Nvidia is AI gold-rush winner, and two ‘weatherproof’ stocks

James Thomson, fund manager of Rathbone Global Opportunities, tells interactive investor’s collectives editor Kyle Caldwell how he finds companies with a “star quality that gives them resilience and lots of growth potential going into the future”. He names Rightmove as an example of a UK-listed business that has the qualities he likes to see.

Thomson also explains why he prefers to run his winners and cut the losers. One stock that has been performing very well for the fund lately is Nvidia. Thomson explains why he remains bullish on Nvidia’s prospects, which he describes as the “picks and shovels” winner of the artificial intelligence (AI) gold rush. He also explains that to balance risk, around 20% of the portfolio is in less economically sensitive companies, and names two “weatherproof” stocks that sit in this defensive area of the fund.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio, I'm joined by James Thomson, fund manager of the Rathbone Global Opportunities fund. James, great to see you today.

James Thomson, fund manager of the Rathbone Global Opportunities: Thank you for having me. 

Kyle Caldwell: So, you look for companies that have a certain star quality. Could you explain what you're specifically looking for and name some examples? 

James Thomson: We’re trying to find companies that are flying under the radar, [and whose] growth is under-appreciated by the market. There’s a star quality that they have that gives them resilience and lots of growth potential going into the future. We like companies that are doing something different and shaking up their industries, growing quickly but sustainably.

We don’t like to get involved at a very early stage. We prefer mid- and large-cap companies that can repeat and scale up their product or their service. I think that’s really been the secret sauce to what we’ve done over the last 20 years. Examples, I suppose, would be companies here in the UK such as Rightmove (LSE:RMV), a business that we’ve owned since 2009.

It’s very difficult to  copy what they do. There are lots of imitators, but trying to copy them successfully is very difficult. They have such a significant market share in the UK property market, but they also have a significant share of our heads. We naturally think of Rightmove as the first place to go when we look to buy or sell a property, and that gives them incredible pricing power. In addition, they’ve put in products and services in estate agents that helps them do their jobs, and that has deeply ingrained them into the day-to-day function of an estate agent.

Another company I would [say has] star quality would be a business such as Visa Inc Class A (NYSE:V), which is the credit and debit card network that we use every day. They too are deeply ingrained, a resilient part of the economy that’s absolutely mission-critical, as we move from a cash society to a card-based one. That’s more mature in developed markets, but in a lot of emerging markets, the journey is just beginning. [Visa] is the type of the company that really benefits from that journey, so that star quality is so difficult to repeat. And that’s what gives them a competitive advantage in growth potential going many years into the future.

Kyle Caldwell: There are hundreds of global equity funds available to investors. How does your fund stand out from the crowd? What do you do differently? 

James Thomson: You’re right. There are lots of funds to choose from in the global equity space. I suppose what we do differently is that we have a good track record of performance. We have a good pedigree of stock picking skills in the market that has been refined over 20 years. And I’m proud to say that we’re ranked number one in the country in the sector over that 20-year period with a 1,000% return.

Sometimes also [it’s about] what you do differently [in terms of] what you admit you cannot do, areas that you think you shouldn’t invest in. For me, that’s not investing in emerging markets or Japan, or in certain sectors of the market that I don’t think have high-quality growth credentials. So, understanding what you’re good at and what you’re not good at is an important differentiator in the market.

Finally, I think what’s often unspoken or underplayed is that we act with honesty and integrity. I’m someone people can trust. I’m putting my own skin in the game here as well. I think honesty, integrity and trust is vital in an industry that perhaps doesn’t have much of it over many years. So, I think those are all qualities that we can look to differentiate ourselves within the global growth space. 

Kyle Caldwell: In terms of your top 10 holdings, I can see that there’s three of the so-called Magnificent Seven. You have exposure to NVIDIA Corp (NASDAQ:NVDA), Microsoft Corp (NASDAQ:MSFT) and Alphabet Inc Class A (NASDAQ:GOOGL). Could you talk us through the investment case for each of those, and how each business is going to potentially benefit from advancements in AI? 

James Thomson: Yes. I think [it’s] sometimes a maligned group, The Magnificent Seven. And you’re right, we own three of them. In fact, we own five of them. Not all up in the top 10, but very much leading the charge in terms of advancing AI would be Nvidia. If AI is a gold rush, I would describe Nvidia as the picks and shovels for that gold rush. It requires 10,000 graphics processing units (GPUs) to make ChatGPT come alive, and each one is about $50,000 apiece. So, you can see just with one company how the scale opportunities of AI growing more widely can benefit a business like Nvidia.

Yet this is a company that I think is still underweight and over-hated by a lot of investors. So, even though it’s had an incredible run over the last year and a half, I think it’s one that’s still very much leading this next computing era in AI. And let’s talk about computing eras in which one or two companies tend to dominate and they tend to be vertically integrated. They have hardware, software and chips, and one or two companies tend to get 80% or 90% of the market. As you move from one computing era to the next, it’s usually a 10x revenue opportunity. So, if you think about mainframes moving to PCs and then smartphones and now this era of AI, you can see how the size of the revenue opportunity for some of these key players starts to come through.

Microsoft is another beneficiary, albeit not of the picks and shovels end, but in applications that people are using for AI. So their partnership with OpenAI and ChatGPT would be right at the forefront of that. But think about how deeply embedded Microsoft is in our businesses. It is a mission-critical, [with] software and applications that our businesses use every day. The idea of ripping it out is impossible. And now they’re starting to actually embed AI features into the suite of applications that we use every day.

• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• Nvidia stock tipped to smash through $1,000 barrier

Think about your Microsoft 365 products, your Word, your PowerPoint, your Excel, which are a key part of how most businesses operate. They are now embedding Co-Pilot, which is an AI application, into that which really generates potentially some significant cost savings and productivity improvements. And they’re charging for it right now. So, we’re actually starting to monetise this AI opportunity.

And then a business such as Alphabet, which is probably a little further behind in terms of the AI zeitgeist. Their product is Gemini, which is a generative AI application similar to ChatGPT, but I think it’s had some teething problems, so they’re a little bit further behind. But [in] their core business of search, which obviously taps into the advertising world, there is a constant desire for advertisers to gain eyeballs. And so that’s almost one of the last things you cut in your advertising budget. If you look more broadly within Alphabet’s business, you’ve got businesses such as Waymo and Google Maps, their cloud computing offering and then YouTube.

My daughter’s personal favourite, YouTube, [where] over five billion videos a day are streamed. The monetisation potential of that is still in the early innings. Probably it’s easiest to hear from the chief executive of Nvidia, where we see the potential opportunity that lies ahead, and he says “the new AI infrastructure will open up a whole new world of applications not possible today. We started the AI journey with the hyper-scale cloud providers and consumer internet companies, and now every industry is on board, from automotive to healthcare to financial services, industrial to telecom, media and entertainment.” This is now gaining traction in so many sectors, and we’re really just in the foothills of the roll-out of this technology.

Kyle Caldwell: You’ve explained that you’ve got some exposure to the US technology companies. In terms of the risk spectrum, they’d be at one end and at the other end, I know you have some exposure to some conservative businesses, as there is a portion of the portfolio in recession-resistant companies. How much is in that bit of the portfolio at the moment, and could you name some stock examples? 

James Thomson: The risk of running a growth fund is that you get carried away, and end up filling your portfolio with too many adrenaline-filled growth stocks. What I realised many years ago, really after the 2008 financial crisis, was that you really need balance in a portfolio. You need a defensive buffer in case of a market dislocation or recession, or a significant change in the market backdrop.

So, after 2008, we decided to put in a “weatherproof” part of the portfolio, [which means] less economically sensitive businesses that are still growing, but perhaps not the sexy growth of the rest of the technology-driven portfolio. At the moment, we have about 20% in this more defensive, weatherproof part of the portfolio.

Examples here would be in companies that we’ve owned for many years. The first one would be a US business called Rollins Inc (NYSE:ROL), which is a pest control business. You can have defensive businesses that are not only selling defensive products, but also defensive services. I think the beauty of a pest control business is that whether it’s a good economy or a bad economy, the bugs don’t care. And particularly in the United States, there is a pest control problem. You get pest infestations in some parts, which is really why you need this essential service. And it has a repeat nature to its business model. I think that’s something that investors [always] prize, that repeat level of business, which ends up giving them the pricing power and real dominance in a market that’s quite highly fragmented.

Another weatherproof business I would point to is a US garbage collection company called Waste Connections Inc (NYSE:WCN), which we’ve owned for many years. Again, an essential service. Things have to get pretty bad before you turn off your garbage collection. In the US, that’s about $35 a month. If you think about commercial customers of garbage collection services, imagine you’re in the midst of a recession. Well, if your bin is full or your bin is three-quarters full, sadly, you pay the same price. And so that really gives them a pretty powerful buffer during difficult economic times. That’s why you really see the resilience of a business like that coming through. So, I think you can end up creating a quite exciting, defensive part of the portfolio that acts as an excellent foil to the more pro-growth, more economically sensitive rest of the portfolio that we own as well.

• US shares to put in your ISA in 2024
• How to build a £1 million pension and ISA portfolio

Kyle Caldwell: You’re a growth investor, but you also don’t want to overpay for growth. Where are you finding the best valuation opportunities at the moment? 

James Thomson: Well, throughout my career, I’ve always found valuation to be more of an art than a science. I’ve never thought valuation is a great predictor of future performance, but you’re right. What you don’t want to do is get sucked into momentum businesses that end up having totally unreasonable valuations that you buy into. But I wouldn’t look at it the other way either. Cheap valuations are also not a great predictor of future performance. Just look at the Russian equity market, which is on a price-to-earnings ratio (P/E) of 2x. Even at that very low valuation, I would say that’s probably still overvalued. Compare that to the US market, which is on a P/E of 20x. That may look expensive, but I don’t think it’s actually overvalued.

So, you always have to blend valuation with growth potential and resilience. If you look at a market like the US, which is sometimes criticised as being one of the most expensive in the world, what you’re paying for is something different. You’re paying for innovation, you’re paying for resilience and repeatability. In many ways, I think that’s worth a premium to the rest of the market. So, over two-thirds of the fund is invested in what people are calling one of the most expensive markets in the world. But, as I’ve often seen over my career, expensive doesn’t necessarily mean overvalued. And that’s where I think the greatest opportunities lie. 

Kyle Caldwell: When you’re investing in a company, and hopefully it performs well, how do you decide whether to run your winner or take some profits? 

James Thomson: Well, it’s probably dangerous having mantras, but I would say one of my mantras is “run your winners and cut your losers”. I think that often runs in the face of what a lot of investors do. But I believe that good companies often use their approach as a platform to continue to grow and use that platform to go into new markets, to expand the size of the addressable market that they can target. So, what might seem like a ceiling is actually just another floor. We often believe in backing these companies continually.

But that doesn’t mean we don’t change our minds. I think you have to be flexible and adaptable to changing circumstances. I remember early in my career talking to a colleague, and I showed him a sell note on one of his investments, and he threw it back in my face. He didn’t want to read it. He didn’t want to know. And I always remember thinking, I don’t want to be that guy. I always want to be open to what other people think. That’s why I surround myself with smart analysts, strategists and economists who are giving me lots of different views and advice. And it’s my job to filter that out and come to a final decision.

But if the facts don’t change meaningfully, and we think the medium to longer-term prospects are still intact and the valuation isn’t outrageous, then we tend to run our winners, and stick with them over the long term. If you look historically at the contributors to our performance, it’s been the companies that we’ve owned for the long term that have driven most of the contribution to performance.

• Nvidia’s just the start: Goldman says the AI boom will have four phases
• Nvidia and Scottish Mortgage made me an ISA millionaire, but now I back these funds too

Kyle Caldwell: In terms of running your winners, all things being equal, are there any companies you would highlight that you could never envisage selling? 

James Thomson: I think never is a strong word, but there certainly have been a significant number of companies in the portfolio that we’ve held for over a decade, and I think it’s hard to envision selling any of them, but I wouldn’t say impossible. I think if I have any skills, it’s a willingness to be flexible and adaptable and change my mind. There certainly have been examples of companies we’ve owned for a long period of time where we have changed our view and sold out. But I think broadly, you’re right.

It’s the sort of portfolio where I think the core list of holdings we’ve backed for a long period of time, and that we really believe in, is growing. I think a good guide for investors would be to look at our top 10 holdings. Those are companies that we’ve owned for many years that have grown significantly and earned their right to be in that top 10. It's difficult to imagine selling them, but I’ll never say never. 

Kyle Caldwell: James, thank you for your time today. 

James Thomson: Thank you, Kyle.

Kyle Caldwell: So, that's it for our latest Insider Interview episode. I hope you've enjoyed it. You can let us know what you think, comment, and please do hit that like button and subscribe. And hopefully, I'll see you again next time.