Q: Do you consider the rally in artificial intelligence (AI) stocks a market bubble?
Hollie: There's been a lot of speculation and headlines about the sustainability of the current AI spending. Is the demand real? Is it just circular? Is there a bubble? Our views are not informed by reading the headlines. Our insights come from our deep research and we have discussions every day with companies across industries and around the world. Every company we're speaking to is investing in AI. Some are doing so to create new revenue streams, others to drive competitive differentiation and all for productivity and efficiency gains.
So yes, we believe AI spending is real. It's sustainable and it's likely to drive trillions of dollars of spending over the next decade. But that doesn't mean there won't be pauses in spending. From time to time, companies will need to digest their GPU purchases. They'll need to manage the level of CapEx spending.
Business is cyclical, so there will be times when growth goes sideways or even down. But we believe these are temporary headwinds. The growth in spending on AI computing power is a long-term structural driver of growth. Knowing that market volatility is a given, our process is designed to take advantage of price weakness, ignoring the noise, having the discipline and the insight to buy long-term structural winners when others are selling in fear. We're able to create a margin of safety on the downside. We stay focused on companies with sustainable competitive advantages that we believe are best positioned to capitalise on this structural growth. And every company in our portfolios sell at a meaningful discount to our estimate of their long-term intrinsic value.
Q: How do you compare AI to prior periods of technological innovation and who do you believe the structural winners will be?
Hollie: During prior periods of innovation and disruption, many experts and investors substantially underestimated the overall impact of the new technology, yet at the same time overestimated the number of companies that would be direct beneficiaries.
The advent of computers, the internet and cell phones impacted nearly every individual and organisation. They had a huge impact that led to increased productivity across the board. In PCs and servers, for example, many companies tried to compete and benefit such as Gateway or Compaq who remembers Digital Equipment? These companies don't even exist today. At one point, all of those companies were considered to be secular winners.
In our opinion, the biggest winners ended up being Intel and Microsoft. They became the largest platforms by attracting developers and programmers, creating a robust ecosystem that in turn supported their growth. In our opinion, the vast majority of today's presumed AI beneficiaries are not likely to be long-term structural winners, so it becomes even more important to block out the daily noise generated by the financial news industry who constantly announce market-moving insights.
We believe the clearest beneficiary and enabler of AI is Nvidia, which we've owned since January 2019 in our large cap growth strategy. Beyond strong demand from hyperscalers, this is Microsoft, Alphabet, Amazon, Meta, Oracle. Nvidia is also seeing strong demand from enterprises who are looking to transform business practices and create new revenue streams. It's important not to forget that each of these hyperscalers have large and highly profitable legacy businesses that are not at all related to AI. For example, although Alphabet offers AI infrastructure, chips, models, and tools, the company uses AI to improve its core advertising and search business. It generates almost 75% of its revenue from online advertising. So we own Microsoft, Alphabet, Amazon, Oracle, and have continuously for more than 19 years. We've owned Meta since its IPO in 2012. Over our long investment horizon, looking forward, we believe each of these companies can sustain their competitive advantages.
We'll generate strong and profitable free cash flow growth, and still today sell its significant discounts to our estimate of long-term intrinsic value. Nevertheless, we've been saying since the first quarter of 2024, that there could be a pause in spending following this initial build-out period for AI. We believe cyclical pauses are characteristic even of the best growth companies.
Q. If you believe cyclical pauses are common, how do you manage this risk given your low portfolio turnover and 100% bottom up research process?
Hollie: Most investors tend to view the market through the lens of risk on and risk off, which is based on observable risks. It's a reactive approach to risk management. For us, it's not about risk on or risk off. We believe that risk is present every day. There's a risk around the corner, an unknowable and unobservable risk that matters. And it's a risk no one is talking about. By the time they are, it's usually too late.
These unknowable risks are not uncommon. Over the last 150 years, there've been 23 downside tail events where the market dropped more than 15%. On average, they've occurred every six and a half years, and in the last 20 years, they've been occurring more frequently.
The biggest one was the Great Depression in 1929. Markets were down 86%. The second largest one happened since we've been managing money. It was the global financial crisis in 2007 when markets were down over 50%. On Black Monday in 1987, markets were down 30%. These events are inevitable, but they're unpredictable.
Whether it's due to changing rates, inflation, geopolitical tensions, investor sentiment, volatility is part of investing. It informs our approach to growth equity investing. We're looking for businesses that can be resilient over the long term, regardless of the current market environment. We believe this calls for a structural and permanent approach to risk management. We believe you can't manage risk at the portfolio level unless you first manage risk at the individual security level. So each step of our quality growth valuation investment process was designed with this in mind. At the portfolio level, we diversify our holdings by business driver, which is the largest growth driver in our valuation model for each company.
Basically, we're combining businesses that are not related to each other. For example, we own Monster Beverage, which is driven by the growth and personal consumption of energy drinks. Regeneron is a healthcare company focused on eye disease. It has almost no bearing on energy drinks. Compare those growth drivers with e-commerce like Amazon, and there's almost no correlation. We also limit our exposure to any single business driver. So what we're doing is building a portfolio of businesses we believe are resilient and which act differently in different business environments.
Let's see how that works. In 2022, our top performers in large cap growth were Vertex, Monster Beverage, and Novo Nordisk. On the bottom that year were Meta, Amazon, Alphabet, and Tesla. In the next year, 2023, these companies were on top. So you want diverse business drivers so that stock prices don't move in unison. Our approach helps us protect in down markets and capture up markets. We call it being able to play both offense and defense. Few managers in the growth space can make this claim. They're typically good at one, but not the other.
What other sectors or industries currently hold significant growth opportunities?
Hollie: Tesla is one of our largest holdings and has been since 2022. It was one of the worst performing companies that year, so we took advantage of the price weakness to initiate our position and built it out over the following several quarters. We've been following and researching Tesla for nearly 10 years.
Tesla meets our quality, growth, and valuation criteria. In terms of quality, we believe Tesla has significant competitive advantages, its brand, focus on EVs, business model, scale, and very entrepreneurial culture.
Tesla essentially created this category of EVs from the ground up and now has a very strong brand with clear leadership in electric vehicles. The company has high market share in North America. It's the number three EV provider in China and has a strong presence in Europe. In fact, the company has become the most dominant global EV player with around 25% of revenue share and margins second only to Ferrari.
Through its focus on EVs, the company's been able to make revolutionary changes in the traditional automotive, production, and sales model. Importantly, Tesla developed vertical integration of its business, which allowed the company to optimise every aspect of the value chain. This is raw material sourcing, battery production, vehicle design, software development, vehicle manufacturing, and vehicle selling. Tesla's focus on optimising all aspects of the value chain has created an estimated structural cost advantage versus peers that equates to 15% per vehicle over our investment time horizon.
Another important change Tesla created in the business model is the software subscription services such as FSD autonomous driving. Today, we believe Tesla has about 12% of its installed base with subscription services. We believe that over time, the vast majority of Teslas will have this recurring subscription revenue, which by the way has very high margins compared with the margins generated at the time the car is sold.
We believe it could take peers more than a decade to replicate Tesla's collective design leadership if they're able to do so at all. In addition to this, you have a visionary leader in Elon Musk. We know he's a very controversial character. What Elon provides for this company is first and foremost, a clear vision of where the business is going. New operational targets include producing one million robotaxis, one million humanoid robots, and increasing their EV installed base from eight million to 20 million.
Boeing is another company we believe has significant growth opportunities. We purchased Boeing during the first quarter of 2020, when after the COVID-19 outbreak, air travel was shut down. The uncertainty around near-term demand for aircraft caused the stock price to drop significantly, but we believe that the impact of COVID-19, along with the 2019 grounding of the 737 Max, were just temporary, not structural issues. So we used the price decline as an opportunity to initiate our position.
Since we invested in Boeing, global air travel has returned almost fully to pre-pandemic levels. The 737 Max plane has been cleared to fly in all major countries, including China. Along with Airbus, Boeing is part of a global duopoly that accounts for almost all commercial planes sold with greater than 125 seats. So scale is one of Boeing's strong and competitive sustainable advantages. Significant cumulative knowledge and experience in aeronautics is another, and its client base faces switching costs due to plane-specific operational and maintenance requirements. We believe improving production rates will be the biggest driver of improved cash flow. In May this year, Boeing reached a key milestone producing 38 737 max planes per month. This number will carefully continue to climb over time. Even though quarterly results remain uneven, we believe absent further issues with the 737 Max and the 787, the company's long-term earnings power remains intact.
We believe that CEO, Kelly Ortberg, who recently visited our offices, seems to be driving operational improvement and positive cultural change after his first year in the role. We believe the current market price embeds expectations for aircraft delivery, margins, and free cash flow growth that are well below our long-term assumptions. As a result we believe the stock price is selling at a significant discount to our estimate of intrinsic value and thereby offers us a compelling reward to risk opportunity.
What is your outlook for 2026?
Hollie: I just saw an article called ‘What Economists Got Wrong in 2025’, and yet forecasts for 2026 are published daily. In 12 months, we'll see the articles about what economists got wrong in 2026. Our approach is 100% bottom-up fundamental research. We think it's futile to try to forecast the coming 12 months or even the next three years. We believe it's much easier to understand longer term competitive dynamics to identify those winners of the future.
So for our outlook, I direct you to our own portfolio's cashflow growth rates and discounts to intrinsic value. For growth, we believe the companies in our portfolio will generate around 19% annualised free cashflow growth over the next five years. And that's on a select group of companies in our large cap growth portfolio we believe is selling at more than a 40% discount to our estimate of long-term intrinsic value.
Market volatility can trigger emotions like fear and greed. Investors who are too focused on the short term can get caught up by irrational decision making. It causes them to trade on noise rather than focusing on long-term business fundamentals. Let me give you an example. We've owned Amazon continuously since 2006 for over 19 years. During that period, Amazon stock experienced 14 drawdowns of 20% or more. Some were more than 30%, some more than 40, one was more than 60%.
However, investors holding Amazon stock over the entire period, experiencing each of those drawdowns, realised returns that were 16 times greater than returns of the benchmark1. Remember, even great businesses can routinely endure significant downside share price volatility in the course of generating substantial excess returns over the long term. Rather than worrying about near term outlook where volatility is inevitable and unpredictable, we believe it's important for investors to stay the course over the long term.
Attempting to time the market is another risky behavior that can cause a permanent loss of capital. Over the last 19 years, $100,000 invested in our large cap growth portfolio grew to $1.4 million net of fees2. If investors who were trying to time the market happened to miss just the 10 best days during that period, their returns were cut in half to around $650,000. The best outlook, stay the course, stay focused on the fundamentals of quality, growth, and valuation.
