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Inflation Spike Thesis Could See Share Values Explode

November 29, 2023

I have been keeping a low profile in recent days because I have Covid. I am feeling better but still testing positive despite having previously used up the world’s stock of vaccines.

Before I keeled over I read a piece on global money supply growth which, according to the author, has turned negative and is like to be followed by sharply falling inflation and lower interest rates. Falling interest rates are like blue touch paper for shares, especially my beloved 3Gs (great chart, great growth, great story).

Even before I read the piece I had been thinking that what we have been seeing is not the return of endemic inflation as we saw it in the 1970s but a spike in a structurally disinflationary world. Truthfully it is a funny old world. Asset price inflation I suspect is bubbling along beneath the surface and wages for favoured workers are ballooning but goods and even some services mostly have a tendency to become. more affordable.

People keep on looking for shares in the Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla) to run out of steam but they don’t. It could be argued that they are bunching for a Great Leap Forward.

The chart of the Nasdaq 100, shown above, is dominated by the MS stocks and is looking promising. We have the golden cross buy signal by the moving averages. We have what is shaping up as a test of the old highs. We also have long term interest rates, which having sparked dramatically higher, could fall and maybe even become super low all over again.

First Reactions Don’t Always Count

Shares in Palo Alto Networks, one of my Innovation Portfolio stocks, fell sharply after the company reported Q4 results but they have since perked up sharply and look very promising.

I read the report of the analysts’ meeting after the Q1, 2024 report and I thought it was great. The shares, I guess, fell because of an accumulated short-term bull position.

There were some negatives but overall the picture is of a company storming through a difficult macro environment.

We delivered total billings of $2.02bn, up 16pc, Total deferred revenue in Q1 was $9.4bn, an increase of 32pc. Remaining performance obligation, or RPO, was $10.4bn, increasing 2pc with current RPO just under half of our RPO. We saw the rising cost of money have an important and incremental impact on customer behaviour in Q1. We are responding to this in the ways we have discussed previously, including using annual billing plans, financing through [Inaudible] and partner financing.

In Q1, this had a negative impact on our billings. Although, as you can see, we saw strength in NGS ARR [next generation security annual recurring revenue] and revenue. Our non-GAAP earnings per share was significantly ahead of our guidance growing 66pc. This was driven primarily by the significant increase in our non-GAAP operating margins, which expanded 760 basis points year over year.

We continue to benefit from the scale inherent in our business, especially as some of our next-generation security offerings reach scale. We again delivered strong cash flow in Q1 with trailing 12-month adjusted free cash flow of $3bn achieving trailing 12-month free cash flow margins of 41pc. Moving beyond the top line. Gross margin for Q1 at 78pc increased 370 basis points year over year.

Nikesh Arora, EO, Palo Alto Networks, Q1 2024, 15 November 2023

The key point and the reason why PANW is in my IP portfolio is what is happening on the innovation front.

We continue to drive innovation across our portfolio and see momentum as customers drive toward Zero Trust architecture.

This month, we unveiled PAN-OS 11.1 Cosmos and Strata Cloud Manager, unifying the management of all of our three form factors and all security services in a single pane of glass and also leveraging AI to analyze security policies, reduce risk configurations and predict and prevent disruptions. Customers who invest in our platform by deploying all three form factors continue to grow rapidly, up 34pc. Of our top 100 network security customers, 60pc have purchased all three form factors, up from 63pc a year ago. On average, these platform customers spend more than 15 times of the rest of our network security customer spend.

The story is similar in SASE [secure access service edge] having just seen our innovations gain multiple industry recognitions in SASE in the second half of our fiscal year, we’ve continued to invest to build on our leadership position. We’re seeing strong momentum in SASE, with ARR growth of approximately 60pc in Q1, we also saw 35pc of our $5m or greater network security transaction include SASE, up from less than 10pc a year ago. Today was the first day of our event called SASE Converge, where we unveiled several enhancements. We have enabled SASE to access applications with performance faster than the Internet.

Nikesh Arora, EO, Palo Alto Networks, Q1 2024, 15 November 2023

PANW is a class act and well worth investing in, like the other IP stocks. If you do not own the IP portfolio yet I am not sure what you are waiting for.

Strategy – Put Your Money Into Innovation

My Spotify list is six songs short of 4,700. My life is a soap opera blasting out from my Bose speakers. What I have since discovered is that listening to music has many therapeutic benefits. It releases endorphins much like doing exercise and can even act as a painkiller. Usually they tell us that what we like is bad for us but not music apparently, which makes me wonder about cakes, alcohol, sex etc.. I have noticed that I seem to be a little bit high all the time and I think the music is something to do with that. Definitely not dope; I don’t even know where to buy it any more.

Also my regular Walking for Life where I walk and then talk with a constantly being refreshed squad of old timers from K&C and we dissect the world’s problems, tear the Wokery to pieces, tease each other unmercifully and generally have a great time as we enjoy post walk coffee and hot chocolate. It is a bit like being on the set of Last of the Summer Wine, which was a TV series in my father’s time.

That is all a bit random but we do need to stay alive to enjoy our ill-gotten gains.

I am becoming ever more convinced of the importance of innovation as a driver of stock market success. We live in a world of accelerating innovation and this is a private sector phenomenon. Why is the US doing so well because it leads this innovation charge and has done throughout the 21st century.

PANW is another of these foot-to-the-floor stocks I like so much. In Q1 2024 the group had revenue of $1.878bn and spent $1.0670bn on research and development and sales and marketing.

Internet is a Cyber War Zone

It’s a big, bad world out there and no wonder that the cyber security stocks (of which there are three in the IP portfolio) are thriving.

The group also talks about positioning itself as a leader in the AI era. They are surely going to become one of the big beasts.

Share Recommendations

Palo Alto Networks. PANW. Buy @ $280

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