Hello and welcome to The Download. I'm your host, Dave Richardson, and it is Stu's Day. Except it's not Stu's Day. It's Thursday, because we're a little bit late this week. Stu, you are a global traveler these days because you got the big job and that means you got to go to Hong Kong and all these exotic places. London, England. Anywhere else? Did you stop in Boston, Chicago, Minneapolis?

No, those have been the two, London and Hong Kong.

Going to wait for better weather to go to the other, the colder destinations?

Yeah, I'm up for anything. It's just so remarkable when you travel these days, you set your system up in whatever your location, and you might as well be sitting back at your desk in Toronto. We have some great teams and great thinkers in the different countries. You always get more of a perspective of different sectors globally that are exposed to different things. I'm sure we'll talk about it, but North America has more software exposure, but the tech sector in Asia is much more the memory stocks, semiconductors, much more hardware oriented. So they haven't really experienced any of the question mark that's been thrown into some business models in the last couple of weeks. Yeah, it's been good.

And talking about that, you have all these companies, Meta, Google, Amazon, Microsoft. I always forget Microsoft. They have been reporting for this quarter, and they announced massive increases in spending in CapEx. I think the total between the four of them is $750 billion that they're planning to spend this year. Just to put that in perspective, I think the entire Canadian economy is about $2.6, $2.7 trillion. So it's like four companies are spending as much as a quarter of what Canada produces in a year, which is just mind-blowing. And then, you expect to say, based on everything that's been happening over the last few years, this is good. AI is real. This makes it even realer. And certainly, companies that are involved in the pics and shovels and the things that are going to go into those big data centers and all this investment, those stocks are going to benefit. They're all part of that build out because all this spend is here. But it hasn't really felt like it's just rippled through the market that way. The winners and losers don't seem to be the same or even within a particular area, there's a winner and there's losers. It just doesn't feel the same as when this has happened previously. What do you make of that?

Well, it's a great point, and it's different than it's been in some of the prior announcements. I would say outside of technology, for most of my career, if some company announced a very large capital expenditure, the stock market would view it suspiciously. In other words, will you get the returns on the capital that you're putting to work? If you were XYZ business, you're building a mine, or you're putting a new plant in, and it was going to be a meaningful percentage of your balance sheet, the stock market might take a wait-and-see mode and say, will it go over budget? Will you get the cash flow out that you've promised us in the plans? And for a long time in technology, when they raise the capital expenditure budgets, the stocks rallied even more. This was last year. This year, it is a bit of a different reaction when you get these huge budgets. You mentioned some of the numbers. This time around it has been a little bit more suspicious. And management have said, we’re seeing this great demand, and we wouldn't put the capital to work without having high return expectations. Of course, that's what they're going to say. They're the ones putting the capital to work. No one puts money to work purposefully to waste it. But the market's reaction has been a little bit more wait and see. It's happened at the same time as different models have come out, and some of them have thrown a further loop into, should I worry about the sustainability of my business model? Because as we get more graphic illustrations of what artificial intelligence can do, it's allowed imagination to wonder, will revenue growth be what I imagine? Will the margin profile of the business be what I've imagined? We've talked a number of times in the past about what are the four things that make a stock go up? You have revenue growth, you have margin expansion, you have valuation expansion, and you have putting capital to work and earning an incremental return. Those four things, when you've had some of these announcements out around what AI can do, they've thrown into doubt each one of those four things in some cases. Then you see some dramatic share price reaction. In that share price reaction, you'll get the defense from management. Nothing's changed. I still have a great business. In many cases, that will still be true. But what investors really care about is, will the margin profile be what I thought it will be? Is the business becoming a little bit more capital-intensive? Does it require more R&D than maybe I thought? We've talked about this. A good example is, I rent an apartment, and I paint it once a year. What happens if I had to paint it three times a year? It's not that these businesses are going to disappear, but will they become a little bit more capital intensive? Will the margin be a little bit different? Will the revenue go from charging me a monthly subscription to, will it be success-based? So these are all things that require a discussion. And then that's what gets debated in real-time in the stock market. Our team has done a tremendous amount of work. We've used AI. We have RBC Assist here. It allows you to speed up a lot of the work you do. We've gone into each business and say, how much of the expense line goes to your customers? How pervasive are you within the organization? Are you an infrastructure or do you sit as an application on top of the infrastructure? To get through the areas of the business that we think will be more defensible as valuation is contracted to say, well, this might be more interesting. It's been a very iterative process. I think the more recent thing is there's been some service businesses. Will these service businesses get replaced with artificial intelligence? In there, we tend to focus on the margin. Software businesses, some of them have 40, 50% margins. And by margin, I mean, that if they have a dollar of revenue, they generate 40 or 50 cents of cash flow per dollar of revenue. So the old business line is, your margin is my lunch. So the first place you're going to go after are higher margin businesses. Some of these services businesses, the margins are 15 to 20%, some even a little bit lower. I think that those are more branded, and there's not quite the gravy there to go after. In which case you might be replacing some labor, but the brand could also replace some labor. There's been a lot of thought going on, obviously, around who's exposed, who's going to have opportunity from this. And that's been an ongoing process. Like anything we do, it's likely to be very iterative.

Yeah, and iterative in a way, just thinking about a service business, for example, that has some really higher skilled people who build sophisticated plans for customers. You've got the people who are maybe just at the front end who take the initial call and who have the initial contact with the customer. And early on, those people can be replaced because AI can do that for them. So it actually reduces the cost. But then AI keeps pushing forward, and then all of a sudden, it's doing some of that planning that was being done by those other people. Or a competitive business using AI comes up against the human-led business and ends up being more cost-effective. So it challenges the profit margins of the more human-based business. So you go through different stages as AI moves through an organization of eroding the potential revenue or margins within that business.

Yeah. The way that I think you sum it all up is that it erodes investors' confidence a little bit in what they otherwise believed. And unfortunately, valuations still continue to be elevated. The stock market is a discounting mechanism, and it discounts all sorts of risks that never present themselves from time to time. But it is trying to sort its way through this environment by prices being more volatile.

Yeah. I think of back… Oh, sorry, Stu, go ahead.

Which seems remarkable because as much as there's been volatility, we're 1.5% from highs. So I think we need to keep that in perspective because there have been other businesses that have had very strong price performance through this period of time. If they've been viewed as immune to some of these pressures, consumer staples and some of these businesses. So there's lots of things in a portfolio that have benefited from some of this rotation as well. We should definitely make that point. But I think any investor, once you see volatility, you want to be moving towards there and doing your analysis on those stocks because that's where a reversion of the current negative sentiment would provide opportunity. So you're trying to indeed come to the conclusion, is there opportunity in those areas?

So are you finding that you've been moving the portfolio around more than normally over the last six months? We've talked about this rotation many times over the last couple of years, that ultimately these tech stocks—and we're not saying that this is the final nail in the coffin in terms of that rotation—but at some point people would start to say, these tech stocks, they have some issues, they have some things that we're concerned about, and they need to deliver at such a high level that they start to look somewhere else and then you start to see the rotation happen. So have you been moving around the portfolio a lot lately, or are you still doing the analysis, but waiting to see exactly how it might play out?

Well, it's a bit of all that. The portfolio is moving around. We've talked in the past, when you get in these situations, you know it's not going to be perfect. I think we've mentioned, I think twice in my career have I sold at the all-time high and bought at the all-time low. You're tending to move in steps. So you see negative momentum, you conclude your financial and fundamental analysis that you think that business is attractive, and then you're using a bunch of other tools to leg into the position. Unfortunately, there's been lots of stocks that I thought were too expensive, and I sold them the day I thought they were too expensive, and they became more expensive. And the same thing when stocks go down, you say, well, this is cheap enough. And then it might continue. We have fundamental views, but then we also know the old quote that we love, narrative follows price. So when you're going through this period of time, it can often take a bit more than just the acknowledgement that something's cheap for it to bottom. It sometimes takes time. So we're being very deliberate. And we always talk about dollar cost averaging for portfolios. You're doing the same thing. You might see some stocks here where valuations have expanded meaningfully because they don't have exposure to artificial intelligence and they're viewed to be safe. Those valuations might hit levels where you say it's pretty hard for that company to compound for me, so you start harvesting those. And then you find some other businesses where you say, well, the stock market has been unduly hard on this company. And I think it's going to continue to flourish. And you start legging into those.

Yeah. And for those of you who are not regular listeners, if you'd like to be a regular to the Download, please subscribe to us or follow us on any of the platforms that you get your podcast. We're also on YouTube if you foolishly want to see us, but it's actually good. I'd subscribe. And we always like a nice review and feedback. But one of the common themes on the podcast when we're talking to Stu is I'll give him a list. Well, are you doing this? Are you doing this? And are you looking at this and doing this? And Stu always comes back with: all of the above. And I point that out. We're doing a little bit of everything. We just have an example of that in the last few minutes. And there's a reason I'm pointing this out, and that's because what a professional investment manager like Stu is doing—because it's not just Stu, it's a whole team of people that he's got people working with him all over the world, that they are paying attention to a much broader number of things than the average investor is. And they're paid to position the portfolio in the right position—or what they think is the right position—every day and making adjustments. So it's often, for me as just a regular investor, I invest on my own, and I think of the things that I'm evaluating and I'm doing and thinking about and think of it as an either-or. But the great thing about Stu and his team is it becomes «and». And, and, and. Because they have the capacity and the tools to do all that analysis. And it just makes it, particularly in times like this, Stu, a lot better for a professional portfolio manager like yourself.

Yeah, volatility is the friend of the active manager. And there's a whole cadre of tools in the toolkit that we continue to employ. There's always lots of work going on, but when you get volatility, that is really a time to get to work.

I'm wondering, we haven't gotten into this yet this year, but the Olympics are on. Are you a big Olympic guy, Stu? You like the Olympics?

I do. I haven't had as much time in the Winter Olympics to get at it as I would like, probably just because it's been busy.

Well, I think so far we haven't quite gotten that big Canadian Olympic hero out of this Winter Olympics. But there's a hero that's always around, Stu, helping us, particularly through these volatile markets. Think of the moguls that we're going through from a market perspective. And this is a strategy that you can employ. And I think you've even referenced it already, that you employ as you're moving in and out of positions slowly and carefully. Do you know who this hero is, Stu Kedwell?

The dollar cost average boy. And he’s going for the gold.

Dollar cost average boy going for the gold. Do they like the dollar cost average boy over in Europe and Hong Kong?

Well, I think it’s such a great tool across asset allocation, individual securities. You always think, well, I'm just going to polish this and it's just going to be just perfect when I put something to work. And unfortunately, the odds of that are not very high. So when you're a long-term investor and you're just leaning into the wind one way or the other against good analysis, dollar cost averaging is just a great tool to have at your disposal.

Yeah. And so I look at, in particular, Canadian investors right now who still have a lot of money sitting in cash, sitting on the sidelines as markets have continued to perform well. And as you say, we've seen this bout of volatility, but markets are still 1 to 2% below their all-time highs. This is a way to make sure that you get that market participation without making that overcommitment and maybe seeing a bout a volatility or a negative run for a short period of time in the markets. It's just a way to make sure that you're continuing to put that money in and getting the benefit, ultimately long term of what stocks do for you.

A 100%.

A 100%. The other thing I wanted to mention is the last episode. We don't get you talking too much specifically about something like gold and silver, but you had some specific things to say the last time. And we've coincidentally seen gold and silver move off their high, blow up higher and then just fall back. And as you reflect on your thoughts, is this something that surprises you or is this another somewhat of a lesson in terms of the way these markets can go when the momentum and the excitement is a little too frothy?

Well, I think an investor always needs a fundamental toolkit, a quantitative toolkit, and a technical toolkit. And at different points of the cycle, you need to lean a little bit more heavily on different tools. So when it comes to those markets, commodities are a difficult one because sometimes the solution to high prices is high prices, and vice versa, the solution to low prices is low prices. In big long-term moves—I think we may have discussed this—but there's been like four or five instances where the gold price does nothing for a period of time and then it breaks out, and it can rise by three or four fold in those moves. And once it gets past a two and a half times move, it tends to get a little rockier, a bit more jagged as it finds its way. So, some steam has come off there, and we'll have to reevaluate it at this juncture.

Yeah. And again, it's not to say you don't want to have gold in your portfolio but have it in a reasonable amount. As Canadians, we've got plenty of gold in our market. If you have a diversified portfolio of Canadian stocks, you've got lots of gold. You never have to worry. This is making the decision to go more into it. And what I always worry about is, this momentum builds and people are going in and not necessarily understanding why they're going in, except that they think it's going higher. So that's why you go in. And that's not, as you say, the basis to make an investment. On a number of different measures, is there value there and is there potential for return given the risk you're taking? And these are always things that happen in the market every day on a smaller scale. But this one was on a larger scale, and I thought it was worth revisiting a couple of weeks later because it was interesting. We did it the one day and then the move happened the very next day. So, Stu, thanks again for the time. I know you've been busy and it's always great to hear from you and your thoughts on the market. I was out with some investors today at lunch, and there's a genuine confusion and it seems like things are a little bit different right now. I think you gave us some really good perspective on some of the things that are happening underneath the major indices and perhaps leading to a little bit of a shift of direction—or not. Stay flexible, use the same tools, stick with the strategy, and you'll be successful because that's what you do.

Great. Thanks very much, Dave. I appreciate those comments, and I look forward to talking to you again.

Excellent.