Seek companies that can use AI tech to their advantage, says Milwaukee-based manager
A fund manager explains why MSA and Watsco are key holdings.
When it comes to artificial-intelligence investments, individual investors should be wary of Wall Street's current hard sell, according to Troy McGlone of Heartland Advisors.
"Even if you identify the winner, if you're at the wrong part of the market and you overpay for it, it can still be a terrible investment," McGlone, co-portfolio manager for the investment adviser's $150 million Opportunistic Value Equity Strategy and $500 million Mid Cap Value Fund HRMDX, told MarketWatch in a Monday interview.
Wall Street's big banks, brokerages and investments firms have been pushing investors to buy obvious AI winners, the Milwaukee-based manager said. "The reality is, that's a very picked-over area, and there are a lot of people selling stuff right now as it relates to the capital cycle."
"The capital is being raised by the same Wall Street firms that are publishing these forecasts that go out into the future that inevitably will be wrong," said McGlone. "You should not read someone's research and say, 'Oh, because they're excited about the cycle that means this is going to continue,' because the reality is that's their incentive."
Owning Cisco (CSCO) at the top of the dot-com cycle meant a 20 year-wait to break even on that investment, he said. And while Nvidia (NVDA) is beloved by much of Wall Street, 70% of the chip giant's accounts receivable are five customers - some of whom are developing their own chips, he said.
"In the long run, it's highly improbable that the current situation will remain intact the way it is structured in the market right now where companies have almost unlimited pricing power because there's a scramble for capacity."
The manager urged focusing instead on companies that can use AI technology, as costs will likely come down over time, leading to benefits for companies implementing it.
One play is MSA Safety (MSA)- the No. 1 player in the fire-service industry which contains a gas-detection business that's largely being ignored. Shares are up 6% over a year.
"They have built their own software and have all their own sensors and so from that perspective, they have an engineering team that's a cost structure. The one thing we know about artificial intelligence is that it brings down the cost structure of developing code," he said.
"We believe it will be a business that actually is a net beneficiary from the technology over time because they have such dominant market-share position in their key markets."
Another pick is Miami, Fla.-based Watsco $(WSO)$, the biggest U.S. distributor of heating, ventilation and air-conditioning equipment, giving it a dominant southeast footprint.
"Most of the revenue comes from repair and replace, so the air conditioner goes out and you have an emergency call to get that replaced," he said. The company competes in a "very fragmented space," and is more than double the size of its next biggest competitor, and has been using AI to optimize pricing.
"On the one side it's a consolidated original equipment manufacturer industry, on the other side there's tens of thousands of contractors that do not have pricing power. So they're in the middle with a fully digitalized platform, but right now the market's focused the fact we're in the midst of a tough housing cycle so the stock's off materially," McGlone said. The stock is 26% lower over a year.
His last mention is a long-term term holding and No. 3 in the Opportunistic Value strategy - Berkshire Hathaway (BRK.B). For one, he likes its "collection of high-quality assets trading at an attractive valuation."
"Because management deploys capital into both public equities and owning entire businesses, analyst earnings estimates understate how cheap the company is."
While most of its wholly-owned businesses are largely insulated from AI disruption, such as railroad Burlington Northern Santa Fe and Berkshire Hathaway Energy $(BHE)$, others such as Precision Cast Parts is getting an AI boost due to its dominant share in the forged-casting industry.
"There are only a few companies globally capable of producing engine parts for the 'hot section' of a gas turbine used to create electricity."
BHE is also well placed to respond to rising power generation demands, he said. "New CEO Greg Abel was previously CEO of BHE so we have a high degree of confidence in his ability to identify attractive opportunities in this ecosystem," said McGlone.
The markets
The Dow industrials (YM00) is set to lead stocks higher (ES00) (NQ00) after a a Nasdaq COMP record. Treasury yields BX:TMUBMUSD10Y are easing and oil (CL.1) (BRN00) is lower.
Key asset performance Last 5d 1m YTD 1y S&P 500 7773.95 1.17% 0.72% 13.56% 15.34% Nasdaq Composite 27,477.31 2.45% 3.66% 18.22% 19.77% 10-year Treasury 5.269 2.00 47.50 109.70 113.80 Gold 4183.5 -0.75% -4.92% -3.43% 4.38% Oil 87.63 -1.47% -7.02% 52.64% 41.25% Data: MarketWatch. Treasury yields change expressed in basis points
The buzz
Alphabet (GOOGL) is reportedly nearing a multiyear deal for nuclear energy from Constellation Energy (CEG) whose stock is up.
Option Care Health (OPCH) stock is climbing after a report McKesson $(MCK)$ and a private-equity firm are nearing a $5 billion deal to buy the medical infusions services provider.
The U.S. trade balance is due at 8:30 a.m. Federal Reserve officials including New York Fed President John Williams are due to speak at various conferences.
Elon Musk's wealth tops $1 trillion. These entire countries produce less.
The chart
Inflation is the reason Treasury yields have risen much, according to investors polled in Deutsche Bank Research Institute's third-quarter survey. However, strategists led by Jim Reid, noted their long-running question about inflation expectations showed just a tenth of a percentage point rise in expected inflation over the next five years. So how can that be? Reid's explanation is investors may view inflation risk as a near-term shock that will eventually fade or be dealt with by the Fed. Reid's own view on rising Treasury yields is that it's mostly because of strong growth.
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-Barbara Kollmeyer