AI Investments: Delivering or Disappointing

Is the AI market a ticking time bomb or a goldmine waiting to be tapped? Join us as Clem Miller helps dissect the current AI landscape, paralleled with the tech boom of 2000, and clarifies whether companies like Nvidia are the kings of the hill or just on a temporary pedestal. We’ll also explore the strategic pivot towards robust defensive stocks—think healthcare and consumer staples—as a buffer against market volatility. Plus, we're challenging the buzz around obesity drugs from giants like Lilly and Novartis, questioning if they're truly revolutionary or just another bubble.

In this insightful episode, we delve into crucial financial metrics such as short interest ratios, beta, and PEG ratios to provide you with a comprehensive framework for evaluating stocks. Discover the red flags and green signals, especially for high PEG stocks like Costco. Additionally, dive deep into AI-related semiconductor stocks, with a keen focus on secondary opportunities in companies like Broadcom and ASML. We also touch on the profound impact of company culture on long-term growth, particularly at Nvidia and Elon Musk's ventures. Whether you're a market veteran or a novice investor, this episode promises actionable insights to navigate the unpredictable AI market.

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Chapters

• 0:00 AI Market Speculation and Portfolio Management
• 17:41 Secondary Opportunities in AI Market

Transcript

Steve Davenport: 0:24

portfolio Welcome. Today it's after Labor Day and we're looking at what's in store for all of the markets, but particularly AI. Today I'm Steve Davenport and I'm here with Clem Miller, and today we're going to talk about AI delivering or disappointing. So when I think about the momentum that we've seen in the big names and the momentum particularly in Nvidia and other semis what happened there and I see a lot of prognosticators talking about how we've gotten away from what we'd call reasonable prices for a lot of the names in the market that are related to technology, particularly AI and I start to think back to 2000 and what it felt like and how every day you went into the office and you said, oh, I wish I bought this, and the next day it was up. My favorite story from 2000 was I had an old portfolio manager and I don't mean old in a derogatory manner, but an experienced person who heard about Cisco and he decided to go buy some, even though he didn't understand what it did, and he ended up buying the food supplier for companies and colleges Cisco S-Y-S instead of C-I-S-C-O, and I think that a similar thing might be going on today with some of these AI names.

Steve Davenport: 2:24

There seems to be just a flurry of activit There seems to be just a flurry of activity and some people don't want to buy the leaders because they feel like they've already seen all the price appreciation, and they're looking for secondary and tertiary names in this space, and my question is are all of them going to survive? Are all of them going to make money? Are all of them going to turn from this is a great idea to this is a great service or product, and this is something that we can do at a reasonable price for future growth? It feels to me like this ar

Steve Davenport: 3:00

I believe it has potential and I believe it will succeed, but I just don't know if it will succeed for all of these names and all of these multiples that are currently out there for some of the NVIDIA and others. And I think that we have to look at this as NVIDIA and others, because NVIDIA really seems to control so much of the market, as we talked about earlier. So much of the market, as we talked about earlie

Steve Davenport: 3:30

there's software for designing chips and also their chips themselves. So, clem, is AI going to be disappointing or is it going to be delivering for us in the next six to 12 months?

Clem Miller: 3:48

So, steveS, thank you. I am growing increasingly concerned about AI, the future of AI and whether markets have really gotten ahead of the reality. Now, ai is a real technology, so I don't want anybody to think that it's like crypto, for example. It's a real technology, it has a lot of applications, it's got a multi-year long or multi-decade long future ahead of it, but I think valuations have gotten ahead of AI, especially compared to other stocks, other opportunities that are out there that one can buy, and so in my own portfolio, I have pulled back a little bit from the large tech stocks and the semiconductor stocks and have moved more into defensive areas which we can talk about. Is that?

Steve Davenport: 5:05

because of a recession, or is that because one has just become out of the pricing has become?

Clem Miller: 5:12

bad. Well, some of my defensive names are also somewhat expensive. So it's not entirely because of evaluatio, it's because they're defensive. So let me just remind everybody what you know, at least, what I mean by defensive. Defensive doesn't necessarily mean, in fact, it doesn't mean the same thing as high valuation versus low valuation. What defensive means is basically high alpha, high beta versus low beta, beta being the sensitivity to the market. So the things that have a high beta are some of the technology stocks not all of them, some of them and things like banks and materials companies and some consumer discretionary companies, some industrials. Then you're talking about lower beta stocks. Lower beta stocks, those that are more defensive, would include healthcare and consumer staples, and consumer staples and consumer staples, healthcare utilities. I tend to stay away from utilities. So, in terms of both the more sensitive and the less sensitive to market movements, stay away from utilities and I kind of stay away from banks.

Steve Davenport: 6:45

in terms of the more sensitive from banks in terms of the more sensitive. But there's some of the fervor around these healthcare companies like Lillia Novo, around the diet, or call them obesity, right, I mean, it feels to me like it's a secondary bubble. Do you agree? Or do you think that when people got tired of buying AI technology, they started thinking about obesity and it feels like it became a secondary? Do you look at that that way or are you interested in those names?

Clem Miller: 7:26

Well, I think that I hold both Lillyly and novartis, as well as a number of other uh pharmaceutical and healthcare companies, and you know, I I think before there was this um, or did you hold them?

Steve Davenport: 7:43

are you holding them because of this?

Clem Miller: 7:47

obesity. No, I think you know I'm focused a lot on some of the numbers, right? So I spent a lot of time thinking about numbers and not necessarily about themes, although themes add into it. So I'm not buying Novartis and Lily because of the obesity drugs. It's not a because of I'm holding them because of other factors. So I've mentioned before about trying to focus on lower short interest ratios. Well, I am looking at that and, in terms of being a little bit more fearful about a market downturn, I've sort of dialed down to a lower beta for the overall portfolio. So that's why I've got more defensive, a higher weight of defensive stocks in my portfolio and to some degree, I'm looking at peg ratio too. I know you look at peg ratio and one of the issues with peg ratio is that it all depends on your expectations, or market expectations, I should say, of earnings growth in the future. Right?

Steve Davenport: 9:02

I think the hardest thing is that peg ratios absolutely kind of lose their value as you go out in terms of a growth rate, three years, three years, four years, five years right, and you can make a a one year peg ratio.

Clem Miller: 9:17

But if you're a lot, not looking to hold stocks for a year but looking to hold them for three, four or five, then so, on a long-term peg ratio, nvidiavidia looks pretty cheap, but that all depends on whether the market or analysts, I should say, are accurate in their prognostications, and I'm not 100% convinced about that. Now I still, you know, I do hold nvidia, uh, but you know, am I, am I, you know, betting the farm on nvidia? No, absolutely not. I don't think anybody really should. Uh, uh should bet the. You know, it's all up to you. I'm not making an investment recommendation, but, uh, let me just say about myself that, uh, I'm not betting the farm on nvidia.

Steve Davenport: 10:12

Well, don't you think that it will eventually be the winner here? I mean it's going to grow into I mean it's already grown into being up 100% in revenue and earning. It's already going into its number that is so high.

Clem Miller: 10:41

The thing you have to worry about is not, or the thing you have to expect is not that it will continue, but that you're going to see some pullback on that 100%. It's actually better, in my mind, to sell some of that NVIDIA and reap the gains than to sort of let that rip. So, from a practical standpoint, what that means is that as the weight of NVIDIA in my portfolio has grown, I have trimmed it to reap some of those gains and reinvest them elsewhere. But I'll tell you, I am not so much concerned about Nvidia as I am about some of the Mag7 stocks. I'm not in Tesla at all. I have concerns about Microsoft. I have concerns about Amazon. I have concerns about Google.

Clem Miller: 11:42

These stocks have not performed well recently and they're not inexpensive. Their peg ratios obviously depend on future growth as well. Their short interest ratios are pretty good, but you just haven't seen the performance there. So you really have to make an educated guess about when they'll turn around. And I just don't have a feel for when those will turn around. And I just don't have a feel for when those will turn around. Now, that's not to say I don't hold them. I do hold them, but I wouldn't be putting new money in there as the market pulls back a little bit Can.

Steve Davenport: 12:35

I just clarify something. Yeah, I have most of my assets in an IRA and when you talk about selling, are you selling in a taxable or a non-taxable? Or can you just talk about what prevents you? Because I agree with trimming, I agree with doing these things no, mine are in-, but I also have to be sensitive to the people out there who might be owning things in taxable accounts where selling and trimming can be a little painful.

Clem Miller: 13:06

Right, the large majority are in an IRA, so I have no issues with selling and buying. So I don't have to track that, although I I'll tell you it is. It is useful to look at the. I find it useful to look at the unrealized gains and losses numbers to give me a sense of of when I might trim. So I think it's you know, it's a it's a useful indicator and if I have a lot of unrealized gains, that just tells me, you know, even though it doesn't mean anything to me on taxes, it tells me that, you know, maybe it's a good time to to sell a little bit, you know, rather than let these things, uh, rather than let these things run.

Clem Miller: 13:58

Now, I know I'm sort of contradicting myself a little bit, uh, from some prior uh podcast episodes some time ago where I would say I have a tendency to let things rip for a while. Um, I think I'm a little more sensitive in this market to not letting things rip. Or, let me put it another way, when I look at my portfolio and its performance and what the market's doing, I would rather stay invested in the market than pull back and have a lot of cash. Stay invested in the market than pull back and have a lot of cash. I'd rather stay in the market, but I want to change and shift around what I invest in, which is why I go to the. I'm shifting subtly towards the lower beta.

Steve Davenport: 14:51

I think that makes sense. I think it's the right idea. I'm just trying to sometimes I get into the you know what are we going to have in the future and what are we going to have in 25 and 26 in terms of cap gains rates, and in some ways, I think now could be a good time to sell, because I think that, you know, after I was a little bit overwhelmed after that last discussion with Steve Gattuso and the debt, it's a very discouraging topic in terms of what are we going to do and it feels like increasing taxes is the natural decision. Increasing taxes is the natural decision, but natural decisions don't necessarily come when you have, you know, other people with other agendas, right, and I just think there has to be some reckoning and some people who you know pay taxes at a lower rate, are going to be a natural place for politicians to look when it comes to how do we find more money. So I'm trying to help everybody be efficient, but the uncertainty about tax rates is a variable that we have to kind of put into the blender as we mix them all up and come up with a smoothie for the future of our portfolios.

Steve Davenport: 16:19

So I like the idea of doing a little bit now, where you know what your rate is, versus pushing it off into the future where you don't know. So when we look at AI, I don't think we have to have the answer, but I want to try to at least give people a sense of when things get out of whack or we feel that they're above multiples, that we think they can maintain. What is the point or the dividing line between something that looks just a little expensive and something that looks like we need to act and do something? I mean, do you have a peg ratio or a number that says, hey, when I'm paying three or four times the growth rate, it's just too much. And is there a number in your mind that you use to try to make those decisions?

Clem Miller: 17:22

So I would say there are three numbers and a way you can kind of think about it as multiplying the three numbers in a sense, so that all three of them are kind of levers, right, so that all three of them are kind of levers right. So I got a little concern. Let's start with short ratio, short interest ratio, which is the ratio of short interest divided by free float shares outstanding. I would you know I get a little nervous. I get nervous when short ratios are above 2%. So that's one indicator. Preferably lower, right.

Clem Miller: 18:04

I don't think that when you get below 1% there's any great improvement that you get. Moving from 1% to 0.7, 0.5. Most things I'm very comfortable with a 1% to 1.5%. When I get above 2%, that becomes a concern. So there's that On beta.

Clem Miller: 18:28

I mentioned that I want to keep beta relatively low in my portfolio and so in order to do so, I have to be concerned about stocks that have higher betas Nvidia being one of those, by the way and I would say that I mean definitely two is too high and I feel much more comfortable with under, say, 1.4 or 1.5 beta on an individual stock.

Clem Miller: 19:00

Of course, that's something where you can do a weighted average in your portfolio, right, if you have a bunch that are like 0.5, like the defensive ones I was talking about healthcare and so on that offsets it.

Clem Miller: 19:12

And then I've got peg ratio, and I get concerned about peg ratios really that are above two, and I've got only a few of those in my portfolio that are above two. I think if you had to weight average the peg ratios in my portfolio, I'd say they're like you know, 1.6, 1.7, something like that. I have a few that are really high and I get really nervous about those because I know that a really high one means a lot of difference, right, and the one that we've talked about, one that is obviously great concern in a prior podcast, one that keeps doing well despite a high pay ratio, and that's Costco. So I always keep my eyes open on Costco. I still hold it, but it's high. So I think one way to look at this issue, like I was saying, is to maybe look at the multiplicative product of the three indicators I just mentioned short interest ratio, peg and beta.

Steve Davenport: 20:28

Okay, that's a good idea. Well, I feel that the AI story has become NVIDIA plus others and I'm trying to figure out. Looking at the secondary names, do you feel that there's some obvious answers in terms of the people who are going to succeed are close. When I look at the AMD and I think about other chip makers, it's going to be very hard for them to supplant NVIDIA. But I look at server farms and some of the storage and some of the other needs and I feel like there's where a pretty big opportunity is going to exist. Opportunity is going to exist. Do you look past the NVIDIA story and say the secondary beneficiary is going to be company X? Where do you see the secondary opportunities around NVIDIA and AI?

Clem Miller: 21:35

So I do not own AMD. I think that they don't fit the numbers that I was just talking about. So they're going to play second fiddle, a way back, second fiddle, a way back, second fiddle. Much smaller proportion of the AI-related semiconductor market than NVIDIA is. So I'm not terribly optimistic about AMD. I like, even though it's not an AI-focused semiconductor company. I like Broadcom. That's AVGO. So I like Broadcom. So that is in my portfolio. I have, you know, when I look at you know, I do have ASML, which is the monopoly, or near monopoly, producer of semiconductor manufacturing equipment. I think they're going to do well, no matter what. I do not own Taiwan Semiconductor, which I think is for obvious reasons surrounding geopolitics Although, honestly, if you have a problem with Taiwan, it's going to affect the entire sector. So I think those are the those I mean at Prodcom and NVIDIA. Let me just look quickly through my portfolio here to see if there are any others I'm forgetting about well, there's one other article I read this week that I'm not sure um no, I don't, I don't have.

Clem Miller: 23:57

You know I don't have any, I've got. You know, I've got other tech companies, but you know I'm really down to those two. In terms of semiconductors, you know, I have things around. I have things around like switching equipment for networks, like ar. Networks is one of my favorite companies, nope. And CrowdStrike right, nope.

Steve Davenport: 24:25

I don't have CrowdStrike now created so many millionaires and that the people in the are all driving cars in the in video color and it's it's got a very tough environment that the engineers there are expected seven days a week, 12 hours a day and it's a very, very difficult to get people to talk about.

Steve Davenport: 24:52

But the culture is very difficult, it's tough on those employees and you don't get those type of bonuses and stock options without delivering on a regular basis in a very competitive space. And I know you look at some of the things on employee satisfaction and some employees. I think that the culture and whether the culture can be maintained should be as much a thought as to whether the growth rate can be maintained, because they're one in the same Right If you don't have the employees who are willing to keep making every quarter super important and making sure they hit every goal. And I think that my desire for nvidia is to improve their culture so that they can maintain their strengths going forward, because I don't think that the culture the way it is today, the culture the way it is today is really possible to maintain I, I, I 100% agree with you.

Clem Miller: 25:55

I would also point out you know SpaceX and Twitter and Tesla. You know the Elon Musk companies. He's got a culture which is essentially a negative culture as well for his companies.

Steve Davenport: 26:17

I understand where you get wrapped up in a concept and an idea and you move it to a point where it gets recognized. But I also understand that people are not machines. They need to be able to rest in order to be able to think clearly and add value. So I'm a little bit surprised that the culture clash of employees being expected to do more that when we took away people's privacy by saying hey, you're on the phone 24-7. If I have a question on Sunday afternoon, I don't just wait until you know 9 o'clock Monday, we talk about it and we interrupt your football time and your family time.

Clem Miller: 27:02

So in my mind, those are still legitimate concerns and I agree, and you know one of the things we may have talked- about this, talk about it much do you call it, you don't hear people talk about it much.

Clem Miller: 27:17

Yeah, in fact, you know you got all this emphasis on ESG and you know employee satisfaction should really be high up on the S and the G part of ESG, but you know they don't look. You know these indicators and these ESG indexes and indicators they don't look at employee satisfaction. You know they look at other things, like, you know, injuries on the job and so on, which are, you know, not reflective of employee satisfaction, and I really think those indexes should. So I do look at Glassdoor ratings for employee satisfaction. I like to see Glassdoor ratings that are above four, but I'll go lower on some of them and in certain cases I'll give the benefit of the doubt and go lower. So, for example, I hold RSG Republic Services Group great company, but it's a garbage company, right, and so how high is the employee?

Steve Davenport: 28:29

standard. You don't have to say it like that, Clum.

Clem Miller: 28:31

You can just say it's a waste removal company? Okay, waste removal company, but how high can its employee satisfaction rating be, Really? So I discount that indicator for that company, all right.

Steve Davenport: 28:47

Well, I think we wanted to touch base and I think we have touched a lot of points about AI. If we were to wrap up, my comments would be it's always good to look at your portfolio and make sure you understand how much risk you're taking and how much you've made, and I think we've covered that pretty well. I believe that there are other things secondarily, like employee satisfaction and how you're treating employees and whether that growth rate can continue based on that. Employees I know they could hire new employees, but there's obviously been a very competitive culture and it's produced great results. But I don't believe you can continue in that vein just using the same resources, because I think there's you know people burn out. So my concern for AI isn't just on the chip usage, it's in employee usage. So do you have any more points to make, clem? For as we close this out on AI and developing or disappointing, I'd say we're somewhere in between right.

Clem Miller: 29:58

Yeah, I think I would just say that this is a struggle between valuation and growth, and I don't think we, you know, I think right now AI is a little bit growthy or a little bit pricey in terms of valuation. I think that the growth story will continue. I think it's a you know, it's a great theme going forward, but it's you know, it's not something where it would be crazy to buy an AI thematic ETF which doesn't distinguish among companies of different valuations and different qualities. I just you know, I just you know that would be a mistake. You need to look at individual companies and make decisions, as I have done in my portfolio, in terms of not holding a lot of different semiconductor stocks, but focusing it.

Steve Davenport: 31:03

Yeah, I would add to that that I'm not sure if you haven't been participating with any of these names that now is the time to start. I believe that this theme and some of these names you could have been participating in without knowing really, by holding a general semiconductor ETF or holding some other exposures here. But I believe that we're seeing more clouds on the horizon that are going to make it more likely that these prices could become more reasonable, and I would say patience is the thing to do here. So that's how I look at it is let's throw a little patience at it and some of these names may come back and be at more reasonable prices where you could expect better long-term returns. So thanks everybody for listening and please share and talk to your friends and let them know that you've enjoyed Skeptics. Thanks, steve.

Clem Miller: 32:08

M Thank you Steve.