The Next Market Winners

Hey,

In our last newsletter we said that we are most probably in a stock market bubble.

AI is a technology that we believe will improve productivity significantly.

Its arrival has already caused large financial shifts in the markets.

We also compared today's market to earlier technological breakthroughs.

Each of them came with the same optimism.

Each of them ended with a sharp fall in stock prices.

Our view is that we are in the second half of the bubble, and that it may end at some point next year.

However, there is no single reliable indicator for the exact timing.

That view can anyway justify a rearrangement of the portfolio.

The objective is to be positioned for the large shifts of capital that may follow.

One way to avoid a deep drawdown, and a long recovery, is to look for opportunities outside the most exposed sectors.

This can also position you well for growth in the coming years.

After a technology bubble ends, the lead is usually taken by traditional companies with strong balance sheets and strong cash flow.

Their value is recognised again in the years that follow.

In this newsletter we want to discuss companies that have been overshadowed by the attention given to AI.

They offer interesting value and they have very strong moats.

These are Zoetis Inc. and Adobe Inc.

Zoetis

Zoetis is the global leader in animal health.

Its portfolio covers both companion animals and livestock, and the company is present in all major international markets.

Its commercial platform is one of the most established in the industry.

The trends supporting the business are durable.

Pet ownership is rising, spending on animal healthcare is increasing, and demand for more advanced veterinary treatments continues to grow.

Zoetis serves that demand with pharmaceuticals, vaccines and diagnostics.

Demand is recurring and the company has strong pricing power.

This has historically supported attractive margins, resilient cash generation and high returns on invested capital.

At the current valuation, Zoetis gives investors a high quality defensive growth business.

It has substantial competitive advantages and a long runway for compounding earnings and free cash flow.

The stock price has been compressed significantly.

There are two reasons: a temporary slowdown in growth, and liquidity leaving the sector in favour of AI companies.

The company is selling today at a 70% discount to its historic maximums.

Zoetis achieves a 30% net income margin consistently.

That is comparable to Meta, formerly Facebook.

Revenue growth has stalled recently because of the slowdown in consumer spending.

The company is increasingly buying back its own shares, because it considers the stock undervalued.

It also spends approximately twice as much on R&D as its competitor Elanco Animal Health, which is currently believed to be taking market share from Zoetis.

Zoetis is a large company with deep moats.

Its capital strength, its distribution network and its brand recognition protect it against any form of competition.

The company will remain in its position for a long time.

Its strength will eventually be recognised again.

There are minor issues, namely the temporary slowdown in growth and the small loss of market share.

We believe these are discounted twice over in the current stock price.

Adobe

Adobe is one of the leading software companies in the world.

It holds dominant positions in creative software, digital documents and enterprise digital experience.

Its main products are Photoshop, Illustrator, Acrobat and Experience Cloud.

The subscription model produces highly recurring revenue, very strong margins and substantial free cash flow.

Its products are industry standards and are deeply integrated into the way customers work, which creates significant switching costs.

The central investment question is about AI.

Will it disrupt Adobe's competitive position, or will it strengthen the company by expanding creative workflows, increasing product usage and creating new opportunities to monetise?

The market is leaning towards disruption.

That is why the stock has declined more than 60% from its 2021 peak.

Software application developers face the same concern.

Adobe, Salesforce, Intuit and ServiceNow are all treated in the same way.

However, few companies are better placed to use AI to their own advantage.

AI is a tool for improving efficiency, and that is where its highest utility lies.

AI is software itself, so it sits very close to what these businesses already do.

The potential to improve software products and to process very large datasets is substantial.

For these companies AI works in both directions.

They face a genuine risk of disruption.

They are also among the companies most capable of monetising AI.

Adobe's stock price is low relative to the results the company reports.

In our view it can be one of the most undervalued high quality large cap companies in the market.

Investors are concerned about its future.

There is no evidence of AI disruption in its quarterly earnings.

Revenue is growing at high single digits, the net income margin is 30%, and the company is carrying out large buybacks.

For an investor who believes Adobe will use AI to improve its business, this is a clear opportunity.

We hope you enjoyed today’s reading!

Talk soon,
Igor and Timur

P.S. Not investment advice. If you want to learn how to invest like a pro, check out my academy: https://www.mba.wildcapital.co/