Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond soundbites and headlines and looks deeper into the processes, challenges,
Speaker 1: and philosophies and security selection. I'm David Cone, I, lead
Speaker 1: mutual fund and active research at Bloomberg Intelligence. Today, my
Speaker 1: cost is Michael Casper, Senior US equity strategist at Bloomberg Intelligence. Mike,
Speaker 1: thanks for joining me today.
Speaker 2: Thanks David.
Speaker 1: So this is actually our last episode of twenty twenty five,
Speaker 1: and as we head into the year end and into
Speaker 1: next year, I wanted to ask about a note you
Speaker 1: put out earlier in the week. You know, basically on
Speaker 1: what two three earnings are signaling for the market. Could
Speaker 1: you give our audience kind of a brief overview of
Speaker 1: what you're seeing.
Speaker 2: Yeah, so the third quarter was obviously a blowout quarter.
Speaker 2: We doubled the preseason expectation for the S and P
Speaker 2: five hundred, nearly doubled the preseason expectation for the Russell
Speaker 2: two thousand revenue growth. And really what I'm seeing in
Speaker 2: the earning stream is a lot of green signs, a
Speaker 2: lot of green shoots. I think they're just a little
Speaker 2: bit less bright than they were in the second quarter.
Speaker 2: So what I'm talking about there is revision momentum, specifically
Speaker 2: cyclical minus defensive earnings. We're hitting a peak on that,
Speaker 2: but revision momentum also has peaked and is starting to
Speaker 2: come down. What I mean by revision momentum is the
Speaker 2: number of companies with hikes, number of companies with cuts
Speaker 2: over the total number of companies that reported. And why
Speaker 2: that's coming down a little bit is just, you know,
Speaker 2: we had such dramatic cuts in the beginning of the
Speaker 2: year as a result of Liberation Day and a result
Speaker 2: of all the tariffs that were flowing through the system.
Speaker 2: Consensus got it completely wrong for twenty twenty five kind
Speaker 2: of yet again, they weren't necessarily great in twenty twenty
Speaker 2: four either, but they got it completely wrong in twenty
Speaker 2: twenty five and they really had to walk that back.
Speaker 2: And much of that happened in the first and second
Speaker 2: quarters as those results rolled in and they were better
Speaker 2: than expected. Third quarter again better than expected, but it's
Speaker 2: a little bit less robust than you know, a double
Speaker 2: digit gain off a two percent expectation like we saw
Speaker 2: in the second quarter, So that's a little bit less green.
Speaker 2: Cyclical minus defensive earnings I mentioned before, we're hitting a
Speaker 2: peak on that. Typically I look for that to peak
Speaker 2: and wane to signal some volatility for the market. And
Speaker 2: the earnings bar is very high going into twenty twenty six.
Speaker 2: Whether we can hit that or not remains to be seen.
Speaker 2: I will mention though that consensus has only overshot once
Speaker 2: in the past four years, so quarters on the preseason
Speaker 2: expectation for the S and P five hundred. So yeah,
Speaker 2: the bar is a little bit high. Typically that means
Speaker 2: a little bit more volatility, given you know, earnings are
Speaker 2: already baked in, but that's yet to be seen in
Speaker 2: twenty twenty six.
Speaker 1: Well, certainly be interesting to watch. Much Speaking of the markets,
Speaker 1: I do want to introduce today's guest. Justin White, is
Speaker 1: a portfolio manager of the US multicap growth equity strategy
Speaker 1: at TROW Price, including the trow Price All Cap Opportunities
Speaker 1: fund ticker PRWAX. Justin, thank you for joining us on
Speaker 1: our last episode of the year.
Speaker 3: Thanks for having me.
Speaker 1: So let's start with your process. The four Pillars framework
Speaker 1: is central to your process. How did this framework evolve
Speaker 1: over time and do you ever feel like you have
Speaker 1: to bend or adapt it? When the markets, you know, change.
Speaker 3: Sure, just to kind of get everybody on the same
Speaker 3: page who might not be familiar with with my process.
Speaker 3: Four pillars is the stock picking framework that drives my
Speaker 3: decision making in the portfolio. And the way to think
Speaker 3: about it is each pillar is an incremental reason for
Speaker 3: a fundamental investor to want to own a stock. And
Speaker 3: the idea is that if you can stack attractive attributes together,
Speaker 3: you have a high probability of that stock up reforming
Speaker 3: because there are lots of people who could be interested
Speaker 3: in buying it for a lot of different logical reasons, right,
Speaker 3: And so the four pillars I look for, but for
Speaker 3: high quality businesses. Look for businesses that have potential for
Speaker 3: positive estimate revisions. Businesses with fundamental acceleration and valuation is
Speaker 3: the fourth pillar. So just how did I kind of
Speaker 3: come up with this? So I joined TROW, you know,
Speaker 3: seventeen years ago as a career switcher. Then didn't know
Speaker 3: what I was doing, had to figure it out. So
Speaker 3: I took that whole you know, Warren Buffett mental models
Speaker 3: approach to heart, and the first year or two I
Speaker 3: was in this in my seat as an analyst, I
Speaker 3: just you know, tried to write down notes about lessons learned.
Speaker 3: For example, in two thousand and nine, when a company
Speaker 3: that was seeing negative revenue growth and the stock started working.
Speaker 3: It kind of didn't understand why, but after talking to
Speaker 3: other pms, they're like, oh, it's because revenue growth bottomed.
Speaker 3: It went from negative twenty percent to negative sixteen percent
Speaker 3: year over year. That's why it's working. Right. So anyway,
Speaker 3: over two to three years, I collapsed to all these
Speaker 3: mental models into the four pillars. I started using this
Speaker 3: framework as an analyst in about the twenty eleven timeframe
Speaker 3: and really haven't changed it at all during my tenure.
Speaker 3: You know, each pillar has been approximately equal weighted, so
Speaker 3: you know, save weight to quality and positive visions and
Speaker 3: acceleration and valuation. The one thing I would mention is
Speaker 3: that recently, as as market structure has changed, I've been
Speaker 3: giving a little bit more weight to the quality pillar.
Speaker 1: Okay, so actually it was kind of goes right into
Speaker 1: my next question is when you're looking at a company
Speaker 1: using the four pillars. You know you mentioned it's you know,
Speaker 1: equal weighted, but you know what happens when one looks
Speaker 1: strong as you mentioned, you know, quality, you're really focusing
Speaker 1: on when something else, like maybe valuation might not be
Speaker 1: as strong. How do you balance that?
Speaker 3: Yeah, it's a good question. So the four pillars is
Speaker 3: a body of evidence approach. Right, you look for stocks
Speaker 3: that have enough pillars working for you strongly enough, and
Speaker 3: not many pillars working against you. Right, You don't need
Speaker 3: all four to be positive. So in fact, it's quite
Speaker 3: rare to have all four working for you at the
Speaker 3: same time. And when that happens, you make a big bet,
Speaker 3: like in Nvidia end of twenty twenty two, like was
Speaker 3: scored awesome on all four pillars, and kind of we
Speaker 3: see what happened thereafter. But I'd say, like to kind
Speaker 3: of answer the questions, you can get to four pillars,
Speaker 3: get to yes in a number of different ways. Right. So,
Speaker 3: if there's a really expensive stock like pal Andeer, where
Speaker 3: the valuation is very difficult to justify, right, but it's
Speaker 3: a super high quality business, high margin rapid growth estimates
Speaker 3: have been coming up a lot, you know, the rate
Speaker 3: of revenue growth they're seeing in dollar terms keeps accelerating.
Speaker 3: You know, it's one where even though valuation is negative,
Speaker 3: there's enough good stuff in other parts of the framework
Speaker 3: that you can justify having a small overweight. You know,
Speaker 3: you can also own lower quality stocks if they check
Speaker 3: all the other boxes. Historically, financials don't sort to the
Speaker 3: top of the pack in terms of business model quality.
Speaker 3: I mean, some are better than others, right, But I've
Speaker 3: been overweight banks and capital market stocks this year on
Speaker 3: the view that the starting valuations were attractive. They're being deregulated,
Speaker 3: which is going to be good for returns. Capital markets
Speaker 3: activity was improving from a trough as a kind of
Speaker 3: Trump cut a lot of red tape and allow more
Speaker 3: activity to happen, and that basically is a set up
Speaker 3: for higher returns and higher estimates. So I'd say that
Speaker 3: it's a body of evidence approach, and it instills a
Speaker 3: cell discipline as well, which is important to point out
Speaker 3: because you know, when a stock checks a lot of
Speaker 3: the boxes, I buy it, and when it doesn't check
Speaker 3: a lot of the boxes, I sell it. This led
Speaker 3: me to sell a lot of my tech exposure in
Speaker 3: late twenty twenty one.
Speaker 1: Well, it makes sense. There's something else I wanted to
Speaker 1: ask you about. Is you know I've read you describe
Speaker 1: your research as pattern recognition, you know, basically looking at
Speaker 1: how the world fits together and making sense of what's happening.
Speaker 1: You kind of walk us through, you know, a recent
Speaker 1: example of how how this you know, might have worked
Speaker 1: for you and how that translated into an investment.
Speaker 3: Sure, so I'd begin by answering by saying that four
Speaker 3: pillars is essentially how I describe my pattern recognition, right,
Speaker 3: because it's a the each pillar kind of is a
Speaker 3: reason for people who want to buy a stock, And
Speaker 3: so that's kind of a pattern I observed over kind
Speaker 3: of over time. But let me start with a historical
Speaker 3: example to get to your question, and that a more
Speaker 3: recent one, because the historical example I think is a
Speaker 3: fun one. Right. So there's a company called Smile Direct Club,
Speaker 3: which kind of you know, doesn't it's not not listed anymore,
Speaker 3: and they had their IPO and it's basically an invisiline company,
Speaker 3: you know, clear retainers. And the reason I passed on
Speaker 3: the IPO was because I had studied Netflix's business model.
Speaker 3: People like, what does Smile Direct Club have to do
Speaker 3: with Netflix? Well, both their consumer products, but Netflix is
Speaker 3: like easy to sign up, easy to cancel, the cost
Speaker 3: is pretty low, the value is pretty high, Like it's
Speaker 3: a low friction experience in contrast Smiled Rec Club. Right,
Speaker 3: it's a considered purchase, high cost, high friction, Like you
Speaker 3: have to go in the store, you have to keep
Speaker 3: using the products you know reliably every day. So basically,
Speaker 3: Smiled Rec Clubs the model had attributes that would argue
Speaker 3: for a much shallower s curve of adoption than Netflix.
Speaker 3: People just aren't going to penetrate the tam as quickly.
Speaker 3: Yet when Smile Direct Club came public, they claim they'd
Speaker 3: penetrate their market by ten points a year. Netflix, in
Speaker 3: the sweet spot of its adoption curve only outed a
Speaker 3: few percent of US households in any given year. Kind
Speaker 3: of knew that SDC's numbers were unrealistic in I passed, right,
Speaker 3: So that's that's one one way to get at it.
Speaker 3: But more recently, I'd say, you know, Carvana is a
Speaker 3: major bet in the fond. It's been a very positive contributor.
Speaker 3: And the powder recognition here is that, you know, Carvana
Speaker 3: is a business that a lot of people think is
Speaker 3: you know, they're not sure how how high quality it
Speaker 3: is or not. But when I look at it, I
Speaker 3: see a business targeting a huge market with a first
Speaker 3: mover advantage, with the material cost advantage very early in
Speaker 3: the s curve. Right, they're one and a half percent
Speaker 3: penetrated in their market, and powder recognition tells you that
Speaker 3: when you have a company this kind of has a
Speaker 3: really open ended runway and a competitive advantage that's going
Speaker 3: to persist. You know, don't worry about the valuation, don't
Speaker 3: worry about the quarterly estimates. The structural tailwinds are just
Speaker 3: too strong and pursas for so long that valuation will
Speaker 3: take care of itself. So so that's one that kind
Speaker 3: of we've done it. We bought quite a quite a
Speaker 3: bit earlier, and it's a it's it's been a performer
Speaker 3: this year.
Speaker 1: Okay, great, And you know with your fund it's it's
Speaker 1: an all cap, so you get a lot of flexibility
Speaker 1: in what you can invest in. And so you've also
Speaker 1: said before, you know, when I've looked at you know,
Speaker 1: some of the things online, the il zigmore growth zagmar value,
Speaker 1: you know, tilt up cap or down cap. How much
Speaker 1: of that is tactical versus like long term in your view.
Speaker 3: It's a good question, and at the risk of sounding repetitive,
Speaker 3: for one sentence, I make buy and sell decisions based
Speaker 3: on the four pillars framework, and so when value stocks
Speaker 3: score more strongly, I own more value stocks, right. I
Speaker 3: think the spirit of the question is kind of getting
Speaker 3: at what are my biases and as like, what kind
Speaker 3: of investor am I know? Deep in my bones? And
Speaker 3: I think the answer to that question is that I
Speaker 3: have a growth bias.
Speaker 2: Uh.
Speaker 3: Most of the time my fund has had a growth
Speaker 3: tilt versus the underlying benchmark. And the reason for that
Speaker 3: is because one of my four pillars is the quality pillar,
Speaker 3: and the highest quality stocks tend to outgrow the economy.
Speaker 3: Lower quality stocks outgrow the economy less often. So value
Speaker 3: stocks are often at a starting point at a disadvantage
Speaker 3: because on average they score lower on one of the pillars.
Speaker 3: You know, all else equal, I'd rather own Microsoft over
Speaker 3: time than a brick and mortar retailer.
Speaker 2: Right.
Speaker 3: So I point out that in late twenty twenty one
Speaker 3: and most of twenty twenty two I did not have
Speaker 3: a growth tilt, and that is because growth stocks scored
Speaker 3: really poorly then, especially tech stocks. The issue was that
Speaker 3: we had peakish growth from the pandemic that was about
Speaker 3: to decelerate. We had extremely high valuations, We had consensus
Speaker 3: estimates that were not anticipating any deceleration and so looked
Speaker 3: generally too high. And so you know, I went zero
Speaker 3: eight Amazon went zero weight Meta With hindsight, this was
Speaker 3: the right move. But the reason that I tiled down
Speaker 3: the growth that and added to some value sector was
Speaker 3: really because of the four pillars framework signaling that was
Speaker 3: the right thing to do. Yeah, makes sense.
Speaker 1: And you know, one of the thing I know before
Speaker 1: it might gets into some of the more market focused
Speaker 1: topics is you know, you've also mentioned in your research
Speaker 1: that you come across a lot of data and a
Speaker 1: lot of it doesn't matter, and you're really focusing on
Speaker 1: a couple of things. What are the one or you know,
Speaker 1: maybe two data points state you think are really being
Speaker 1: underappreciated by the market.
Speaker 3: Yeah, so when you say what's underappreciated by the market,
Speaker 3: I do want to point out that that's a different
Speaker 3: question than underappreciated by the media. So just because we
Speaker 3: see headlines about AI bubble one week or it doesn't mean
Speaker 3: the market's doing that or the prices reflect that they
Speaker 3: believe that. So the market's generally brutally dispassionate and right
Speaker 3: most of the time. But in terms of the prices,
Speaker 3: we see out there.
Speaker 2: Now.
Speaker 3: I think they're are a couple things top of mind
Speaker 3: that the market may be missing or getting wrong. I
Speaker 3: don't know if I call these data points per se,
Speaker 3: but but they're just a couple areas where I'm disagreeing
Speaker 3: with the market. The first one is I think the
Speaker 3: market is still too complacent about believing the depreciation schedules
Speaker 3: for AI chips among the cloud platforms. Right. I personally
Speaker 3: don't believe the GPUs have a six year useful life.
Speaker 3: And if these companies are buying chips and advertising them
Speaker 3: over six years but they only last four, then their
Speaker 3: earnings quality is being overstated and returns are being overstated.
Speaker 3: Oracle and core Weave are starting to snit this out
Speaker 3: because they're kind of the tip of the spear, but personally,
Speaker 3: I think there's still a ways to go. I mean,
Speaker 3: if Oracles chips last four years instead of six, then
Speaker 3: they're locking in a half trillion dollar backlog at value
Speaker 3: destructive return levels, and that would be that would be
Speaker 3: a problem if that's the case. One other thing I
Speaker 3: kind of struggling to understand here is the markets enthusiasm
Speaker 3: for the value potential of humanoid robots and autonomous driving.
Speaker 3: And my hang up here is that, you know, like
Speaker 3: Tesla has a market have of one and a half
Speaker 3: trillion dollars, and the logic underlying it feels kind of lazy,
Speaker 3: right as an industry structure issue. You know, suppose Tesla
Speaker 3: figures out humanoid robots, do you think China is going
Speaker 3: to figure it out too? Do you think China is
Speaker 3: going to have a dozen manufacturers? Will they be selling
Speaker 3: those robots below cost for a decade?
Speaker 2: Right?
Speaker 3: And autonomy it's not going to be winner take all.
Speaker 3: There's a lot of Chinese options, There's Weamo, et cetera.
Speaker 3: And so so I feel like this idea that you know,
Speaker 3: one company is going to have monopoly type profits and
Speaker 3: we are confident that that's going to be true for
Speaker 3: decades to come, I'm a little bit unsure about that.
Speaker 2: Do market valuations in general, and maybe particularly for tech,
Speaker 2: do they concern you at all in terms of your portfolio?
Speaker 3: The short answer is absolutely, the valuation concerns me because
Speaker 3: it's always less comfortable when you have to invest with
Speaker 3: a lower margin of safety. But personally, I think that
Speaker 3: stocks tend to follow earnings and will continue to cooperate
Speaker 3: as long as earnings cooperate. And you know, I think
Speaker 3: you mentioned at the start of the of the podcast
Speaker 3: there's been some broadening out of earnings across the market,
Speaker 3: including in small caps. So so you know, just because
Speaker 3: the valuation is uncomfortable doesn't make that a good timing tool.
Speaker 3: It just means there's more negative asymmetry if we have
Speaker 3: have a market hiccop. So one argument in support of
Speaker 3: the higher multiples, by the way, is that the mix
Speaker 3: of stocks in the markets has changed over time. It
Speaker 3: has become higher quality. Right, the megacap businesses are very
Speaker 3: high quality businesses, so some degree of premium is warranted
Speaker 3: versus his. But the areas that make me really uncomfortable
Speaker 3: are stocks where you kind of know approximately what the
Speaker 3: earnings growth is going to be and you just have
Speaker 3: to pay too much for it. Right, So seeing Walmart
Speaker 3: pushing forty times earnings, like, there's a lot of good
Speaker 3: stuff happening at Walmart. But now, even if they do
Speaker 3: grow earnings that at a rate a little better than
Speaker 3: the street expects, couldn't that not go sideways for three years?
Speaker 3: You know? I also think some of the more commoditized
Speaker 3: AI data center component stocks going parabolic because they're in shortage,
Speaker 3: like cables that connect one server to another, and there's
Speaker 3: not enough of them, and so stocks are up tenfold
Speaker 3: in a year. You know, a lot of these stocks
Speaker 3: are beating numbers, but they make no sense on a
Speaker 3: DCF basis, and so when fundamentals peak, in turn, a
Speaker 3: lot of these are going to be down eighty ninety
Speaker 3: percent from the peak. So I say that there are
Speaker 3: areas that make me more uncomfortable and some areas where
Speaker 3: I feel like it's more okay. But on balance, valuations
Speaker 3: are pretty.
Speaker 2: And it seems that tech and maybe more specifically AI
Speaker 2: companies are transitioning from an asset light to a capital
Speaker 2: intensive model with all of this infrastructure build out that's
Speaker 2: kind of necessary to support that theme. Does that change
Speaker 2: how you value companies at all or change your or
Speaker 2: change your view on growth companies?
Speaker 3: Yes, this is a super important question. The rising capital
Speaker 3: intensity of the hyperscalar platforms makes it harder to make
Speaker 3: big bets in them than before. And here's how I
Speaker 3: frame it. So in the past financial metrics that say meta,
Speaker 3: they all trended the same way. Right when revenue was growing,
Speaker 3: ebit was growing, free cashal was growing they all trended
Speaker 3: in the same direction, and now there's this divergence, right,
Speaker 3: and get a setup where you're like, Okay, suppose Meta's
Speaker 3: next quarter, Suppose they beat on revenue by quite a
Speaker 3: bit but miss on ebit because they're investing so heavily
Speaker 3: in AI and guide to no free cash on in
Speaker 3: twenty twenty six. How does the stock process that? It
Speaker 3: depends what people want to focus on, and that's it's
Speaker 3: just harder to know. So essentially the degree of difficulty
Speaker 3: has gotten harder. Oracle has robust earnings growth, accelerating revenue growth,
Speaker 3: and burns a ton of cash. And that cash burns amplifying.
Speaker 3: Like if you look at a chart graphing oracles free
Speaker 3: cash flow against its share price over the last three years,
Speaker 3: it's like a mirror image. It's fascinating. Right, The more
Speaker 3: cash they burn, the more the stock goes parabolic up.
Speaker 3: So I'm not trying to pick on Meta and Oracle,
Speaker 3: but the point is just it's getting harder to score
Speaker 3: these stocks cleanly on four pillars because it's harder to
Speaker 3: score each pillar. Right, is Oracle getting is it accelerating? Well?
Speaker 3: Revenues are, but free cash flow is the wrong way.
Speaker 3: Is meta cheap? Well, it's twenty times earnings, but one
Speaker 3: hundred times free cash flow right, And it's only twenty
Speaker 3: times earnings if you trust the DNA assumptions on their chips.
Speaker 3: So overall, this dynamic is causing you to rotate capital
Speaker 3: to other names and other pockets at the market where
Speaker 3: the setup feels cleaner. Not that I'm running, you know,
Speaker 3: rapidly away from the mag seven, but on balance, the
Speaker 3: incremental dollar of capital is going elsewhere.
Speaker 2: I'm a macro guy at heart, and it seems rates
Speaker 2: are coming down. You know, the White House is influencing
Speaker 2: the FED a little bit and might install their preferred
Speaker 2: FED chair in twenty twenty six in fact, and then
Speaker 2: they may even come down even faster. Does that concern
Speaker 2: you that there might be a lasting shift from growth
Speaker 2: style to value style.
Speaker 3: Yeah, so, I personally wouldn't make the connection that lower
Speaker 3: rates necessarily means you buy value and sell growth. I mean,
Speaker 3: if you took your business school textbook out and thought
Speaker 3: about the concept of duration, theoretically, duration will argue for
Speaker 3: the opposite. Right, lower rates should be more of a
Speaker 3: tailwind for growth stocks than value stocks because more of
Speaker 3: their values terminal value, which was more sensitive to changes
Speaker 3: of discount rate. We kind of saw this with profitless
Speaker 3: tech in twenty twenty and early twenty twenty one. So
Speaker 3: I think the answer to the question about, you know,
Speaker 3: value versus growth really comes down to company specific fundamentals.
Speaker 3: I mean, if you force me to abstract and generalize
Speaker 3: that the times that you want to overweight value are
Speaker 3: either when growth stocks look particularly dangerous like they did
Speaker 3: in late twenty twenty one and early twenty two, or
Speaker 3: the economy's early cycle and broadening out because value stocks
Speaker 3: have a heavier cyclical component to them. I point out
Speaker 3: that even though we've seen some breadth in earnings, which
Speaker 3: is encouraging, it's unclear how much magnitude of improvement there's
Speaker 3: going to be in twenty six. It doesn't feel like
Speaker 3: you're starting at a very depressed level with an imminent
Speaker 3: massive acceleration coming. So I think that the case for
Speaker 3: value stocks is more favorable now than it has been.
Speaker 3: But my portfolio is still growth tilted because on four pillars,
Speaker 3: I'm getting more bisignals and the growth cohorts.
Speaker 2: And how about small versus large caps? Small caps obviously
Speaker 2: been an underperformer for some time, but the valuations are
Speaker 2: looking really attractive at seventeen year lows. I've noted a
Speaker 2: couple of days ago. But do you see any opportunities
Speaker 2: emerging in smaller capitalizations in twenty twenty six?
Speaker 3: So there's the kind of question about next year versus
Speaker 3: like a structural question. So let me just start by
Speaker 3: talking about like structurally, I'm pretty bearish on small caps
Speaker 3: because we're in a world where the stronger are getting stronger,
Speaker 3: and AI amplifies this. Small caps have grown revenues more
Speaker 3: slowly than large caps over the last twenty plus years
Speaker 3: on balance their lower quality. Over the last twenty years,
Speaker 3: there are were two periods where small caps had meaningful
Speaker 3: outperformance that sustained for a full year. Right that was
Speaker 3: two thousand and nine, and it was coming out of COVID,
Speaker 3: And if you think about those two periods, right nine
Speaker 3: and steps of COVID, the setup was like a bloodbath
Speaker 3: starting point stocks down huge Russell two thousand basically didn't
Speaker 3: have earnings. So I don't feel like we're at a
Speaker 3: starting point like that now. So I would argue against
Speaker 3: a huge outperformance of small caps versus large caps next year.
Speaker 3: That said, small cap earnings didn't grow over the last
Speaker 3: three years, and growth has bottomed and recently started improving
Speaker 3: as he mentioned, which is encouraging. Valuations are cheap on
Speaker 3: a relative basis, but on an absolute basis, I think
Speaker 3: they're not that cheap personally, and so in small cap land,
Speaker 3: I'm still just really trying to make idiosyncratic bets rather
Speaker 3: than trying to make a sector call. Now we've made
Speaker 3: good money in biotechs like Insmed, which is no longer
Speaker 3: a small cap, or aero copper because we're structurally bullish
Speaker 3: on copper, always looking for ideas. But right now there
Speaker 3: aren't a ton that jump off the page at me.
Speaker 3: But they might not perform in twenty twenty six. I
Speaker 3: just don't think it'll be shocked in awe if they do.
Speaker 1: So if we go into actual sectors or even themes,
Speaker 1: are there any of that? You think the market's underestimating
Speaker 1: any type of structural change, and you know or are there,
Speaker 1: you know, any mistriced opportunities you're looking for?
Speaker 3: Yeah, So a couple things I think the market might
Speaker 3: be underestimating. First is that as people focus so much
Speaker 3: of their energy on the AI trade, the market is
Speaker 3: starting to kind of ignore and just push to the
Speaker 3: side a number of high quality open ended winners that
Speaker 3: are pretty early in their s curves, and I see
Speaker 3: some opportunities in kind of a number of those. I'll
Speaker 3: just mention a couple quickly, like See Limited is the
Speaker 3: Southeast Asian e comm gaming payments company, extremely well managed company.
Speaker 3: You know on street numbers, it trains it sixteen times
Speaker 3: free flow on twenty twenty seven. It's like a thirty
Speaker 3: percent EBIT dot compounder, and the stocks lost a third
Speaker 3: of its value because people are like nervous about a
Speaker 3: very minor investment cycle for the next couple of quarters.
Speaker 3: And I just see that and think, you know, if
Speaker 3: you put that in a box for three years, and
Speaker 3: it's like, I don't know, twelve times twenty twenty eight
Speaker 3: free cash li like you're going to outperform the market,
Speaker 3: like by a lot as long as the numbers come
Speaker 3: in approximately how we think. Door Dash is another one
Speaker 3: where it's probably sixteen times free cashlo on twenty twenty eight.
Speaker 3: You know, in three years, you know, the multiples can
Speaker 3: be a lot higher on that twenty twenty eight number.
Speaker 3: So I feel like there's opportunity those types of stocks
Speaker 3: that are just kind of not as not as front
Speaker 3: and center as ASAI takes mind share. One other thing
Speaker 3: I think the market's underestimating is the structural supply shortage
Speaker 3: we have in copper.
Speaker 2: Right.
Speaker 3: So in my fund, I own Southern copper and Arrow copper.
Speaker 3: And the insight here is that it's just getting harder
Speaker 3: to get minds permitted, proof moved open in more parts
Speaker 3: of the world right in emerging markets. It's a structural issue.
Speaker 3: It's like a Nimby issue that's metastasized around the world.
Speaker 3: And copper's required in so many things that has no substitutes.
Speaker 3: It's rapid price in elastic. I think copper has the
Speaker 3: potential be well above ten dollars a pound by the
Speaker 3: end of the decade. So those are two that I'd
Speaker 3: point to.
Speaker 2: We've already covered the public market bubble or air quote
Speaker 2: bubble in depth pretty much, but does a possible private
Speaker 2: credit equity private equity bubble concern you at all in
Speaker 2: public markets?
Speaker 3: So I think that if there's carnage in private credit
Speaker 3: at some point, that it will be largely a contained event.
Speaker 3: It'll hit some of the alts, but it's not going
Speaker 3: to really impact the overall economy in a big way,
Speaker 3: it would be my view, because it's you know, it's
Speaker 3: the you know you have you know, people have invested
Speaker 3: in private equity funds and they might take a hickey
Speaker 3: on some some some bad loans being written off, but
Speaker 3: that's not like a bank losing capital and having to
Speaker 3: you know, get help or get get bailed out. So
Speaker 3: I think that they're the hiccups we've seen in private
Speaker 3: credit uh well publicized issues in the last couple of months.
Speaker 3: It feels like it's more one off than structural right now,
Speaker 3: Like there's there's you know, there's some fraud uh and
Speaker 3: and some bad behavior, but you know, overall, we don't
Speaker 3: really have a have a reason to be that that
Speaker 3: concerned about uh the activity. I mean, you know, high
Speaker 3: yield bomb spreads have been quite well behaved this year.
Speaker 3: They're still pretty tight equity markets at the highs. It
Speaker 3: just feels like there were a couple of cockroaches. And
Speaker 3: I hear Jamie Diamond when he says, when you see
Speaker 3: you know one, then there's you know a lot more
Speaker 3: of them. But I think that people are kind of
Speaker 3: like looking for thus ignore that like this is the
Speaker 3: top and I just don't feel like that's I'm not
Speaker 3: kind of on board with that. And I think that
Speaker 3: if there is a problem, it's not going to bring
Speaker 3: down the economy with it. Like if the ai cat
Speaker 3: X bubble unlines, that could bring down the economy, but
Speaker 3: I don't think private credit souring would would would would fantastasize.
Speaker 1: So I got one more question for you. If we
Speaker 1: look out a few years into the future, what are
Speaker 1: a couple areas of the market that could you know,
Speaker 1: meaningfully outperform or underperform through say twenty thirty And you
Speaker 1: know what would be the secular forces that really underpin that.
Speaker 3: So so yeah, look, I like the question because it
Speaker 3: does force you to take a longer term perspective. And
Speaker 3: so if we're talking about, you know, themes through twenty
Speaker 3: thirty and beyond, I just want to be clear by
Speaker 3: saying I could be right over that timeframe, but look
Speaker 3: terribly wrong for six or twelve months first, right, So
Speaker 3: one one area I think could really underperform between now
Speaker 3: twenty thirty is semiconductor sector, and for three reasons right.
Speaker 3: One is just the risk that we have an overbuilding
Speaker 3: ai CatEx that unwines I'm not trying to call the
Speaker 3: top in AI CatEx, but I do think there's a
Speaker 3: real risk that we're overbuilding capacity now and into twenty
Speaker 3: twenty six, and this could become more obvious in twenty
Speaker 3: seven and twenty eight. I also think industry structure in
Speaker 3: many parts of the semiconductor complex is getting less favorable.
Speaker 1: Right.
Speaker 3: Analog semiconductors have more competition than China. GPU market structure
Speaker 3: is still essentially just in Vidia today, but there's more
Speaker 3: challenge coming from Google's TPU, from A and D, and
Speaker 3: against this backdrop, you know, valuations are quite elevated, right.
Speaker 3: It's like the socks is at twenty eight times forward
Speaker 3: earnings if earnings grow twenty five percent next year, and
Speaker 3: the historical average is seventeen times, So you know, it's
Speaker 3: not like a near term call. Like it still looks
Speaker 3: constructive in the near term, but I think over the
Speaker 3: course of several years that it could be quite dangerous
Speaker 3: in terms of areas that could outperform. I think that
Speaker 3: the market's ignoring a number of high quality, cash generative,
Speaker 3: asset light, durable growth businesses, and I think that the
Speaker 3: the insight I would or the hypothesis I would throw
Speaker 3: out there is that for a lot of these companies
Speaker 3: that are lagging, there's a bearish narrative that you know
Speaker 3: there there's there's a there's a problem looming, that there's
Speaker 3: a disruption coming. And in many cases I don't believe
Speaker 3: these narratives, right, And so as these durable compounders just
Speaker 3: keep putting up numbers and keep doing what they're doing,
Speaker 3: fell out perform as you know, people start to dismiss
Speaker 3: some of the bearish narratives and the stocks just compound
Speaker 3: with their earnings growth. So two specific examples there, I'd
Speaker 3: point to Booking dot Com right trading at fifteen times
Speaker 3: free cashrow. Next year, it grows free cashual mid teens
Speaker 3: a year ish. The market thinks it's an AI loser.
Speaker 3: I actually think it's an AI winner. I think they
Speaker 3: have a huge cost out opportunity as they automate more
Speaker 3: of their processes. Because they're the merchant of record, it's
Speaker 3: hard to disintermediate them. And also point only Visa. Visa's
Speaker 3: trading at point eight times the markets free cashual multiple. Right,
Speaker 3: this is a mid teen's earnings grower with no capital intensity.
Speaker 3: And there's always a concern that visa is going to
Speaker 3: get disrupted by by stable coins or pick your reason,
Speaker 3: but it just hasn't happened. And so I feel like
Speaker 3: that those cohort of stocks over the next several years
Speaker 3: could do really well because they've just kind of traded
Speaker 3: down to low multiples on things I don't believe are correct,
Speaker 3: and they're growing twice the market.
Speaker 1: So great. Unfortunately we need to end here, but I
Speaker 1: really enjoy this. Justin thank you so much for joining us.
Speaker 3: Thank you David, thank you Michael In Mike.
Speaker 1: I'd also like to thank you for being my cost
Speaker 1: for our year end episode.
Speaker 2: Thank you both.
Speaker 1: And I also want to thank our listeners for joining
Speaker 1: us on this ride over the past year and a half.
Speaker 1: We'll be back in January with more episodes. In the meantime,
Speaker 1: wishing you happy holidays and a great start to the
Speaker 1: new year. Also, if you liked the episode, please subscribe
Speaker 1: and leave a review. And if you'd like to see
Speaker 1: more of our research on the terminal, go to bi fund,
Speaker 1: Go for fun research in Bisto x N go for
Speaker 1: Equity Research. Until our next episode. This is David Cohne
Speaker 1: with Inside Active