Key Takeaways
- Investment Company of America manager Grant Cambridge still believes in the capacity of the Magnificent Seven group of stocks to drive the investing narrative of US exceptionalism.
- Long-term holding Broadcom has grown through acquisition and made “profound” changes to the companies it bought.
- Cambridge focuses on companies with “the ability to generate cash and then the willingness to return it to shareholders”.
Ollie Smith: Now, it’s been the investment story of the decade. But there are clear concerns that the dominance of the so-called Magnificent Seven group of stocks may, in fact, be waning. Indeed, amid a tumultuous February, in which investors appear to be almost continually repricing the cost of artificial intelligence progress, some are now asking questions about more than just concentration risk.
So, here to discuss all that and more with me is Grant Cambridge, portfolio manager at Capital Group’s Investment Company of America strategy, which has a Morningstar Medalist Rating of Silver. Grant, thank you so much for your time today. Absolutely brilliant to have you with us.
Can we just get to the thorny issue of allocations?
How have your allocations to the Magnificent Seven actually changed specifically? And moreover, why does it actually appear so much still in the portfolio?
Grant Cambridge: Well, thank you for having me here. It’s a very rich topic as you might expect. The allocations to technology in general have been somewhat stable over the last few years. Specifically, to the Mag 7, we are about 29%, versus the S&P’s almost 35%. So we are underrepresented relative to the S&P, but relative to our history, we’re higher than we’ve been. We were somewhere around 19-20% when the S&P’s exposure was like 31%, so some of those stocks have done exceptionally well, so they’ve gotten there the right way. But there’s things going on in the portfolio as I speak, because, remember, we have the Capital System, so we have multiple decision-makers making decisions in the Investment Company of America. But, I would say generally there are companies that we’ve held for many years, and many of them we still believe in very much.
Alphabet’s Place in an AI-focused Portfolio
OS: Could you give an example of one in particular? I note Microsoft is no longer top stock in the portfolio. How do you feel about that?
GC: Well, we feel good about all of them. But you could see last year there were only two companies, Nvidia and Alphabet, that outpaced the broader market. So we’re up almost 85% over the last three years. We’ve had three double-digit, very heady returns in the US, and the Magnificent Seven now is performing, individually, much different from it was. I think, collectively, most people felt they had to own most of them, if not all of them. We’ve never thought that. We take every security individually.
But to get to your question, a company like Google, Alphabet, I should say, has been a top holding both for my sleeve of responsibilities and, at the fund level, it’s been a fairly significant. Within the Magnificent Seven, Alphabet did not do well relative to the Mag 7 for a number of years. In the last year it was one of the best-performing Mag 7 [stocks], so it took time. But we’ve invested in Alphabet almost since it was at IPO, so we’ve known the company very well. We believe in their business model, and it didn’t lead the AI frontier model.
It had an offering, but it wasn’t the first. And as a result, there was a lot of skepticism around what it would do to Search and whether or not they were going to be able to compete with the new frontier models. That’s something that now we’re starting to see with each version of Gemini. We’re starting to see more and more adoption. We will see. It won’t be a one-takes-all market, but we probably have fewer competitors as we did with Search, by the way. We forget that, when search came out, there were a number of search engines you could choose.
OS: Oh, yes, Ask Jeeves. AltaVista.
GC: You have a very good memory. And, you know, when’s the last time you did some searches on something other than Google? So we’ll see who the market share leans toward, but last year was a good year for Alphabet.
How Tesla Has Evolved Since IPO
OS: Sure. Very briefly, from notable presence to notable absence, Tesla is not in your top 10 holdings. Why is that, and do you have any concerns about the direction of the company and the way it’s managed?
GC: No. It really, I think, partly comes down to valuation. First of all, Tesla, Meta, Alphabet. I mean, the Magnificent Seven have a remarkably strong set of leaders. In many cases, founder leaders, and those founder leaders are some of the most innovative and forward-thinking individuals.
Certainly with Tesla, that’s no different. The business mix of Tesla has really changed since the IPO [in 2010]. When we invested initially, you were really anticipating what the growth of EVs would be and what models—what’s the volume? And actually, there’s a debate on whether or not they could keep up with the demand model, so whether or not they built enough capacity to build that many [cars]. We’re well beyond that now with Tesla. Tesla is now thought of as a multifaceted innovative company. And of course, what’s happening most recently with the discussion around SpaceX is another whole chapter of their future. But the core business of Tesla, if you want to say the core is auto, is augmented with the potential for robo- and for self-driving cars.
And then, of course, the battery business is a very interesting and fast-growing business. And with all the needs around compute, you’re seeing more and more needs for battery storage. So Tesla, Tesla’s evolved into a very, very different company than it was once when I first remember it.
Broadcom’s Growth Driven by Dividends and Cash Flow
OS: Let’s just talk about Broadcom AVGO for a second because our analysts say it’s a cash-generating machine. They call it a “prolific” cash generator. What are your thoughts on its future given its status in the portfolio?
GC: Well, we’ve held Broadcom for many years—over a decade—in the fund. So Broadcom is an interesting one because the story there was not as well known initially because it was thought of as an acquisition-driven company. It was thought of as a company that maybe wasn’t the leader in its field. But then it just slowly started to evolve into growing its software business. It grew through acquisition, but what it would do with the acquisitions once they had them under their control was profound. I mean, they would drive for margin, cash flow and return on invested capital.
And you take that with the chip business, and they were doing the exact same thing. I mean, they were a very interesting evolution with the company, because they had two legs of the stool that were really working at the same time, and they were generating cash. I think, if I remember correctly, Ollie, the initial estimates we had for margins were in the mid 20%. And now you see it, you know, you’re surpassing 60%. So this is a company that has just done a fabulous job of integrating acquisitions and continuing to serve some of the most demanding hyperscalers on the chip set side, and continuing to grow and raise price on the software side.
OS: So why is it so heavily discounted?
GC: Well, I’m not sure it’s discounted any longer. But when we first met the company, it had an above-average dividend. It was a well-established company—pretty much what Investment Company of America looks for. It had a track record of returning cash to shareholders. It’s run by some very, very sophisticated leaders who really thought about the business longer term. And we believed that they had a better valuation than the market was … Now, that valuation has caught up a lot.
But what we didn’t know was that they were going to have a front seat in the AI road race. That is what’s changed, and of course that is what’s gotten a lot more attention, and they’re doing a superb job. They had a partnership years ago with Google to develop the [Tensor Processing Units, or TPUs] and of course now that’s another segment and that’s a growth area. And the pipeline for AI-related chipsets is significant and growing very fast. But at the time we invested, initially, it was just a very well-run company where we had conviction they were going to run even better and harder and return cash to shareholders.
Quarterly Dividends and Sustainable Growth in Tech Stocks
OS: Sure. I think that begs a conversation really about luck versus skill and judgement. It’s important to look back with the benefit of hindsight. Are there any investing themes or an investing phenomenon that you’re surprised by, in terms of performance—something perhaps that you’d wished you’d seen, you know, before it happened?
GC: Well, there’s lots of things I wish I had seen before. Let me talk about one overarching theme that goes across many of our funds, particularly in our growth and income or our income funds. We look for companies that have the characteristics to provide, well, two things: they have to have the ability to generate cash and then the willingness to return it to shareholders.
The market pays a lot of attention to earnings per share growth rates over the next two or three years, or maybe even two or three quarters. We also look at that, but we also look at dividend per share growth rates over the next two or three years. If a company has the ability to generate growing cash flows and the willingness to share it with shareholders, then we many times find that there’s something good going on in the business—if the board and the management have the conviction to keep those growing streams of income for us. And let’s face it, nobody ever turns down a quarterly check they get in the mail. So it’s a good dynamic to have because it augments your total return.
Lessons Learned from Missing the Commodities Rally
GC: Regrets, themes that I wish I’d [followed] … I’m talking for myself, not the fund, but I have been almost unexposed to the materials sector. And if you think about the daisy chain of events related to data centers or the growth of things, I don’t have any exposure to gold or silver. I think that comes from a historical bias I’ve had where I’ve been trying to invest in cyclical companies in the iron ore business.
Now, we have an analyst that has been on this from Day One, and he’s like an expert in copper and silver and gold, but I just didn’t follow those recommendations. Now I’m looking back and saying, jeez, these have been some of the best stocks over the last few years. So that’s an example where I missed it personally.
But you have to remember, the Capital [Group] system has multiple decision-makers managing the fund because we’ve always believed that having diverse perspectives—that is, diverse styles within one fund—gives you the ability to make sure that it’s not on only one person, to have all the opportunities fall into their lap. Somebody might be very much leaning into materials, so I don’t feel as bad because our shareholders are benefiting from that knowledge where I missed it. So as long as we have somebody in our team that is exposed to companies that are doing well in various different market conditions, we’re satisfied as long as the full portfolio reflects those opportunities.
Why the US Market Remains the Global AI Leader
OS: Just finally, I really want to ask you about American exceptionalism. You’re visiting here from the US. Could you just give me your succinct summary of, you know, where you see the US markets are at in terms of the [US] exceptionalism narrative?
GC: Well, Ollie you know I’ve lived in London. I’ve lived in Hong Kong. I was involved in opening a Mumbai office. I mean, I’ve been around the world a long time, but I’m really a predominantly a US investor. I love traveling and investing globally, but a smaller percentage of my time is spent toward that. And because I do really think the exceptionalism in the US is here to stay. I mean, last year we did well over 200 IPOs. This year we’re supposed to surpass that. That’s just on new initiatives and all different market segments.
The talent, the resources, the capital related to AI is happening in the US at a rate that you wouldn’t believe. I mean, these are large-scale projects and they take significant capital and expertise to build. So you kind of go through the series of things that are conditions you need to set up a successful business at scale and then deliver it to a large addressable market. That’s what the US offers.
OS: Sure, thank you so much, Grant, and thank you again for your time.
GC: Thank you for having me. It’s great to see you.
OS: For more on the companies exposed to this next wave of artificial intelligence progress, check out Morningstar.co.uk and indeed any of our international editorial websites, where you can sign up for our new editorial newsletters wherever you are in the world. We are just about out of time, unfortunately, but until next time, I’ve been Ollie Smith. My thanks to Grant.
