In the June 2024 quarter, artificial intelligence (AI) remained the dominant narrative in markets. Companies perceived to be AI beneficiaries have seen their share prices markedly outperform those where the benefit appears less clear in the immediate term.  

Nowhere is this more evident than in the Semiconductor industry, which rose 19 per cent in the quarter and accounted for more than 50 per cent of the MSCI ACWI Index return. Add in the Technology Hardware industry, and that figure increases to 80 per cent. NVIDIA alone has contributed 40 per cent and 24 per cent of the Index return over the quarter and year-to-date periods, respectively. 

This is not unprecedented. Markets go through periods where a single theme can drive performance to the exclusion of almost everything else. For example, in the lead-up to the dot-com bubble, we saw certain types of companies experience tremendous stock market gains, like Corning, which then had a monopoly on the production of fibre optic cable, and Cisco Systems, the era’s dominant supplier of routers and switches to move data across the internet.1 

What we find interesting in today’s markets are the crosscurrents contributing to this narrow leadership. 

Heading into the year, it was generally expected that the Fed would taper rates several times into the end of the year. Amid higher-than-expected inflation readings and a tight labor market, interest rates have remained higher for longer. The Fed recently signalled the potential for just one rate cut this year. On the one hand, it appears to us that increasing uncertainty around the macro backdrop has led to a “crowding” into secular growth wherever it can be had now, ostensibly AI. On the other hand, it also seems that this uncertainty has contributed to the outperformance of lower volatility, lower growth businesses with a high degree of earnings stability (downside protection/safety trade). 

As a quality growth manager investing for the long-term, we can readily admit that environments like these come with their undue share of frustration. But by having a long-term mentality, we must be willing to have the discipline and mental fortitude to look wrong, foolish, or out of touch for periods of time. By definition, if we as long-term managers are trying to chase the latest fad, we may look out of touch. But it’s important to emphasize that quality, growth, and predictability are all important aspects of what we seek in businesses. This means that it’s hard for us to underwrite or get enthused by 1) businesses with extremely high growth yet extremely low levels of predictability or 2) paying high valuations for quality businesses with strong balance sheets and cash flows yet little to no growth.  

Based on our philosophy, allocating capital to these two “zones” will lead to poor outcomes over the long term, regardless of short-term stock price movements in a given quarter. 

During narrative-driven periods like today, it’s helpful to take a step back to not lose sight of our goal – pay a fair price for a small group of great businesses that can grow earnings per share at a mid-teens rate or higher over time. 

In our experience, a methodical approach to compounding earnings growth is what leads to compelling, long-term compounding return potential for our clients. Our approach is more tortoise than hare. But it’s this sort of durable mid-teens earnings growth, which is ~2-3x the Index’s long-term average earnings growth despite its now elevated levels, that has led to the strong track record that can be observed in our U.S. approach over 35 years.  

Emphasising durable earnings growth has been our unwavering focus since the inception of Polen Capital in 1979, and it will continue to be our focus well into the future as we look forward to delivering long-term value for our clients. 

Polen Capital Global Growth Fund contributors and detractors 

In the June 2024 quarter, the top relative contributors to the Polen Capital Global Growth Fund (the Fund) were Alphabet, Adobe, and Amazon. The top absolute contributors were Alphabet, Amazon, and Adobe. 

Alphabet 

Alphabet represented our top relative and absolute contributor. The stock responded very positively to strong results across the board that came in ahead of expectations, with particular strength in Google Search, YouTube, and Google Cloud. In all, the business’s revenues accelerated to 16 per cent constant currency growth, which is compelling for a business of its size. Additionally, the company introduced a dividend and announced an additional $70billion share buyback. 

Adobe 

With Adobe, in some ways, we see it as a microcosm of the market’s “shoot first, ask questions later” approach to categorising AI winners and losers. In the early part of last year, Adobe came under pressure with a perception that generative AI (GenAI) would represent a material headwind to their suite of creative offerings. In short order, the company introduced its GenAI offering, Firefly, which shifted the narrative to Adobe as a beneficiary with a real opportunity to monetize GenAI in the near term. Earlier this year, that narrative was again challenged as the company reported a slight slowdown in revenue growth. Results in the most recent quarter were robust as the company raised its full-year forecast across a number of key metrics and showcased better-than-expected results. 

Amazon  

Amazon reported better-than-expected results in the quarter, most notably showing a re-acceleration in revenue growth in its Amazon Web Services (AWS) segment. Equally impressive, the AWS segment saw margins increase compared to the prior quarter and year as it continues to grow its economies of scale. For some investors, the good news was balanced by the company saying it would be ramping up its capex spending in AWS to meet cloud demand, including demand from GenAI. It’s important to bear in mind that 1) this is in response to real demand the company is experiencing today and 2) the ability to continually reinvest capital at high returns is what drives outsized long-term compounding of per share earnings. 

Amazon has shown both the will and the skill to continually reinvest capital at high returns over many years. The largest relative detractors in the quarter were NVIDIA, Workday, and Paycom Software. The largest absolute detractors were Workday, Paycom Software, and Aon. 

NVIDIA 

For the second quarter in a row, NVIDIA represented the top detractor to relative performance as the stock climbed another 40 per cent, bringing the year to do date return to 153 per cent. As of this writing, NVIDIA is the third largest company in the world, but for a brief moment towards the end of the quarter, it surpassed Microsoft to become the largest company in the world. Yet again, the company delivered blowout results that came in ahead of already lofty expectations, reinforcing the narrative that NVIDIA is the only obvious “AI winner” due to the eye-popping revenue growth it’s generating now. 

However, our research shows that most businesses are only experimenting with GenAI rather than actual, proven use cases. If proven use cases with real return on investments for businesses do not materialise in time, it’s possible that the huge infrastructure build and ravenous demand for graphics processing units (GPUs) and AI servers may be ahead of the true demand for that infrastructure. 

We have previously spoken at length about the cyclicality of NVIDIA’s business and the potential for significant changes in its revenue and earnings growth from year to year. 

While NVIDIA is a highly advantaged business with many things to like (especially its current growth!), we believe it has a wider range of possible outcomes for revenue and earnings growth over the next three to five years than we are comfortable with at the company’s current valuation. 

This is a dynamic environment on the bleeding edge of innovation and could change rapidly. While we’ll continue to study the developments closely, we’re confident that we can achieve our goal of being long-term owners of a concentrated portfolio of high-quality, competitively advantaged businesses that, in aggregate, can grow earnings per share (EPS) at a mid-teens rate or higher without taking undue risk. 

Workday 

In line with broader weakness across the enterprise software complex, Workday sold off more than 15 per cent as management guided to organic subscription sales growth in the range of 16.6-17 per cent, 50 basis points lower than previously guided. Zooming out longer term, we believe nothing has fundamentally changed for Workday. According to our research, it remains a solid, market-leading, long-term compounder with a substantial runway for future growth in the market for both its human capital management and financial software. 

Finally, Paycom Software – a new addition we started at a smaller position size –represented another relative detractor in the period. Paycom is a leading cloud-native payroll and human capital management (HCM) software provider. A recent go-to-market hiccup with their new BETI product and some macro weaknesses have led to a deceleration in their near-term growth. However, we continue to think the long-term picture remains intact as a leader in an attractive industry, providing mission-critical software with highly recurring revenue, 90 per cent+ retention rates, and high returns on capital. The stock price performance has effectively been all price to earnings (P/E) multiple compression. 

Past performance is not an indicator of future performance. Returns are not guaranteed and so the value of an investment may rise or fall.  

This report has been prepared for the purpose of providing general information, without taking into account your particular objectives, financial circumstances or needs. The issuer of units in the Polen Capital Global Growth Fund (ARSN: 647 518 723) is the Fund’s responsible entity Fundhost Limited (ABN 69 092 517 087) (AFSL: 233045). The Product Disclosure Statement (PDS) contains all of the details of the offer. Copies of the PDS and Target Market Definition (TMD) are available from Montgomery Investment Management, contactable on (02) 8046 5000 or at www.montinvest.com and at https:// fundhost.com.au/ An investment in the Fund must be through a valid paper or online application form accompanying the PDS. Before making any decision to make or hold any investment in the Fund you should consider the PDS and TMD in full. The information provided is general in nature and does not take into account your investment objectives, financial situation or particular needs. You should consider your own investment objectives, financial situation and particular needs before acting upon this information and consider seeking advice from a licensed financial advisor if necessary. You should not base an investment decision simply on past performance. The investment returns of the Fund are not guaranteed, and so the value of an investment may rise or fall.