Transcript: Investing in AI? Be prepared for long ‘digestion period’

Dave Taylor on strategies to capitalize on the AI theme

Dave Taylor (DT): Our overarching strategy is really to own these sets of enablers, these companies that just win, no matter what, without the real risk. So, it’s companies like ServiceNow [Santa Clara, Calif.-based ServiceNow, Inc.]. It’s companies like Accenture [Dublin-based Accenture plc]. It’s companies like Cadence [San Jose, Calif.-based Cadence Design Systems, Inc.]. The best part about a company like Cadence is it’s software, it’s recurring, it’s a subscription. This company is incredibly well positioned. ServiceNow would be another one. And, again, avoiding the risk, here’s a company with recurring revenue, basically unchallenged from a competitive standpoint, and they grow 20%. So there’s a long runway here for this company. And then, lastly, Accenture, which is just very well positioned as these secular trends play out.

Tyler Hewlett on areas of caution within tech

TH: An important distinction to make is software versus hardware. We’ve always gravitated more towards software. The growth is more steady. Growth rates can trend higher or lower, but generally they’re not very volatile. You think about software companies growing at 15% a year, it may be 12, it may be 17, but it’s usually not wildly variable from there. You contrast that with hardware. Hardware is typically not recurring, which means that it’s harder to predict. It means things like supply and demand become a lot more important. When you catch industry off guard from a demand perspective, supply can’t adjust fast enough, which means that you get double and triple ordering from customers. Eventually you get a supply response, and then when the spending slows down, you’re left with too much supply. And that’s when you get a lot of digestion in the industry. Typically, we spend a lot more time trying to ensure there’s more predictability in the longer-term revenue profile of the companies we invest in in that area.

Dave Taylor on why the big names in tech are still attractive

DT: While the returns have been incredible with the big names, valuations are not completely unreasonable. These companies have network effects. They have that flywheel around them. I think Google [Mountain View, Calif.-based Google LLC] has eight or nine businesses with over, you know, a billion users, which is just incredible. So they’re scalable like we’ve never seen before. Companies like Apple [Cupertino, Calif-based Apple Inc.], our phones have become an extension of ourselves. I mean, it’s our wallet, it’s our keys, it’s our camera. I think they’ve positioned themselves really well with AI. Everyone wants access to Apple’s large installed base. And the best part with Apple is it’s a capital-light strategy. So different from the other hyperscalers, they’re not the ones that have to spend the capital. Microsoft [Redmond, Wash.-based Microsoft Corporation], it’s the world’s operating system. It’s a fantastic moat. Advantages around this business is distribution, high recurring revenue, you have the cloud with Azure. And they’ve positioned themselves very well with Copilot and these AI tools that they’re rolling out. Maybe lastly, just quickly on Amazon [Seattle, Wash.-based Amazon.com Inc.]. It’s a rare moat where I think the moat is actually getting better. There’s Prime, there’s AWS. So it’s scalable. They have network effects. Again, they have the same drivers that Azure has with Microsoft. They’re the leader in cloud, and their growth is really coming from their highest-margin areas. When you think about Europe, you don’t find a lot on the technology side. You find a handful of companies. ASML [Netherlands-based ASML Holding N.V.] is a special business. RELX [London, England-based information and analytics company RELX plc]. Wolters Kluwer [Netherlands-based information services company Wolters Kluwer N.V.]. In Canada, I mean, it’s a small marketplace. There’s a handful of names that are special, unique, have those characteristics that we look for. Companies like Descartes [Waterloo, Ont.-based Descartes Systems Group] in the global logistics business. I think Shopify [Ottawa-based Shopify Inc.] is a name that we’ve known for a long time. High growth, innovators in their space. Everything for us is underpinned by free cash flow. That is a core tenant of our philosophy. Free cash flow is what drives a business. Companies that can use their free cash flow and grow it over time, there’s a long runway for these types of businesses.

And finally, Tyler Hewlett on the bottom line for tech investing in the current moment

TH: Tech, over the years, has become increasingly important, both from a societal perspective and from a market and investing returns perspective. We don’t think that’s going to stop. Technology only moves forward, and it only gets better. But you do have to be careful as an investor, because it is an exciting area that is prone to lots of hype. We like to focus on how this is likely to look over the next five to 10 years, and on those companies that we are highly confident will continue to make their businesses larger, more important, better revenue growth over time, but usually to a much smaller degree than the very exciting things that happen in the short term.

Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Dave Taylor and Tyler Hewlett of Mackenzie Investments. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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