MW This growth portfolio looks far beyond 'Magnificent Seven' stocks to profit from AI

By Philip van Doorn

Daniel Kim of Saturna Capital touts gains in corporate profitability while pointing out that Nvidia 'is still a cyclical business'

The "Great Bifurcation" is helping investors as the deployment of artificial-intelligence technology improves corporate profit margins, even as the new tech disrupts the labor economy, according to Dan Kim of Saturna Capital.

It is easy to imagine an investor wearing two hats. The stock market has been soaring, while recent layoff announcements tied to the deployment of generative-artificial-intelligence technology may be frightening. So while you are hopefully building up a nest egg with broad investments in stocks, you might also face a forced change to your career path.

Here is some of this week's coverage of corporate layoffs:

-- Amazon to cut 14,000 jobs. Credit - or blame - goes to AI.

-- The 'no-hire, no-fire' job market may have ended, as Amazon, UPS make bold layoff moves

So far this year, the S&P 500 SPX has returned 18.4% with dividends reinvested, following returns of 25% in 2024 and 26.3% in 2023. This means that since the end of 2022, the U.S. large-cap benchmark index has returned 86.9%. Yes, the index fell 18.1% in 2022. But if we go further back, the S&P 500's five-year return through Wednesday has been 124.2%.

Dan Kim, who co-manages the Saturna International Fund SSIFX SIFZX with Bryce Fegley, cited "the divergence between the consumer and enterprise economies, especially because of the proliferation of AI," during an interview with MarketWatch.

Kim and Fegley took over as the fund's managers in 2023, the same year Kim joined Bellingham, Wash.-based Saturna Capital, which manages close to $10 billion in client assets. Fegley has been involved with the fund's management since joining the firm in 2001.

There are still plenty of areas, especially in international markets, to capitalize on undiscovered inflecting blue-chip stories.Dan Kim of Saturna Capital

When discussing the "Great Bifurcation," Kim said, "the corporate-enterprise sector is doing fantastic," with tremendous increases to profit margins. "At the same time, we are seeing cracks in the consumer-credit market and weakness in the labor market."

There are bearish concerns over what Kim expects to be a disruptive transition for people forced to look for work, as well as "worries of an AI bubble."

But, Kim said, "We are not in the latter stages of this AI rollout." He expects corporate profit margins to continue to improve, underlining "robustness," even as the consumer economy is going through "some disruption." The Saturna International Fund is being managed with the aim of "capitalizing on these trends but avoiding typical areas most U.S. investors are focused on," he said.

The S&P 500 is weighted by market capitalization. On this basis, the 500 companies' combined operating margin (earnings before interest and taxes as a percentage of revenue) improved to 29.58% over the past 12 months from 29% for the previous 12-month period, according to data compiled by LSEG. And on the same basis, the operating margin for the S&P 500 information technology sector improved to 39.40% from 37.54%.

These numbers point to "staggering efficiency and productivity gains," Kim said. "Even a 60-basis-point improvement is impressive." The figures above amounted to a 58-basis-point expansion for the S&P 500's operating margin and an improvement of 186 basis points for the IT sector's operating margin.

Kim said the margin improvement would continue "at an accelerated pace."

"There are still plenty of areas, especially in international markets, to capitalize on undiscovered inflecting blue-chip stories," he said.

Expanding your AI investment horizons

The S&P 500 is now 40% concentrated in 10 companies, which, according to analysts at Ned Davis Research, is the highest concentration for the index since at least 1972.

The $696 billion SPDR S&P 500 ETF Trust SPY tracks the index. Its top holding is Nvidia Corp. (NVDA), which makes up 8.6% of the portfolio. Even if you think you are highly diversified in this type of index fund, you have a high concentration in this one stock.

"Companies such as Nvidia have off-the-charts revenue per employee," Kim said, "but it is still a cyclical business." Nvidia dominates the market for graphics processing units (GPUs) being installed by data centers to support AI technology, even in the face of increasing competition from other companies, such as Advanced Micro Devices Inc. $(AMD)$.

The term "Magnificent Seven" is still being used in the financial media to describe a group of high-profile tech-oriented stocks. It includes (in size order by market cap) Nvidia, Microsoft Corp. $(MSFT)$, Apple Inc. $(AAPL)$, Alphabet Inc. $(GOOGL)$ $(GOOG)$, Amazon.com Inc. (AMZN), Meta Platforms Inc. (META) and Tesla Inc. $(TSLA)$. Together, this group makes up 35.9% of the SPY portfolio.

Kim described the Saturna International Fund as "the non-[Magnificent Seven] global-growth portfolio." Most of the companies held by the fund are based outside the U.S., although the top holding, Broadcom Inc. $(AVGO)$, is based in Palo Alto, Calif.

Broadcom is not included in the "Magnificent Seven" group, but it is the fifth-largest holding in SPY, making up 3.1% of the ETF's portfolio. It had an 8.7% weighting in the Saturna International Fund as of Sept. 30. Kim said that the fund doesn't focus on companies' domiciles, but on their sources of revenue. Broadcom reported that, for its fiscal quarter, ending Aug. 3, 70% of revenue came from outside North and South America.

Kim said that a company with good investment characteristics won't necessarily outperform against a broad index of stocks. He believes an ideal investment can spring from a large difference between "the market's perception and reality."

He described a "resetting process" that can take five to 10 years as investors recognize a company's quality. "I am only allocating capital to stocks I feel have a nice delta between expectations [of analysts and other portfolio managers] to the reality I see playing out," he said.

He spoke about two other companies.

Fujikura Ltd. (JP:5803) "dominates the world in ultra-high-density optical fibers and cables," with a 35% market share, Kim said. These are mission-critical items "if you want to build any GPU cluster or data center," he added. It was the third largest holding of the Saturna International Fund as of Sept. 30.

The estimates for the company's growth might be conservative if the pace of rapid expansion for high-capacity computing holds up. Analysts polled by FactSet expect Fujikura's sales to increase at a compound annual growth rate (CAGR) of 10% from 2025 through 2027, with earnings per share increasing at a pace of 25.3%. By comparison, the S&P 500's weighted sales are expected to increase at a CAGR of 6.5%, with EPS increasing at an annual rate of 13.9%.

Kim said Teradyne Inc. $(TER)$ was "a new name I have been adding to" in certain Saturna portfolios, but which had not yet been added to the Saturna International Fund. He described the company as "essentially one of the oligopolistic semiconductor-testing vendors."

He predicted a long runway for growth for Teradyne because of the need to increase computing density by "getting more efficient with stacking [of semiconductors], optical fiber and software optimization."

"Teradyne is another example where I feel market participation is misaligned with reality and [eventually will be] discovered," he said.

Top holdings

The Saturna International Fund tends to hold between 30 and 33 stocks, Kim said. Here are the fund's largest 10 holdings as of Sept. 30:

   Company                                       Ticker    % of Saturna International Fund  2025 total return through Oct. 29 
   Broadcom Inc.                                AVGO                                  8.7%                                68% 
   Taiwan Semiconductor Manufacturing Co. Ltd.  TSM                                   8.2%                                56% 
   Fujikura Ltd.                                JP:5803                               7.9%                               211% 
   ASML Holding N.V.                            ASML                                  6.4%                                56% 
   MercadoLibre Inc.                            MELI                                  5.3%                                35% 
   Ferguson Enterprises Inc.                    FERG                                  4.1%                                45% 
   SAP SE                                       SAP                                   4.0%                                 6% 
   Dassault Systemes SE                         DASTY                                 3.9%                               -17% 
   Wolters Kluwer N.V.                          NL:WKL                                3.7%                               -33% 
   Johnson Controls International PLC           JCI                                   3.7%                                45% 
                                                                                                              Source: FactSet 

Click on the tickers for more about each stock or fund in this article.

Read: Tomi Kilgore's detailed guide to the information available on the MarketWatch quote page

Competing funds

The Saturna International Fund was launched in 1995. It has two share classes. The investor-share class SSIFX is the older of the two and has annual expenses of 0.96% of assets under management, which means an investor's annual fees will total $96 for a $10,000 investment. The fund's Class Z SIFZX shares started in 2017. They have a lower expense ratio of 0.73%. Both funds have a $1,000 minimum investment. Brokers might charge a fee for purchasing the Class Z shares. The fund itself doesn't have sales charges.

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