Thoughts on The AI-driven Market
Since ChatGPT was first announced in late 2022, the market has been trending up. For example, the S&P500 index is up roughly 45% since December 2022. Microsoft, an investor in ChatGPT’s parent company OpenAI, is up more than 84%. Nvidia, the company that designs the chips that other companies need to train AI models, is up 745%!
AI is seemingly the next big thing, and companies mention “AI” anywhere they can. So I want to give my thoughts on the current market conditions and provide an update on our portfolio.
AI is all the craze right now. Everyone mentions AI on the news, earning calls, and even at work (-.-’). While I think AI is pretty interesting and has practical uses, labeling everything as AI is misleading.
I find it funny whenever I come across an “AI-powered” service like a translation service, website builders, or flight finders 😀 when it’s just a glorified chatbot with a machine-learning algorithm.
Companies like to label their products/services with buzzwords to market to customers and investors. Remember when headlines were about “big data”, “cloud computing”, and “blockchain”? AI is no different. Sure, the technologies behind these are oftentimes innovative, but it’s important to know the difference between genuine innovation and hype, especially in the stock market where even coffee could be “AI-driven” 🙂
Portfolio Update
Now onto our portfolio, we did make some major changes to it. We sold our entire position of Starbucks and Blackrock, and we recently bought MSCI.
Starbucks recently reported earnings, and it was not pretty. Revenue stayed flat, profit went down, and comparable store sales went down. Fewer people are going to Starbucks while they keep raising prices.
Their China business also did poorly for the quarter despite recovery last year. The brand is also not as strong as I originally thought. With the revival of Luckin Coffee, one of the competitors in China, and Cotti Coffee, an uprising competitor, Starbucks was forced to participate in a price war.
Starbucks also lower its FY24 guidance to flat growth from 15%-20% just a quarter ago. The free cash flow also went negative. This along with the previous issues prompted us to sell the stock. Until these issues are solved and free cash flow goes in the right direction, we will not buy back in.
As for Blackrock, we sold it not because the business was doing bad, but because there was a better opportunity at the time. MSCI, an index provider, was on the decline around the same time.
Like how Blackrock provides ETFs for investors, MSCI provides the indexes that are required to create ETFs for asset managers like Blackrock. MSCI’s business model is one of the higher-quality business models that I’ve seen.
There are a couple of ways MSCI makes money. They create and maintain various indexes, and they then charge licensing fees to institutions that use these indexes to create ETFs, mutual funds, etc. Along with that, there are also asset-based fees that are linked to the assets under management of the ETFs that track their indexes.
Think of the licensing fees as the price you pay to access these indexes and the asset-based fees as extra ongoing revenue. MSCI also provides services like analytics and risk management tools, ESG ratings, etc. that usually generate revenue in the form of subscription fees.
MSCI’s business model is extremely asset-light compared to companies that involve manufacturing, infrastructure, etc. Most if not all of MSCI’s assets are intellectual property, and they generate money through licensing and subscriptions.
It is also scalable as it doesn’t take much for MSCI to get new clients as the marginal cost to acquire is very low. MSCI also doesn’t have to spend much on capital expenditure to keep its business going, which results in a very high margin both on the net income and on a free cash flow basis.
Evidence of this is the steady revenue growth rate of 11% and free cash flow growth rate of 14% in the past 5 years. It also has a lucrative 40%+ free cash flow margin. Not only that, it’s also one of the fastest dividend growers, with a 5-year average growth rate of 20%.
The only thing I don’t like about MSCI is its debt-heavy balance sheet. It currently has ~$500 million in cash but ~$4.6 billion in debt. However, I’m not too worried about this as long as they continue to generate free cash flow like they have been.
Those are the big changes that we made to our portfolio. In our opinion, these are positive changes as we continue to invest more in higher-quality business models. Also, as a side note, Apple is currently our biggest position, sitting at $24k in current value and 14% of our portfolio. Apple’s total return is sitting at 40%.
Our most profitable investment yet, however, is TSMC, with a current value of $18k, a roughly 104% return since we invested in this company. While it is enticing to take some gains from TSMC, I am refraining from doing so because it is difficult to find a business with a larger moat than TSMC.
It doesn’t matter if AI ends up being the future or not, TSMC would still be necessary in the modern world as it manufactures most of the world’s advanced semiconductor chips. There are geopolitical risks, but I find that a lot of times these are noises that promote certain political agendas that don’t affect the actual performance of the business.
Dividends
In the dividend realm, we received $691.13 in Q2 2024. Year over year, it’s an 11.5% increase from Q2 2023. However, it is a 14.9% decrease from Q1 2024. That’s because SCHD, which usually pays dividends in June, pays dividends in July this year.
So far year to date, we received $1999.25, a 61.8% increase from the same time last year! We’re happy with our dividend growth, and it’ll continue to grow as we continue to invest.
As always, we continue to stay invested and try not to time the market by jumping in and out of it. And we’ll keep holding onto the companies in our portfolio unless the thesis changes (like in the case of Starbucks) or if there exists a better opportunity (like MSCI).
Thanks for the update!