Hello and welcome to the Download. I'm your host, Dave Richardson. And it is Stu’s days. And if you were wondering if we were going to skip the entire month of March, well we got pretty close, Stu. We were letting people down.

What do they say, Dave? March comes in like a lamb and out like a lion.

Oh, wow. So you're going to be on fire today. And if you're not this week, then stay tuned for next week's Stu’s days because apparently that's going to be a killer. But I guess they actually let the old guys here get a bit of a break. Well, you're not that old. I'm old. So we were able to get a vacation. And you had a good break with the family?

Yeah, it was fantastic. We went to Costa Rica, which was amazing.

Oh, really. Really beautiful. Any highlights?

Well, I'm not a surfer, but there were these swells that had taken place, so there were ten to twelve foot waves, and just sitting on the beach watching the pros have a go at the waves was something else.

Wow. That's just like the podcast. The listeners get to hear how the pros surf these unbelievable markets that we've been having and learn some new techniques and styles that they can use to get more success in their portfolios. Is that a good analogy or have I botched that one, coming back from a break myself?

No, that's quite a segue. You got a couple in there. You even got a good break.

Well, speaking of surfing and riding the high wave, we've had a lot of stocks, particularly in technology and quite specifically in artificial intelligence, that have been riding an unbelievable wave. We've talked about the Magnificent Seven and we might even come back to it a little bit later with maybe a different way than we did before. But you get to a certain level of valuations. If you're doing the boogie board like I do. I'm out in California sometimes and I'll get on the boogie board and maybe a three-foot wave. I got a lot of weight on that board, too. I'm not a little fella. I guess they call it blubber in oceanic terms, that the whales might have. So I got that. And I'm there and I'm coasting along, and then the wave come crashing down and it still knocks me all over the place, and I get a gulp of water and some sand in my eyes, and I dust myself off. And it's not too bad. I guess if you're coasting along on a twelve-foot wave, though, and a big board and standing up, you fall down off of that, and it can hurt if you can't stay up on top of that wave. And we've seen some companies where that's happened through this past earnings season.

In the US market in particular, enthusiasm often goes to levels that you can't imagine, and also the way that they might deal with a period of concern. And the way that a stock price trades is a two-legged stool. There's earnings on one side and valuation on the other. And we get differences in both sides. But if we get elevated valuations, then we have to be very focused on the persistence and the growth of those earnings. And with artificial intelligence coming along, some companies have been using it in some form, maybe a rudimentary form, for a long time. That sets to accelerate in almost every aspect of business to some degree. But there's also going to be new competitors emerge out of nowhere and the confidence that investors might have around the current earnings of the business comes into doubt. There's all sorts of things that we're going to have to pay very careful attention to as investors in the coming years. There'll be companies that become more efficient. These companies with big brands, they have the customers, so they'll be able to look at all their lines of expense and maybe become more efficient and serve their customers in new ways, and they'll become more profitable. And there's a mirror to what happened in the 2000s, where a lot of big businesses were slow to embrace the Internet. Then they embraced it, and it took off in terms of driving efficiency. But there's also other technology providers that have been providing things in a certain manner, and it's been very resilient. And that might be at risk, because artificial intelligence comes along and either directly threatens their current business or throws some doubt in investors mind that they might. And we've seen it time and time again, where industries will start to lose their valuation on a modest change in cash flow, and it's the stock market sniffing out this new competitive threat to their business. We've seen that in a couple of software stocks in the last weeks. The thing that often happens is that if you lose a bit of your valuation because of one of these competitive threats, your business can keep growing, but it's sometimes hard to get that back because once an investor has been exposed to something, they often remember that risk, and it's hard to get that fully back into the bottle.

It shifts the momentum. And I think one of the companies you were referring to is Adobe. Now, we don't spend a lot of time on individual companies and individual names, and Adobe is a great company. I bet a lot of the listeners today have used Adobe in some form or another. But an example of a company that had high valuations and high expectations, and disappoints, and then you see what happens to the stock after that.

100%. Will they have the competitive abilities to embrace AI and put it into their products? Most definitely. But there was a shadow of doubt put in place with OpenAI throughout some video-type software. If I asked to show me a picture of a dog, we'd get four legs with a stencil or something like that. But when you asked OpenAI to show me a dog drinking water, and they showed you back a video, and you're like, wow, that is really something. This is simplifying it, but it raises that shadow of a doubt. And then when your financial results aren't quite as strong or it looks like there's a delay in terms of people embracing some of your tools, you get that combination of a small change in the earnings and a larger change in the valuation, and the two-legged stool falls by more than just the earnings alone.

Another software company. We didn't really talk about this before, so I may catch you, and if so, we'll move on to the next topic. But a big software company, or a relatively new software company, I should say, Snowflake. And the CEO resigns, and all of a sudden, the stock drops 30% just on the resignation. There's some mixed results in the numbers and strategy and all that. Is it fair to put that kind of a value within a large company on one leader at the top of the house?

Well, that did come again with some changes in the underlying financial forecast. So it was a combination of some adjustments in the financial forecast and then the leaving of the well-known CEO that cast doubt on the confidence. When you think about the valuation that a company trades at, or the multiple — whether or not it's of sales, cash flow, earnings, whatever it might be — that multiple starts with interest rates, because that drives the discount rate. Then it's some premium for risk and growth. So in that instance, you affected two of the three underpinnings to valuation because the growth forecast ever so slightly changed. And at the same time the risk premium goes up because the CEO is leaving. And that's why you get a more dramatic change in the share price. So you look at a company — that's why I say this is a two-legged stool — we would go to our Bloomberg or whatever your machine might be and say, okay, show me the valuation metrics. But you cannot look at valuation metrics in isolation. You need to say, show me the characteristics of the business that are driving the earnings that we're applying or the sales that we're applying. So if the sales growth forecast is astronomical, then you can go and compare it to your database of companies and look at historical growth rates and say, am I expecting something that's never been seen before? If I'm looking at margin expansion, I can take businesses and say, well, what are their margins? Are they too high? Are they too low? And come up with some type of cash flow type estimate. So the combination of revenue and margins on my earnings front and valuation, whatever the chosen metric, I always look at those two charts and say, me personally, I'm not comfortable betting on very high valuations, on very high optimistic earnings or sales outlooks.

Yeah. And then as you say, some CEOs have a certain level of notoriety, and others don't have quite as much. They sit in the background and quietly run the business. When you see the CEO, it's another risk factor, as you say, that would make you a little hesitant or make you look a little closer at what's going on.

And it happens in both directions. There was a cardboard box company, International Paper, obviously very different than anything in the tech world, but its stock surged when their CEO changed to someone from private equity. Because the market is then assigning a probability that the private equity person will be very numbers focused. They're going to really get in there and look at the returns on capital and make the business more efficient. Anytime there's a change, the market tries to handicap the implications of that change. Sometimes it's right, sometimes it's wrong, but that's what they're attempting to perform.

Okay, what do you think, historically? Does the market do a pretty good job of that handicapping?

It does. Often the first reaction is a good one around mergers and acquisitions, all sorts of things. Normally the initial reaction is pretty good. And the reason that it's pretty good is that normally it's like a historical reaction to the type of event, and each event has certain odds of taking place.

I'm just going to let you know, I'm probably going to work another five or six years; if that impacts your decision making around our stock. Just another data point for you. Not overly significant, but just put it in the back of your mind there. Talk about changes in cash flow and cash flow projections and an area that we've talked about. We've had Scott Lysakowski on, who's talked about the cash flow that's generated out of energy companies all around the world. But the Canadian energy companies have done a particularly good job of elevating their cash flow to a point, with current energy prices, where they can do some interesting stuff. And I guess there's a Canadian energy company that's going to commit this success they've had in cash flow generation to their shareholders. Why don't you talk about that?

Well, most of the large energy companies, the integrated oil sands producers like CNQ and Imperial Oil and what have you, they wanted to get the debt on their balance sheet down to a certain level. And when they reach that level, they'll use the majority of their free cash flow for dividends and share buyback. And we're seeing that Imperial Oil has done a handful of substantial issuer bids along with regular buyback. And then the interesting thing is that if I buy back 5% of my float, I can increase my dividend by 5% just because I'm paying it on less shares. So you get this kind of flywheel of shrinking share count, rising dividends, even in a variety of commodity assumptions, you set the dividend for a realistic commodity assumption. And then if you get above that, you're using that additional cash flow to buy back shares.

And I think in the Canadian energy case in particular, again, they're dedicating a portion of that money to innovate and move towards a carbon neutral position, which is also very important in terms of the way shareholders and just the general public views that company.

100%. And the reason that shareholders are interested in this is because it will extend the duration of their cash flows. So if they can be successful with carbon capture, then these asset bases will be able to run longer and the cash flow will last longer.

Excellent. So that's an interesting area. Not everybody wants to invest in that area, but those companies are part of the group of companies that you're so familiar with, Canadian companies, that are very good and consistent dividend payers.

I do like dividend paying stocks, Dave. You're bang on that front. Today, you can build a portfolio of dividend stocks that yields you somewhere in the neighborhood of 4%. And we think those dividends are going to grow 4 to 7% over time. We've probably had a period where it's been at the lower end of that range. But as interest rates start to come down, and a lot of these businesses have embraced efficiency programs in the last twelve months, and as the economy starts to do a little bit better in response to lower interest rates later this year, we think that the dividend growth can move back closer to the middle of the range. And you never have a day in the dividend fund that's as exciting as Nvidia or what have you. You never wake up and look at yesterday and say, what a day to own the dividend fund. But as a water-on-stone element to your portfolio, driving to your long-term financial plan, that combination of a reasonable current dividend yield and dividend growth is a pretty sweet tonic to that long-term financial plan.

That reminds me of one of my favorite stories. When I was a practicing financial planner, a client calls me and said, why don't you have any Nortel in the dividend fund? This is back when Nortel was really spiking high, back in 1999-2000. And I said, well, it doesn't pay a dividend. That would defeat the purpose of having a fund called a dividend fund, to have stocks that don't pay a dividend. And he went, it doubles every two weeks. Isn't that the kind of dividend that I want in my dividend fund? No, it's not exactly that. Of course, we went on to have the conversation and I explained what could happen to a stock like that relative to the other stocks in the dividend fund. Of course, that's the way it played out. But that dividend income and the ability to pay that dividend by generating cash flow consistently. It’s the track record of repaying shareholders that makes the types of stocks that you want to have in a dividend fund unique.

And the other thing, too, is there's lots of way to bake a cake. The important thing as an investor is to apply your baking skills consistently. And if it's growth investments or momentum investments or whatever, there's lots of ways to get the job done. That's one thing. But inside of a dividend fund, you're going to find a very stable set of ingredients that get the job done slow and steady over the long haul.

And that's a great segue to remind the listeners. They probably don't even realize it, but they're in the investment Stu right now. On Stu's days, we started the investment Stu. The idea that we'd have kind of a hodgepodge of things we'll throw into a pot and stir around and see what we get. It was very popular with the listeners, by the way. I ran into a couple of people who really like the investment Stu, which is why we're right back at it again. So let's put in the last ingredient of this week, Stu, and that is the financials on some of the US banks. And you already talked about interest rates coming down. We had the Fed meeting yesterday. Still looks like they'll be cutting rates through the year. And then what is that an indication of to you in the broader economy and then potentially earnings and where interest rates go?

Well, a couple of things. I'll be brief here, but the stock market has done quite well and broke out of this two-year range, say, before Christmas. But that was led by a handful of stocks. What we've seen in the last couple of months is financial stocks, particularly in the United States, start to make new highs and just break out of that same two-year range. We've seen a similar movement from the equal-weighted market. But when financial stocks start to perform better, that's not usually associated with imminent recession. When you think about recession, you think about too much credit losses, you think about slowing business, you think about slowing activity. So seeing the financials take on some leadership characteristics in the market is certainly a positive. That's definitely been the case from the big money center banks, the investment banks. We've talked about investment banking on prior podcasts. But those stocks have been quite strong in the last couple of weeks, and that's normally a leading indicator to the market's strength.

Absolutely. Very quickly, to finish off today, we had a big IPO in the US today: Reddit. It looks like it's having not such a surprising jump in the midst of a market where, as you say, there's a lot of exuberance and enthusiasm, particularly around tech, AI or social media. Is it a good sign that we're starting to see some IPO activity?

Yeah, the initial phases are always good when you get a lot of IPOs. That means the animal spirits are going. So on the one hand, it's an enthusiastic sign. On the other hand, there tends to be an initial period where IPOs are really good, and then it tends to peter out a little bit. So we'll have to be watchful that we'll see all the things that get brought out of the cupboard to try and go public. First, out of the gate is normally some of the higher quality stuff, and then we'll have to evaluate it from there.

Yeah, and you can go back in the history of the podcast episodes. We did a whole episode on IPOs and then talked about the quality, how it starts, and then how it deteriorates. To the point where we were IPOing the Stu’s day's podcast, and that was going to be a bad sign for the market. So go back and listen to that previous episode, and hopefully you enjoyed this hodgepodge of topics because we've been off for a few weeks. And Stu, thanks as always for being here to teach people. I learned quite a bit today.

Well, I'm not sure that's a high bar, Dave, but thanks for your time and for everyone who's listening.

All right, we'll see you next week, Stu.