Listen in as Motley Fool co-founder Tom Gardner and Chief Investment Officer Andy Cross talk about stocks!
In this podcast, Motley Fool co-founder and CEO Tom Gardner talks about separating AI contenders from pretenders, his two favorite market indicators, and lessons from the dot-com bubble. Plus, Tom shares six stock ideas for the next five years.
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See transcript is below.
Tom Gardner: TransMedics has built up their organ care system. They have one of the great CEOs in the US. It’s been a wonderful stock for us. I think our cost basis on some of our shares are down around 15-20, and the stock is at about 145 today. But I think it’s got another 3X over the next 6-7 years for TransMedics shareholders as it continues to expand.
Mac Greer: That was Motley Fool co-founder and CEO Tom Gardner, talking about TransMedics, one of his favorite stocks for the next five years. I’m Motley Fool producer Mac Greer. Now, Motley Fool Chief Investment Officer Andy Cross recently sat down with Tom for our Stock Advisor podcasts. They talked about the current stock market. Tom shared two of his go to market indicators and six of his favorite stock ideas. Andy kicked things off by asking Tom about AI.
Andy Cross: How do you think about trying to determine those AI contenders from the AI pretenders when you’re looking at it as an analyst and as an investor in companies you might be studying and thinking about investing in?
Tom Gardner: Well, one of the things to look at is cultural change and to just read about the companies. Again, it depends how many comes you have in your portfolio and whether you think you’d have pattern recognition on understanding the decisions they’re making. But you basically want dramatic action culturally at companies now because the winners are going to be AI native companies. The winners were going to be and did become Internet native companies. It wasn’t like Google was actually a physical bookstore. Google wasn’t a bunch of physical space universities and it was going to try and create online learning. It was just, we’re just using the Internet for our whole business. We wouldn’t even think twice. This is what people are not quite understanding, but, of course, I don’t want to say that too much because it’s becoming more and more real, and we’re seeing transformations in company cultures, but I don’t think what people fully realize is that companies with 2,800 employees may be able to be replaced by companies with 108 employees. In order for a existing technology business to get there, how do you get from having 2,800 employees, let’s just say down to 400 employees who are all AI native? All advanced AI coders, totally bought it, not even questioning, not even like, I use AI and it came back, and it gave me the wrong computation. Gave me the wrong answer like, good. You’re supposed to go back and keep working so that it gets it right for you. You’re using a tool. You’re trying to shape that tool to work for you. You don’t just give up after you put a one line prompt in and it doesn’t give you the right response. I think what we want to see in companies is that they are bringing in teams of people who have expertise with advanced new technologies and that they’re letting them lead, and that’s so hard to do. We got such great advice from outside tech advisors at the Motley Fool who essentially said, when you hit a big transformation like this, just go back and read only the Paranoid Survived by Andy Grove.
The leaders of today at your company, they’re not likely to be the leaders of tomorrow. Unless they go to sleep and wake up the next day and they’re like, I’m all in on this. I’m only going to work through this. I’m not going to try and incrementalize my way forward. I’m all in fully on it. It just becomes too difficult to stage your transition in a workplace when there are newcomers into the market that are only using those tools. We saw it at Time Magazine. We saw it at Businessweek magazine. We were interacting with so many magazine and newspaper companies in the 1990s, and I had a lot of respect for them. After all, they were the big brands of the last 15 years. They had huge balance sheets. We were flattered that they were talking to the little old Motley Fool, but now they’re all gone. Their commercial value collapsed. Some of them were bought for $1 a share or their stock went down 95%. When you say, which ones are going to be real, which ones aren’t, I think you have get proof that they are AI native. The clearest way will be that they’re born in this era and come public with that. But anyone who’s in denial or any cultural challenge it has been interesting to follow Duolingo because some of the leaders in Duolingo said something, a year ago about how we’re going to use AI, and if there was a cultural issue about that. What do you mean? We’re not going to use AI. But the problem is, I think those points that were made, if you go back and look at them, they were accurate. The question is, can these companies act with respect for all the people that work there, but with a deep understanding that if we don’t change right now, we’re going to lose relevance, and we’ll despair. There won’t be any jobs left. It’s hard to face this, and we’ve actually never faced anything quite like this. We can save the Internet. It’s an obvious illustration, but this technology is moving a lot faster, and the implications are more profound, scarier, and more exciting than the Internet. I think you need to be looking for companies that are fully all in. They’re not in transition mode. They’re creating everything through AI in their workplace.
Andy Cross: Having founders like Toby, who own meaningful stakes and are all in like that and very vocal about it is a good indication of that exactly, Tom.
Tom Gardner: That’s such a great point, Andy. Because I can’t remember which founder CEO said, I feel sorry for all CEOs in the public markets that aren’t a founder because they have to work slowly through a procedure with their board. As the founder, spiritual leader, and largest individual stakeholder, I can walk into the board and say, I have to make this change now, and it has to go quickly. I’m going to make the case, but we’re not going through a bunch of bureaucratic checklists here. We have to move.
Andy Cross: Yeah, a lot of real equity and sweat equity into those decisions.
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Andy Cross: You remain cautious and moderate with your investing stance, but the AI powered indicator that you use in hidden gems actually turn more positive about the markets. Why, and has it impacted your thinking, maybe define what that tool is and how it’s impacted your thinking?
Tom Gardner: Yeah, I use two market indicators primarily to guide my thinking, and I really am using market indicators to tilt, not to go all in, or exit entirely the market. I just don’t think that way. I think the history of people who made extreme calls, of course, they’re going to get some right. But in general, they actually at best, they’re net neutral and they probably cause a lot of tax implications for people. I think what we should be teaching investors worldwide is to be more incremental and to recognize that the equity markets go up over time. There can be some bad stretches. We could take some extreme cases like Japan since 1989, so I don’t want to generalize too much or oversimplify this. But I think in a market that’s dynamic like the US market has good regulatory standards, and there isn’t a lot of inside baseball dealings between boards and executives all protecting each other. We have a really competitive market in the US. I think I would look at the market and say, of course, there’re going to be 40% declines at certain points along the way. I would definitely want to work back from a 40% decline with my investment portfolio and ask what will that mean for me and my life?
If I have a million dollars in this portfolio and it goes down 40%, I’m down at 600,000. That is a horrible experience to have. Most people, the idea of losing $400,000 in your lifetime, but as you get older and move closer to retirement, you have more and more people who have $1 million portfolio. Also, they’re starting to run out of their income years, so those 40% declines can have a much more profound effect on their lifestyle and their quality of their life. Of course, there was a great depression, but I think we have a lot more protections and a lot more solidity and dynamism to our market that 40% is a good one to work off of. Then tracking back from that, I use my two market indicators. The first is the potential growth indicator, the PGI, and the second is our market view tool, which is AI Power.
The first is just measuring the amount of cash that’s flowing in and out of the market. It’s basically saying, if there’s a lot of cash on the sidelines, that’s a good time to invest because that cash will come back in. If there’s not that much cash on the sidelines, it’s all in the market. You could even have great earnings reports, and companies could be doing amazing innovative things, but if there isn’t more cash that can come into the market, you’re not going to get a lot of upsides. That tool is essentially saying that the market is somewhat overvalued now and that we might want to expect something more 8.5% or 9% a year instead of the 10% to 11% a year that US equity markets have delivered over very long periods of time. You’re like, good. I’m going to be cautious. I’m going to be moderate. But the market view tool is using floods of data sources, and it’s not just following cash in and out of the market. It’s following cash flow projections across all US equities, multiples, historical multiples, interest rates, unemployment, it’s bringing in a lot of data points. Our formula calculates, and we can update that more frequently, but we update it once a month. That is basically saying more 10.5-11% a year. The reason that that tool is advancing that, I think my conclusion is that there are two reasons. One, margins are going to improve. If there are companies that have 2,500 employees, and that can be done with 250, either a new company is going to come along and do that, or a large company is going to gradually or suddenly, depending on their cultural approach reduce their workforce costs and be able to create a lot more.
Vinod Khosla of Khosla Ventures said recently that the marker for Silicon Valley companies is $1 million in revenue per employee. That’s what tech companies have been targeting as they’ve gotten funding and gone public, one million in revenue per employee. He said with AI, the new target is 5-10 million in revenue per employee. That either means that everyone who is in a workplace is going to become 5-10 times more productive using the tools right away, or that company is going to reduce its employment by 80%. The answer is it’ll be somewhere in the middle, and those puts and takes across who’s willing to use the tools and become a 10X producer and who’s not and therefore, is going to get a performance exit or an exit offer and will exit that workplace. There’s going to be operating and gross operating and net and cash flow margin improvements, and that those will translate to higher valuations. Companies will be a lot more profitable because of that. The second factor is that the margin improvements will come in technology companies that are many of the leaders of the S&P 500. You’ll see continued outsized gains by large tech, which is already making up a bulk of total market cap in the US, and those margin gains will translate to higher valuations, and you’ll end up with closer to 10.5% per year.
Anyway, predictions would be somewhere between 8.5 and 10.5%. On the one hand, that’s not that big a deal. That’s not a big gap. On the other hand, it is about a 30% swing either way per year. If it’s going to be closer to 8.5%, we’re going to see more volatility. We’re going to see some bigger losers and we’re going to not get as many big winners. If it’s closer to 11% a year, well, we’re going to be in an exciting market where there are some big winners, particularly in new technologies. There’ll be a lot of IPOs, as well. I guess I’m somewhere in the middle overall, that might sound boring or wishy washy, but I’m still pretty firmly in the moderate camp, leaning more toward adding cautious investments alongside my moderate rex than aggressive investments alongside, but I still want to have a good mix of all.
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