Quality investing beyond the AI momentum boom

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DUDUZILE RAMELA: The global economy is facing challenges but has fared much better than anticipated in the face of one shock after another.

In the capital markets, though, there’s accelerated momentum, more so in global markets, where there’s an exponential AI capex boom and an all-time return when it comes to other sectors.

The speed and momentum is reshaping how equity markets move, with assets showing an increased rate of price change over time.

Neal Hoogwerf is an equity analyst with Merchant West Investments. He joins us now to take a look at how we can find quality companies in a momentum world. Neal, thank you very much for your time. How are you advising your clients, at least, on understanding and managing momentum investing?

NEAL HOOGWERF: We view it from a different lens.

So to separate the words momentum and quality – momentum definitely tells you what’s currently popular within the market environment at the moment, but quality actually tells you what’s durable.

And those are two fundamentally different questions.

From our side, we believe that the market keeps actually confusing those two.

DUDUZILE RAMELA: So you contend that the crowd pays for what’s moving this quarter and underappreciates businesses that compound quietly for a decade. Can you expand on that for us?

NEAL HOOGWERF: From our perspective, we believe that the market is actually very good at pricing in the next quarter and adjusting to the estimates from analysts when companies do actually release quarterly results. But we believe that where quality is the differentiator is that they’re actually terrible at pricing in the next decade.

So we believe that gap to be the opportunity.

DUDUZILE RAMELA: The hot topic right now of course [is] artificial intelligence [AI]. When you look at the capex boom right now, there’s going to be a lot of winners and losers. How do you see separation, where you’re separating the AI losers and winners?

NEAL HOOGWERF: It’s very important to put those into various different buckets. So we currently contend with three different buckets at the moment.

We’ve got the AI losers, the AI winners, and then there’s that just ‘too hard’ pile.

[The latter is] where the mental return on effort is quite difficult to actually get a fundamental answer about where the winners and losers could actually fit in.

DUDUZILE RAMELA: Help us understand the AI supply chain if we take a step back.

NEAL HOOGWERF: Yes, we’ve seen the hyperscalers come out with these extraordinarily large amounts of money that are being spent across all the data centres in the US.

So these are impacting a lot of different companies at the moment, such as the equipment manufacturers.

Then you can think of the likes of the ‘fabs’ – [semiconductor fabrication plants].

So TSMC [Taiwan Semiconductor Manufacturing Company], as well as ASML [Advanced Semiconductor Materials Lithography] – and that’s where we currently are finding the opportunities in the quality buckets in the AI supply chain.

DUDUZILE RAMELA: So if you can expand on that, please, for us, because finding quality companies in this world driven by momentum can sometimes be tricky.

NEAL HOOGWERF: Yeah, I fully agree with you.

How you define a quality company is that if you gave it another rand – or dollar, for that matter – to invest, it earns far more than it cost to actually raise that rand, and it’s really the durability of that which matters.

If they can do that for an extended period of time, you really start to see that coming through in the durability of the moat of the business, as well as the return on capital that the business is able to produce through the cycle.

DUDUZILE RAMELA: What do you say to those who predict the market, if you will, or predict the next move on the market? What’s the advice there? Is that a prudent move?

NEAL HOOGWERF: No, I’m strongly against that.

Forecasts are exactly that, they are forecasts, and market commentators love to just create noise around different figures and forecasts within the market.

So we prefer to separate the numbers from the narrative, and that ultimately plays into the strength in quality investing.

DUDUZILE RAMELA: Neal, a good story at any price is not an investment, it’s a subscription to other people’s optimism.

NEAL HOOGWERF: No, exactly, and that’s just how we view it.

Ultimately, we are bottom-up fundamental investors.

So the price we pay for an asset has to matter down the line because you’re ultimately getting entitled to that stream of cash flows.

So we’re very sensitive to when momentum dominates the market, as well as just trying to read through the actual storylines and feel – like if it’s actually impacting the underlying fundamental qualities of the business, and if that intrinsic value is ultimately compounding over time.

DUDUZILE RAMELA: Thank you very much, Neal, for your contribution. Neal Hoogwerf is an equity analyst with Merchant West Investments.

Brought to you by Merchant West.

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