Over a decade ago I had lunch with Rob Arnott at Bardi's steakhouse in Toronto. Rob founded Research Affiliates which runs $130 billion in what is best known as “smart beta” strategies. In a recent Financial Times article, Rob Arnott was interviewed and quoted as saying that there is a ‘big market delusion’ in AI stocks and in particular mentioned Nvidia. When Rob speaks, I listen. In a nutshell, Rob was arguing that basically, a big market delusion is when something important is happening with just a handful of companies that are pioneers in the field. And a narrative emerges: “This industry is going to be huge. It’s going to change the world. The companies in it are dominant players. They’re going to remain dominant players. So, you can’t value them based on conventional valuation metrics, because this is going to be big.” Narratives have the advantage of being largely true and the disadvantage of being entirely reflected in current share prices. One error made in big market delusions is assuming the dominant players today will still be the dominant players 10 years from now. Often new disrupters come along and disrupt the old disrupters. Another error is valuations getting out of hand, based on speculation that the market will grow big faster than it actually does. In the article Rob takes on one of my biggest holdings: Nvidia. He illustrates with an historical warning about Qualcomm. Back in 1999, it had risen more than any stock in the world. It was up over 27x. Since then, it has remained a dominant player in the plumbing of the internet. How has it done as a stock? You would have been twice as wealthy today investing in the S&P 500 than investing in Qualcomm back at the start of 2000. Furthermore, you had to wait 18 years to be back above water. How’s Qualcomm done as a business? Profits have risen 60x! So, the narrative was correct. But the market bet that narrative would play out a lot faster than it ultimately did. Right now, Nvidia is posting strong earnings growth, making its multiple less extreme than Qualcomm at the peak of the dotcom bubble. But the current narrative with Nvidia is that they have a wide moat in which produce the fastest chips that are needed in AI, and that it’s expensive to design and build new, even faster chips. Competition will likely challenge their moat, and valuation will likely become a concern at some point, but The Newton Group will continue to hold Nvidia and buy with new cash. One difference with our approach is we will never be a bag-holder, as our risk management in trimming overweight positions and ultimately using stop losses if needed will defend our portfolios from outsized downside if and when Nvidia mimics Qualcomm one day.

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(new) Alibaba (BABA-US) Jack Ma, the co-founder of Alibaba, has largely disappeared from public view after clashing with Chinese officials over his outsize persona and critical comments about the government. And he had appeared to distance himself from the tech giant last year by giving up control of Ant Group, a fintech sister company of Alibaba. Yet in recent months, the man once regarded as China’s top C.E.O. has been buying up shares in Alibaba, as has Joe Tsai, his longtime business associate and the company’s chairman. Alibaba has had a tough time in recent years. The company and Ant were among the first to be hit by a broader crackdown on the tech industry that wiped out roughly $1.1 trillion in market capitalization from the sector. In 2020, Ant was forced to call off its potentially record-breaking I.P.O., a stunning move that was widely interpreted as regulators reasserting dominance over private enterprise. Chinese officials later imposed a $2.8 billion antitrust fine on Alibaba. New position in Opportunity Portfolio.

(+) Alpha Metallurgical Resources (AMR-US) Although there has been a global push towards cleaner energy sources, coal still remains a vital part of our energy mix. In fact, a recent report by the International Energy Agency found that global coal demand hit an all-time high in 2022 amid the energy crisis, far outpacing the previous record set in 2013. According to the U.S. Department of Energy, coal accounted for about 20% of the country's electricity production as of October of last year, highlighting the commodity's significance in maintaining grid stability. Despite the fact that the coal industry has grappled with major headwinds like a string of coal companies going bankrupt, the broader coal industry had an impressive year in 2023. The Tennessee-based miner, whose operations are mainly concentrated in Tennessee, boasts high-quality reserves, and specializes in supplying metallurgical products to the steel industry. Its portfolio also includes highly productive and cost-competitive coal mines across the Central Appalachian coal basin. The company is America's largest producer of coking coal, producing about 20% of total 2022 production. In FY2022, Alpha Metallurgical produced 16.1 million tons of coal and had over 300 million tons of reserves. Roughly 70% of the company's coal output is exported, which ties in well with the fact that it owns 65% of the DTA (Dominion Terminal Associates) export terminal, which is capable of loading up to 6,500 tons per year. Since January 2022, AMR has bought back 28% of its stock, making it one of the most aggressive buyback programs on the market across all sectors and industries. Going forward, the company has increased its share repurchase program authorization by $300 million to a total of $1.5 billion, allowing for approximately $560 million in additional repurchases. Looking ahead to 2024, the company provided guidance, anticipating shipping between 15.5 and 16.5 million tons of metallurgical coal. Owned in Opportunity Portfolio.

(+) Canadian National Railway (CNR-T) produced a top and bottom line beat relative to consensus expectations driven by broad strength across volume categories. The widely followed operating ratio also came in at 59.3%, approximately 30 basis points better than street forecasts. CNR also announced a 7% increase to its dividend. We view both rails in Canada as core holdings given their critical roles in the economy, solid pricing power, and high barriers to entry. Owned in Core and ESG+ Portfolios.

(+) Crown Castle (CCI-US) reported a good Q4/23 quarter with a beat on AFFO/share and showed accelerating organic billings growth. Excluding the impact of Sprint cancellations, organic billings for site rental revenue were 4.9%, up from 4.0% last quarter. We just recently purchased the shares but CCI’s stock price is down 27% over the past 52 weeks, underperforming the S&P 500 due to the deceleration of 5G buildout activity by carriers as well as concerns over rising interest rates given the high leverage position. As a result, the stock trades at a forward P/AFFO multiple of 15.5x, a discount to its historical long-term average of 21x. We continue to like CCI given its leadership in the oligopolistic towers market in the U.S., leverage to secular growth trends such as 5G, overall revenue and cash flow visibility of the towers segment, and an attractive dividend yield of 5.8%. Owned in US Portfolio.

(new) IBM (IBM-US) Big Blue is Back. The tech and services provider has been stuck in the mud for the last decade while its competitors have enjoyed the bull market of a lifetime. However, its business results have recently started to exceed expectations, making the stock one of the best performers in the S&P 500 in 2024. It is well positioned to benefit from a host of tailwinds in CY24 and beyond driven by a combination of Enterprise IT spend improving to drive productivity and AI centric tailwinds that could drive upside to consulting and software segments overtime. We think as Enterprises look to deploy AI tools to enhance productivity – the process will be complicated and messy, furthermore we think data security and not running enterprise data on public LLM models will be a key focus – IBM with their unique set of consulting and software assets can help solve this bottleneck and enable enterprise customers to deploy AI tools on and off premise more seamlessly. Therefore, we think IBM is an overlooked beneficiary of increasing AI adoption. Shares yield 3.87%. New Position in Cash Flow Portfolio.

(+) Intuitive Surgical (ISRG-US) The global technology leader in minimally invasive care and the pioneer of robotic-assisted surgery, announced financial results. Worldwide da Vinci procedures grew approximately 21%. The Company placed 415 da Vinci surgical systems, compared with 369 in the fourth quarter of 2022. The Company grew its da Vinci surgical system installed base to 8,606 systems - an increase of 14%. Revenue of $1.93 billion increased 17%. In January 2024, the Company obtained CE mark certification for the da Vinci single-port (SP) surgical system for use in endoscopic abdominopelvic, thoracoscopic, transoral otolaryngology, transanal colorectal, and breast surgical procedures. The Company plans to commercialize the SP system in select major European countries throughout 2024 as part of a measured rollout strategy. Owned in Opportunity Portfolio.

(+) Louis Vuitton (LVMUY-US) is a global producer and distributor of luxury goods. The French company is a dominant force in the luxury industry with a diverse portfolio of brands that cover a wide range of consumer products and experiences. LVMH operates more than 5,000 stores around the world. They are the second largest company in Europe after Novo Nordisk. In general, LVMH’s results were great. Growth accelerated again during the last quarter of 2023. Revenue: €86.2 billion (13% organic growth versus 2022). Profit from recurring operations: €22.8 billion (+8% compared to 2022). Net profit: €15.2 billion (+8% compared to 2022). Double-digit organic revenue growth in Europe, Japan, and the rest of Asia. LVMH will propose a dividend of €13 per share (dividend yield: 1.9%). Owned in Core Portfolio.

(new) McDonald’s Corp (MCD-US) stock rallied to new highs, its first in seven months, dismissing Wall Street concerns over declining sales and traffic in an uncertain macroeconomic environment. The company is expected to report fourth-quarter results in early February. The FactSet consensus for same-store sales is for growth of 5%, down from growth of 8.8% in the third quarter and 11.7% in the second quarter, and less than half the 12.6% growth seen a year ago.

Despite this deceleration, McDonald’s has beaten same-stores sales expectations in the past 11 quarters, and in 17 of the past 20 quarters. Growth in the number of restaurants of 4% to 5% is encouraging as this is the first time in recent memory that this has happened. McDonald’s has made significant investments in the past decade to improve the productivity of new stores. Shares yield 2.07%. New Position in Cash Flow Portfolio.

(+) Netflix (NFLX-US) Netflix’s stock price jumped after topping analysts’ revenue and subscriber growth expectations during the fourth quarter. The streaming giant added 13.1 million subscribers during the quarterly period, reaching a record 260.8 million in paid subscribers. Owned in Core, ESG+ Portfolios.

(sold) Norfolk Southern (NSC-US) Not impressed. Non-GAAP EPS of $2.83 misses by $0.04. Railway operating revenues of $3.1B (-5% Y/Y). We sold our shares in the US Portfolio.

(+) Procter & Gamble (PG-US) is demonstrating its ability to navigate stubborn inflationary tides. The consumer durables titan, offering numerous familiar household brands like Tide and Mr. Clean, has been raising prices, slashing costs, and focusing on its premium brands over the past two years to maintain its margins as labor, fuel, and commodities remain material headwinds. While this strategy has come at the expense of volumes as consumers trade or hunker down, reducing the size of their overall basket, the metric continued to improve in Q2, an encouraging sign that perhaps headwinds are finally shifting. Sales growth was slim in Q2, edging just 3.2% higher yr/yr to $21.44 billion, relatively in-line with consensus. Growth was broad-based but uneven, with PG's Grooming division leading all other categories at 6% while Beauty was at the bottom at just 1%. Fabric & Home Care, Health Care, and Family Care comprised the middle of the pack, expanding net sales by 5%, 4%, and 2%, respectively. While revenue continues to expand primarily from prices as opposed to volumes, PG's Q2 results demonstrated its brand prowess, leveraging the loyalty of its consumers to maintain impressive margins and keep revenue growth positive. Inflation may continue to prove challenging for PG. Still, given how well it has traversed the landscape so far, its appeal as a defensive stock continues to grow. Owned in Cash Flow and US Portfolios.

(+) ServiceNow (NOW-US) Overall Q4 results beat street estimates on broad-based strength across the business, despite a relatively steady, but still challenging, demand environment. The biggest positive surprise was that NOW is already seeing early GenAI contributions from faster than expected Pro Plus adoption following its first full quarter of availability. Management raised 2024 guidance above levels given at its analyst day, with stronger subscription revenue growth of 21.5% to 22.0%. Operating margin and FCF margin of 29% and 31% were largely in line. The stock is up +72% over the past 12 months, outperforming the broader market. Owned in US and Opportunity Portfolios.

(+) Taiwan Semiconductor (TSM-US) Shares jumped on earnings results. Revenue of $19.62 billion increased 13.6% over last quarter. TSM forecasts revenue growth in 2024 of over 20% from last year. Not only is Taiwan Semiconductor the world’s largest dedicated contract chip manufacturer, but the company is also the industry's technology leader. TSM holds a near 60% share of the foundry industry and an 85% share of the market for high-performance chips designed for AI and accelerated computing processes. This dominant position allows TSM to post industry-leading profit metrics. More importantly, management indicated that as a result of rigorous capital management, TSMC's Board of Directors approved the distribution of a NT$3.5 per share cash dividend for the third quarter of 2023, up from NT$3 previously. This will become the new minimum quarterly dividend level going forward. In the next few years, we expect the focus of the cash dividend policy to continue to shift from a sustainable to a steadily increasing cash dividend per share. That’s a fairly hefty increase, and management is broadcasting that TSM intends to reward investors with bigger payouts moving forward. TSM's debt is rated AA-/stable by Standard & Poor's and Aa3/stable by Moody's. The company finished the quarter with $55 billion in cash & cash equivalents and $30 billion in debt. The stock yields 1.61% with a single-digit payout ratio. The 5-year dividend growth rate is 6.97%. During the earnings call, management announced a dividend increase of roughly 12%. Owned in Opportunity Portfolio and new position in Cash Flow Portfolio.

(-) Tesla (TSLA-US) reported their quarterly numbers, and the market was not impressed, sending the stock back below $200 a share for the first time since May 2023. Tesla has fallen out of favor with traders since September last year when it became evident that higher interest rates were having a serious impact on vehicle sales. This has resulted in big price cuts for Tesla cars, which naturally impacts margins and revenues, both of which missed analysts' estimates. However, the long-term story is still very much intact. I am of the firm opinion that the drop in demand has nothing to do with competition or a diminution in EV demand. This is a purely macro issue related to interest rates. No company is immune to macrocycles and internal challenges. These usually create good long-term buying opportunities. For investors with a higher risk appetite, we feel now is a good time to accumulate more Tesla shares. Owned in ESG+ Portfolio.

(~) UnitedHealth Group (UNH-US) is a cash-flow machine but dipped on poor results from Humana. Over the past decade, UNH has hiked its payout by an amazing 571.4%. The ever-rising dividend is a result of ever-increasing cash flow. UNH's perennial growth isn't simply due to good fortune. Management had the foresight in 2011 to start its own technology driven Optum unit. Optum provides pharmacy benefits, runs clinics, and supplies data analytics and other cutting-edge tech to streamline healthcare. Shares yield 1.49%. Existing position in US Portfolio but new to Cash Flow Portfolio.

(+) Verizon (VZ-US) Shares jumped after the telecommunication giant exceeded Wall Street expectations for its fourth quarter. Verizon posted $1.08 in adjusted earnings per share on $35.13 billion in revenue. Shares yield 6.28%. Owned in cash Flow Portfolio.

(~) Visa (V-US) Visa’s stock declined even after the company topped quarterly estimates. Revenue clocked in at $8.60 billion, surpassing the analyst expectations of $8.54 billion, a 8.37% increase over sales of $7.94 billion the same period last year. The digital payments company, however, adjusted its operated expenditures guidance higher and said payments volumes have slowed in January. Very happy to own the company and would add to any weakness. Owned in Core, ESG+, US Portfolios. New position in the Cash Flow Portfolio.

Weekend Reading

RBC MacroMemo - January 23 – February 5, 2024 Priced to perfection / Consumer tailwinds / Higher rates hurt / Survey versus hard data / Geopolitics / Shutdown averted / Republican race / Election platforms / Canadian housing stress RBC

Why the S&P's New Record May Not Mean a Bull Market The new all-time high is welcome news. But the S&P has failed to get back to its 2022 high in terms of gold, or in real terms adjusting for US inflation. It has, however, completely walloped the stock markets of the rest of the world, and bonds. BLOOMBERG

The Art of Looking Stupid Instead of being embarrassed, we view our ability and willingness to look stupid as a competitive advantage. PALM VALLEY CAPITAL

Tesla Preview: Margins Stabilize in 2024, Competitive Lead Expand Margins are particularly important to the TSLA investment case given they’re at the front line of the investment debate: Is Tesla a car company or a tech company? DEEPWATER

Peter Bernstein: Embracing Surprise When something you expect to happen, doesn’t happen, you get surprises. In markets, the result is an adjustment in prices. Some people might call it volatility. NOVEL INVESTOR

Do I get to keep any assets in bankruptcy in Canada? And is bankruptcy cheap? Yes, quite a few, actually. And yes, it sure can be cheap. Canadian insolvency legislation is quite generous, as a matter of fact. Interesting article from a good friend of mine. SCOTT TERRIO