defied expectations of what Cisco has been for a while? Yeah, it's so surprising to be talking about Cisco, one of the poster children of the dot-com bubble over 20 years ago, but really the business is booming unlike ever before. You look at the most recent quarter, 12% top-line growth. Really, all of the growth is coming from one part of the business. Cisco has various components, but there's one part of the business that's driving everything, and that is networking. So the company reported 25% year-over-year growth in the networking side of the business. Everything else is either down or basically flat. Essentially, what is happening here, as the AI infrastructure build-out marches on, all of these GPUs, the clusters, even the data centers themselves need to be connected. And this really plays to Cisco's strengths. It's getting a ton of demand, in particular from the hyperscaler businesses. And so you think of the public cloud giants, the tech giants, the magnificent seven. These are the companies that are needing network solutions, such as the ones that Cisco provides. And what is fascinating here, when you look at the orders to the hyperscalers last fiscal year, about $2 billion total for Cisco. Going into this fiscal year, it was expecting $5 billion total. And so that was quite ambitious of a projection more than doubling year over year. But we're three quarters into its fiscal year now. We're already surpassed that projection. And now management is saying we're expecting $9 billion of orders in this fiscal year from the hyperscalers. So incredible year over year growth there. And it's not just hyperscalers. It's also the neocloud businesses. We just got a report from Nebius today, signed a $27 billion deal with Meta. I mean, its business is growing like crazy. It needs networking solutions as well. But all in all, good quarter for Cisco. Yeah, I wanted to lean into something John just mentioned and emphasize the word orders. So product orders to hyperscalers are growing at a triple digit rate. AI infrastructure orders from hyperscalers were $1.9 billion in the third fiscal quarter. That's up from $600 million a year ago, so more than tripling. Overall, Cisco's orders were up by 35%. John mentioned the top line only grew by 12% in the quarter, but overall product orders, which are very indicative of future revenue, were up 35%. Even excluding hyperscalers were up 19%. So we're seeing really strong demand across the business. Networking orders were up 50% year over year. As John mentioned, that was the strongest segment. And hyperscalers are the real story here. And just to kind of put this in perspective, John correctly mentioned that now Cisco expects $9 billion in orders this fiscal year for AI infrastructure. And that's compared to just $4 billion, just $4 billion in expected recognized AI revenue. So more than double what they're recognizing in AI infrastructure revenue, they're expecting for future revenue because they're getting these orders in. So this is really just a long way to say that the reaction to Cisco's quarter isn't necessarily about revenue. No one's that excited about 12% year-over-year top-line growth or the earnings that they just reported on a per-share basis. It's as much about the orders it now has on its books that will be recognized in the future periods and the anticipated acceleration in that number over time. Getting back to the question that our listener, Ahilish, asked related to it, it's like, is this a good idea? And this is one of the things I've been struggling with with Cisco. And we'll get into it with when we talk about Lumentum in the next section as well, is that these are businesses that have been notoriously cyclical for pretty much all of their life as publicly traded companies. I mean, Cisco, like to John's point, was the poster child of, you know, massive build out during the dot-com boom of everybody had to have Cisco systems equipment. And then everyone was like, well, maybe we don't, maybe we can use other stuff. And it was okay. You know, it took like decades for investors to see the highs of Cisco stock again. Looking back over the past 10 years, you know, revenue has kind of been up and down. Operating cash flow for this company is more or less what it was 10 years ago. And so this is where it's been a little bit of a struggle for me that the company is doing much, much better right now. But is this just a, you know, shorter term catalyst of a typically cyclical business? Or is this something that's fundamentally different about the business and we as investors should look at it differently? Yeah, I mean, well, Cisco is at an all-time high after this earnings report. It's nearly doubled over the past year. The AI business has nearly doubled their expectations as well. So I would argue that not only is it a move that's justified, but this is kind of a fundamentally different time. This isn't just cyclicality right now. I don't think we've seen an AI cycle over the past couple of decades. This is something that's new. It's something that wasn't really a big market opportunity. No one was talking about AI infrastructure a few years ago. So shares trade for about 26 times forward earnings right now. There's a solid case to be made that revenue growth will accelerate in the 2027 fiscal year, which starts very soon. I'd actually be comfortable opening a small position in Cisco at this level, even at an all high and then adding incrementally That just kind of my take on it For me Cisco just kind of bores me I sorry to all the Cisco shareholders out there I just want to be honest about that up front So I wanted to just move on from this. However, given the question, I really took a honest, hard look at it. And I think I need to agree with Matt here that there may be a case for owning Cisco stock here at this price. Listen, it's still quite the value compared to some of its competitors in the space. growth is accelerating. We look at the next quarter's projections, projecting 19% growth up from, what was it, 12 to 13 this quarter. So that's an acceleration. That's a good thing. Operating margin recently went from 23% to 25%. That's a good thing. And you look at what Cisco's products it provides, it does seem like they are starting to take some market share here. And if that continues, I don't think this is a terrible stock today. I think that I would still prefer Arista Networks. So that's A-N-E-T for its debt-free balance sheet. I like nice, clean balance sheets, especially in the face of uncertainty. Cisco's isn't as clean as that. But I don't think it's crazy to own Cisco stock here. You know, hearing both your response and thinking about it myself, I've always kind of looked at it in the same sense of like, these are all, how bullish are you on AI buildout? And you can look at the rates of spending and all the studies that are going out related to this. And if you are a wholesale believer in what is being published and what is being projected for AI spending, then absolutely. These are four, five, six-year catalysts that are going to be hard to avoid as investors. It all comes down to how much you believe it. We've discussed it many times a year before, and I feel bad like a broken record saying it all over again, but it really does come down to how much of a believer in this AI infrastructure build-out you are. Coming up next, we're going to even talk more about this with earnings related to Lumentum. Dell PCs with Intel Inside are built for the moments that matter, for the moments you plan and the ones you don't. Built for the busy days that turn into all-night study sessions, the moment you're working from a cafe and realize every outlet is taken. The times you're deep in your flow and the absolute last thing you need is an auto-update throwing off your momentum. That's why Dell builds tech that adapts to the way you actually work. Built with a long-lasting battery so you're not scrambling for the closest outlet and built-in intelligence that makes updates around your schedule, not in the middle of it. They don't build tech for tech's sake. They build it for you. Find technology built for the way you work at Dell.com slash Dell PCs. Built for you. Similar to the stock move that we saw with Cisco earlier today, shares of Lootmentum were up as high as 21% on recent earnings reports. This is a company that we got a question about from one of our listeners, Nathan Holstein. It's also a prominent member of several scorecards on the hidden gem side of various Motley Fool investing services. It's been recommended a couple times by our CEO, Tom Gardner, and some of the other in some of our recommendation services. So it is something that's probably on a lot of investors' minds today. So we want to get into earnings and try to get to Nathan's question as much as possible. But this isn't probably one people have heard about a lot. It's really one of those behind-the-scenes sort of businesses. So, Matt, before you dig into what was actually in the report, give us like the too long didn't read of the 10K for Lumentum as what it actually does. Yeah. So Lumentum has been around for a long time. It produces optical components for things like 3D mapping, for high speed communications, think fiber optics. For the longest time, this was a company that got most of its business from like, you know, the rollout of 5G technology and telecommunications and things like that. But the key thing to know now is that the components Lumentum makes are extremely valuable parts of data center infrastructure, specifically when it comes to interconnections and other forms of AI infrastructure. And that's what's really driving the business today. So the recent quarterly report was fantastic, even by Lumentum standards, which has produced a string of blowout earnings reports over the past year. Revenue was up 90% year over year and 22% sequentially. That's an acceleration over the previous level. Earnings came in even better than expected. Adjusted operating margin expanded by 21 percentage points year over year to 32%. So beyond those headlines, NVIDIA just made a $2 billion direct investment in Lumentum. Lumentum announced a brand new facility that it's building that should be online in 2028 that is directly related to its partnership with NVIDIA. They're going to be providing the demand for it. It's like building a factory and you already have someone who's buying all the products. That bolstered its already cash-rich balance sheet. Lumentum now has over $3 billion of cash just sitting around. It solidified that partnership between NVIDIA and Lumentum, which is honestly its most important customer. And its guidance calls for 22% sequential growth in the current quarter. So things aren't slowing down just yet. So this was a very strong report, and I completely see why the market reacted the way it did. When we were talking about Cisco, you're talking about a historically cyclical business that has this catalyst that is driving things. And the Lumentum story is not any different. I think it's actually probably just the Cisco story on steroids right now because it's an even more extreme. Right now, as over the past year, shares of Lumentum are up 1200 percent and currently shares trade for about 189 times earnings. So definitely not the more value-oriented, you know, 26, 27 times earnings that we were talking about with Cisco here. This is a high-flying stock that has a lot of very lofty expectations built into it, almost entirely related to AI buildup. Because as to your point, Matt, previously, this was a business that came and went with the deployment of whatever wireless protocol was the new hot thing for telecom. When 3G was coming out, they had a lot of work. When 4G came out and those periods in between, it was pretty dead. So again, when we're looking at Lumentum and those amazing numbers that we just saw, How do you reconcile that with these massive premium that you have in the stock? And does that make this a compelling investment? Or is this just a, hey, this is really fun to watch, but I don't know if I want to be adding money to something like this. Yeah. So this has been more than a 10 bagger in a year, like you correctly point out. But I would counter and say that this is not the same business it was a year ago. And by the way if you never heard of Lumentum back when it was primarily a telecom networking company It was part of JDS Uniphase So maybe you heard of that So it was a spinoff So let me tell you a quick story So about a year ago Lumentum set a long-term target that they plan to get to, quote, eventually of $3 billion in annualized run rate revenue and a 20% operating margin. It wasn't even close to that a year ago. Now, fast forward a year to now, Lumentum has $3.2 billion of annual recurring revenue and a 32% operating margin. It has already surpassed its long-term targets in a year. Now, management sees a path to $8 billion in annual run rate revenue, and that's not even including that new manufacturing facility that with NVIDIA is going to be its key customer that's going to be capable of an additional $5 billion of revenue when it comes online in 2028. So let me be totally clear. At more than 30 times sales and 62 times even generous forward earnings estimates, Lumentum is not a cheap stock, but it could be the most attractive, quote, expensive stock that's on my radar right now. Yeah, I really like the point that Matt is making. I think the temptation for investors so often is if a stock is already up big, therefore it can't keep going up big. And that's just a complete misconception. What it has done recently is not indicative of what it's going to do in the future. It's not as extreme as an example, but just would point to NVIDIA here from 2023 through 2024, it was a nine bagger. And since the end of 2024, it's still gone on to outperform the S&P 500 now a year and a half later. So what was going on? I mean, the massive adoption curve of NVIDIA GPUs, which has continued to grow and has continued to be sustainable over this long time period. And so what it has done is not indicative of what it will do. So I wouldn't say that Lumentum, just because it's up big, doesn't mean it can't keep going up from here. And as I'm looking at it, I'm honestly not sure what to think with Lumentum, but I would take a slightly different angle than Matt. I understand his point. I think it's a very well-founded point. I will just point out that CEO Michael Hurlston recently said that its supply of products is trailing demand by about 30% right now. So he's just throwing that number out there. When you look at its current growth, when you look at how much the hyperscalers intend to increase spending in the coming year, the coming years, and then you look at the imbalance between the supply and demand for what it is, I would say that it's pretty pricey at over 30 times sales right now. I don't know if that is quite a good valuation. I think Lumentum may be a little out in front of itself right now. That said, if the market is truly growing at a rate that I can't comprehend, then this stock can continue to outperform from here. Looking through it myself, one of the things that stood out in terms of like we see all these AI infrastructure build out numbers that are kind of overwhelming and how big they are. And sometimes you look at it and think, yeah, but is this really going to do that? Because, you know, maybe it's just a commodity product or something like that. One of the things that is interesting about what Lumentum is doing with fiber optics and some of its products that it sells, for example, to NVIDIA, the big selling point that it has is more compute for less power, kind of making systems more efficient because your transfer of data from one place to another, it just makes it more efficient. And this is something I've been kind of harping on as we've had these discussions, too, is the idea of the way that we are growing consumption, whether it be power, water, just usage of AI. On its current path, it seems unsustainable. We've always talked about the gains in efficiency that are going to make it more possible. because Lumentum sits in that efficiency gains sort of realm, it seems more likely to do what it's saying versus, I don't know, somebody just kind of throwing together commodity parts together to satisfy some demand. That seems like one of the more likely places in AI build out that we'll struggle to do as well. So, you know, even though I almost am aghast at its current evaluation, to your guys' points of it might being worth it. These are the sort of like particularities of an investment thesis that would make it more worth it to look at growth versus being scared away by, we could say, high stock prices. Well, that's a lot about AI, kind of two similar stories with Lumentum Cisco. And now for our next segment, we're going to do something completely different and just go away from AI as much as possible after the break. Starting a business can be overwhelming. You're juggling multiple roles, designer, marketer, logistics manager, all while bringing your vision to life. Shopify helps millions of business sell online. Build fast with templates and AI descriptions and photos, inventory and shipping. Sign up for your one euro per month trial and start selling today at Shopify.nl. That's Shopify.nl. It's time to see what you can accomplish with Shopify by your side. quick reminder as always if you want to get your questions in email us at podcasts at fool.com that's podcasts at fool.com our three requests for all of these is number one keep it foolish number two keep it short enough i can read it on air and number three we cannot give personalized advice so try to make it somewhat generic to how should investors do this how what do we think about a stock because we can't give you one-on-one advice we're not registered investment advisors So just keep those three things in mind. We'd love to get as many questions as you can. Today's question comes in from Tyler Grossman. And his question is, I know everyone has a big AI kick right now as the boom keeps going. We just had two segments on it. And it seems that almost every company has a big increase in revenue and profit. It's tied to AI. I'm relatively new to investing and tried to look to diversify Mark Portfolio outside of AI stocks. Very sensible thing for somebody who's new at this to look to diversify immediately. My question is, what are some hidden gems outside of the AI world to keep an eye to help diversify my portfolio? Thanks from Tyler. So, John, I've let Matt go first for the other couple segments. So I'm going to give you honors. What are some of the companies when you're thinking non-AI stocks to like diversify portfolio? What are you looking at? Yeah, I absolutely love this question, Tyler. Before I give some answers, I do want to temper expectations because I think that maybe behind the question is the thought that what if AI is a bubble and what if the AI bubble pops? I just want to be clear that if the AI bubble does pop if it is a bubble and it does pop you talking some of the largest cap stocks out there are going to go down The whole market is going to go down and that normal Even when we diversify our portfolio, there can be non-correlated things that do go down below for what we purchase them at. So I don't want to say that these stocks would be immune to a stock market correction or a crash if AI goes south. But I think that when we talk about diversity here, it really depends on what our goals are. So if you're just looking for a solid diversification, there are solid options out there, right, that are just kind of, they're not going to go up a ton, but they're probably not going to go down a ton either. I would look at things like Pepsi, McDonald's, just kind of these bellwether things that perform reasonably well in and out of cycles. But there's not a lot of growth there. But I wanted to bring some more growthy ideas that don't have an AI component. And two of these, I would consider them more hidden gems. The first one I want to talk about is shoe company Deckers. And this would be a good one to keep an eye on for someone looking for non-AI diversification. There's multiple reasons why I think that Deckers is kind of a cool company. First, it has grown a lot in recent years, but growth continues to be good. So up 7% in the most recent quarter. That's not outstanding, but it's not bad either for a company that's already grown so much in recent years. Its gross profit margin is about 60%. That's one of the best gross profit margins in the shoe business industry. Third, it has a debt-free balance sheet. and if you think about maybe challenging economic times, I think that you want a company with a strong financial position, a strong balance sheet and Decker's has that. And then finally, management routinely repurchases shares that boosts the profit per share profits at a better rate than revenue. And so I think Decker's can be a solid performer from here. The other one that I would point out for our, oh, and that was symbol D-E-C-K. And the other one I would point out here is Casella Waste Systems. And this is ticker symbol CWST. I would have said Waste Management here, but I know that our listeners like more hidden stocks. And so I wanted to point out Casella. This does very similar thing to Waste Management. I mean, it's garbage, it's recycling, it's transfer stations, it's landfills, all this stuff. But it's not as big as some of the other players in the space. Because of that, it's been able to systematically gobble up competitors in its Northwest USA region. kind of bolt on these other companies. So it's spent about $2 billion since 2018, acquiring a billion dollars in annual revenue. So pretty good deals. And it's been able to grow its profits because oftentimes these are adjacent markets and it can enjoy some cost synergies there. So a business like this, very resilient to economic pressures. We have to take out the trash regardless of what the stock market is doing. And it's down about 30% right now from its all-time high. And that's its largest pullback in over a decade. So I feel like that's a timely stock to bring out. John, to your point about deckers, all I can say is I can see why they have gross margins like that when I end up buying my Hoka trail running shoes every once in a while from them. So yes, can confirm good pricing power on whatever they do. Matt, what are you looking at for non-AI stocks right now? So this was a harder question than you might have thought to answer. To John's point, if an AI bubble does pop, there are a lot of AI adjacent stocks that you might not think of. The financial sector is one of my big focus areas. There's so much AI that kind of permeates, even through the traditional banks like Bank of America and JPMorgan Chase, that they're investing so much in AI right now. The insurance industry, Progressive is one of my favorite stocks right now, but they're considered the AI leader of insurance. So there's so many like little, you know, AI has its claws in a lot of things. So I'm going to try to name just a few that are on my watch list that have little exposure to AI. I don't want to say none. Trex is one of them, T-R-E-X. I'm a big proponent of housing right now and especially people investing in their homes. I think we're going to see a refinancing wave whenever interest rates decide to turn. Trex will be a big beneficiary of that. Companies like Home Depot have specifically called out, you know, higher interest rates on the reason why people are delaying big projects. I look at some of these companies, even Home Depot, as kind of like a loaded spring right now that, you know, when people decide to really pull the trigger on projects. So Trex is one. As boring as it might seem to some people, Berkshire Hathaway, I think, is a tremendous value right now, down significantly from all-time highs. Massive cash stockpile. if you do if you are afraid of an ai bubble causing the entire stock market to fall at some point berkshire is in arguably the best position of any company in the world to take advantage of it with about 400 billion dollars in cash i mean talk you know berkshire's management is their artists when it comes to to value investing and after the the financial crisis they kind of painted a masterpiece when it came to like the goldman sachs and bank of america investments that they Bank of America, they essentially got for free in the wake of the financial crisis. I mean, they had warrants that they literally got for free because they made a preferred equity investment. And I mean, and beyond that, Disney is another one that's toward the top of my list. There's some AI there. I mean, the streaming side of the business is very AI driven, especially when it comes to their advertising momentum. But Disney's cash cow is its in-person experiences and things like that. But as someone who's been a fan of this company for a long time, they're investing heavily in their parks, which was long overdue. I think the market's kind of discounting the potential of getting a, I mean, everyone's talking about $200 billion in AI infrastructure spending and things like that. They're spending $60 billion on amusement parks. And just like a lot of the AI infrastructure spending, a lot of investors are having a tough time wrapping their head around that number and how they're going to get a good ROI. but I really think they will. So Disney is one that's on my radar. So there's three ideas for me. Hopefully that helps. You know, five is actually pretty good. So we got Deckers, we got Casella Waste Systems, we got Trex, Berkshire, and Disney. You know, that's a pretty good basket of non-AI players. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, check out our show notes. Thanks to our producer, Dan Boyd, and the rest of the Motley Fool team. For Matt, John, and myself, thanks for listening, and we'll chat again soon.
