Transcript:

Caroline Woods: Joining me now, Peter Lazaroff chief investment officer at Plancorp. Peter, great to have you at the desk.

Peter Lazaroff: Hey, thanks for having me, Caroline.

Caroline Woods: All right. So after the recent volatility that we’ve been experiencing in AI stocks, you say we’re still in the early innings of this AI boom. What gives you confidence that this isn’t the beginning of a much bigger AI unwind.

Peter Lazaroff: You know when you look at the data on just how few people are actually using AI in their daily lives, that’s probably what gives me the most confidence that, sure, maybe you and I and our viewers are constantly talking to Claude or ChatGPT, or they’re using AI assistants, but less than five people are really using AI on a daily basis.

Peter Lazaroff: And of that, maybe like 1% are using it for really heavy lifts that truly leverage the power of AI. I also think you’re in the early innings of seeing corporations adopt and sort of rewire their workflows to gain productivity, to have better customer service, and to maybe turn some shoppers into actual buyers on the sales side. We are a consumption-based economy.

Peter Lazaroff: There’s no doubt that the health of the consumer is going to drive massive what goes on in our economy and often in the stock market. But when you have something in the background nudging people towards sales or improving their preferences or improving the inventory that these corporations have. There’s a lot to be optimistic about.

Caroline Woods: And on that note, you believe the best opportunities as it relates to investment opportunities may be in companies that are already profitable and that can use AI to be more productive. Why is that a better opportunity than owning the companies that are responsible for building AI?

Peter Lazaroff: So I think if you are thinking about AI as a general-purpose technology, something like railroads or electricity or the internet, well, the winners aren’t always the people who are making the actual product. And so right now, everybody wants to be the winning model or the winning chipmaker, or they want to have the right data center exposure. But when you are focusing on that, there are going to be winners and losers, and I’m not going to be able to decide who those are.

Peter Lazaroff: And when you look at past adoption rates of general-purpose technology, the winners tend to be those who are applying the technology rather than making it. And so really, what you’re looking for are opportunities for people to improve work, to improve worker productivity, to improve the cash conversion cycle, to maybe manage inventory differently. It’s not something that’s exciting, but it’s the sort of improvements that we saw even as recently with the internet, that really can lead to multiple decades worth of growth for a number of names.

Caroline Woods: So I know you brought three stocks that you think could benefit from AI, or they are benefiting from AI. Before we get to those though, because everyone if you look at earnings call transcripts, everyone is actually talking about AI right now. So how do you distinguish a company that’s actually making money and productivity gains from AI versus simply just talking about it?

Caroline Woods: Is there a specific, you know, evidence that investors should be looking for?

Peter Lazaroff: Well, I think if you’re listening to the earnings calls, you’ll hear what CEOs and executives are focusing in on. I mentioned inventory management being a big thing. You can see improvements in how long people are holding inventory. You can look at something like the cash conversion cycle. So how quickly are people taking payments and turning them around to suppliers, or how long are they allowing themselves to actually hold that cash?

Peter Lazaroff: These are very small differences at the margins, but multiplied over time. And you really see big impacts. I think the workplace productivity area, though, is the place where we haven’t yet seen the biggest gains that I anticipate seeing. And what gives me confidence that, yes, this is the early innings really with stocks, you see a lot of stocks that have been held up just by some of the big names, by the Magnificent Seven, by the hyperscalers.

Peter Lazaroff: I think this next leg is where you’re going to see sort of the thesis I’ve been talking about since the beginning of the year, which is these more general-purpose technology beneficiaries, whether that’s in health care or financials or consumer discretionary or consumer services. I think that’s really where most people are going to see the biggest boom from AI.

Caroline Woods: Okay. So let’s bring in the picks that you brought starting with BNY. What’s the investment case there? How does AI make the business more profitable? Noting that it’s already a company that’s up pretty significantly year-to-date, too.

Peter Lazaroff: So I’m always going to like stocks that have characteristics relative to other stocks in the market that are cheap, that have positive momentum. Some of the names you’re going to hear me say are things that have done well recently. You’re going to hear things that have high profitability. And sometimes I’m going to favor a small cap over a large cap, but something like BNY really across the board hits all of those.

Peter Lazaroff: You know, if you’re holding a custodial accounts, a lot of your efficiency gains comes from managing those accounts, eliminating errors, improving customer service. They have an AI agent or an AI platform, I should say, called Eliza, that’s focused both on the customer and internal enhancements. There’s something where you’re seeing leadership, making a specific investment to enhance everything across the board of what they’re offering.

Peter Lazaroff: They already have the customers, they already have the data. They already have the infrastructure to run a successful business. Now they’re looking at how can we amplify that and squeeze more productivity out of it?

Caroline Woods: Why a small cap over a large cap in this space? Why BNY over JPMorgan?

Peter Lazaroff: You know, in general, on average, because we’re trying to buy all of the cheap, quality, high momentum small company stocks where we don’t necessarily have to pick one over the other. But on average, if you buy them all, you tend to outperform those that are expensive, less profitable, a little bit larger, negative momentum. We’ve been doing quantitative investing for over 30 years at Plancorp.

Peter Lazaroff: And so when you hear some of the stocks that I talk about, they reflect some of these portfolio characteristics that you’ll see. And this isn’t to say that something like JPMorgan couldn’t do well, they have a huge consumer business where they could start up selling products through AI assistants. But in general, when you’re looking at some of the earnings beats, some of the competitive advantages.

Peter Lazaroff: Is that something like BNY has versus a JPMorgan? I think it maybe has a little bit more of a compelling story.

Caroline Woods: Okay. We’ll circle back to that factor in just a minute. But let’s get on to your next pick. Visa already a highly profitable company. How much additional growth can AI realistically deliver for Visa?

Peter Lazaroff: It’s another example where you think of something like we can push through payments. We don’t have to detect fraud in the way that we used to. It can happen in a more automated way. People can spend with confidence. You know, Visa’s already worked with OpenAI to get into some of these virtual AI assistants. We’re a big theme you’ll hear from me, is turning shoppers into buyers.

Peter Lazaroff: And so I think Visa at the margin can maybe benefit from a little bit more payment flow, but they’re already the dominant player. So if you’re a tech first financial institution like Visa, this is the place where if your processes are already lean, they’re about to get leaner. And something like fraud, where they’re losing money to fraudulent payments.

Peter Lazaroff: That’s something that they can suddenly squeeze out a little differently.

Caroline Woods: And why Visa over Mastercard or American Express, which is technically cheaper if you look at the chart, that’s actually—

Peter Lazaroff: Is cheaper.

Caroline Woods: Here.

Peter Lazaroff: Today. Well, that’s a good point. So I’m often looking for something with positive momentum. It’s also the cheaper is going to maybe in aggregate pay off over the long term. But in the short term it’s funny how momentum works. It is working until it suddenly isn’t. I acknowledge that, but in general, things that tend to go up tend to keep going up, and things that are going down tend to keep going down.

Caroline Woods: I was going to ask about that because Visa is another name that’s up double digits year-to-date. Is there a risk that investors are already paying for some of these future benefits?

Peter Lazaroff: I think so. We think we’d be naive if we didn’t say some of the things that I’m sharing aren’t somewhat priced into the stock today. What I like about what they have going is you are seeing continued revenue beats. You’re seeing earnings beats from Visa. You’re seeing them do share repurchases things that are really contributing to a lot of balance sheet health and income health.

Peter Lazaroff: And you don’t see much leverage at all, that they’re taking on. So they’re just in really healthy position. But that positive price momentum certainly is one of the reasons that I would choose it over something like a Mastercard today.

Caroline Woods: And your third pick that you brought is Williams-Sonoma. Not a name that we talk about often here on the show, but it’s actually a name that’s done really well, outperforming the broader market, up something like 40% year-to-date. Why is that your pick and why are so many other people buying it?

Peter Lazaroff: So even in 2020, we thought Williams-Sonoma might go out of business, you know, to play if you were buying Williams-Sonoma back then is that they’re going to get bought up by somebody, which is still, I think, an interesting thesis, or they’re just simply not going to go out of business. But when you look across the parent company brands, whether it’s Pottery Barn, Williams-Sonoma itself or any of the others, 65% of their revenues come from online sales.

Peter Lazaroff: Now, let’s think about AI virtual assistants turning those shoppers into buyers. I think that’s a real thing here. And also the operating margins here at Williams-Sonoma are absolutely incredible. You’re kind of getting one of those smaller names. So less coverage, less attention on it. And so over the long term, in aggregate, in general, those small caps have added return to versus large caps, particularly if they have high operating quality, high profitability.

Caroline Woods: Back when I used to shop in the store, it’s been years since then I loved Williams-Sonoma, but I would go right to the back of the store where the sales were. I haven’t been in years. But you know, given the the pressure that the consumer is under and given Williams-Sonoma’s price point, what makes you think that they’ll be able to hold up if a consumer is pulling back and they’re expensive?

Peter Lazaroff: Now, if you think of something and this is maybe not the best example because it’s doing poorly, but like Nike’s been doing really poorly for quite some time, but it’s such a strong brand where maybe it comes back at some point in Williams-Sonoma, when you have weddings, when you’re thinking of gifts, when you’re trying to buy upscale items, one of the things that our U.S. consumer seems to do is appreciate luxury or quality items, and they’ve built a brand around that.

Peter Lazaroff: Same goes with Pottery Barn. There’s something with the brand name there that I think is encouraging people who just want to buy that specific brand. But I go back to like the online retailing, sort of like when Domino’s became a technology company, as their CEO used to say, they thought more about the experience less in how do I create an in-store experience?

Peter Lazaroff: Now, if you’re more of an online retailer, it’s more about managing inventory, making sure that pricing is dynamic for the customer depending on their preferences. These are all things where AI can play an enormous role in improving outcomes. And I think, you know, yes, positive price momentum, quite a theme of the stocks that I’m going to talk about.

Peter Lazaroff: You’re seeing people probably playing into that narrative a little bit these days.

Caroline Woods: Maybe I can help you find the discount codes to make those better. Might not actually help the companies then. So, all three of those names are names you would still buy here?

Peter Lazaroff: Yes, I think so.

Caroline Woods: And which of those three names has the most upside over the next 12 months?

Peter Lazaroff: Wow. Well, I guess I’m throwing a dart, but I’ll go Williams-Sonoma if I’m looking for something that I feel like will persist for 50 years, I’m likely to pick Visa. But Williams-Sonoma, I really do think, has a lot of things going in its favor.

Caroline Woods: Which one carries the greatest risk?

Peter Lazaroff: I think Williams-Sonoma, for the same reason. One of the things that could happen with higher interest rates in the consumer overall, like we are seeing higher prices because of the war and energy prices, obviously, I don’t think that we’ll see inflation impacted that unless oil prices take another leg up, which isn’t outside of the realm of possibilities, but certainly a risk.

Peter Lazaroff: Similarly, I think we’re going to get to the spring next year and see that it is year-over-year comparisons aren’t that big of a deal from the tariffs. Then it’s really how much is AI driving, productivity gains that show up in inflation. And as a result go back to what I was originally mentioning was higher interest rates.

Peter Lazaroff: So I think in general, a higher interest rate environment is not going to be conducive to the consumer, who for most of two decades has made a lot of financial decisions around the idea that debt is cheap and that they can’t earn any money on their cash. Now, debt is expensive, and cash, or even short-term bonds is an alternative to going out and buying something.

Peter Lazaroff: At Williams-Sonoma, for example, I went with your visa card for the rapture. Yeah.

Caroline Woods: I want to circle back to the idea of buying them all. And now that you’ve given stock picks, should the retail investor in this environment be stock picking, or should they just invest in the S&P 500 to get exposure to 500 companies.

Peter Lazaroff: So I’m always going to prefer the buy everything approach. I think it’s one thing. And if you’re interested in this space, I’m interested in this space. I think it’s fine to have a portion of your portfolio where you’re expressing your views, but you want to have the vast majority of your assets in something that is not trying to predict the future.

Peter Lazaroff: An index fund is rules based, where the most successful largest companies get the biggest weights. But you’ve heard me mention factors throughout things that are cheap, highly profitable, positive momentum, and you can buy funds that I tend to call factor funds. Some people will call them smart beta funds where you can own the whole U.S. market, the whole international market, the whole world if you want, and still not try to be predicting the future, but just tilting your portfolio towards areas with higher expected return.

Peter Lazaroff: And you can see it in the data across multiple decades, multiple asset classes, multiple geographies. It’s really persistent data doesn’t mean it works all the time, but on average, if you’re a long-term investor, it’s a place where I like to be.

Caroline Woods: So where should we be tilted right now?

Peter Lazaroff: I’m always a fan of profitability. Like, who doesn’t like a company who has high profits? And surprise, surprise, the data would show you the companies that are highly profitable tend to be companies that are less profitable. A lot of even when you look at the track records of someone like a Warren Buffett, mostly what they’re doing is buying value and profitability.

Peter Lazaroff: And so value is one of those things. When things get cheap, they tend to get cheap for a reason. And so when you’re trying to pick which cheap individual name, it’s really, really difficult. But the data suggests you buy all the cheap names and you apply a profitability screen to them, maybe a positive momentum screen. Suddenly you’re doing something with the information that is in price.

Peter Lazaroff: There’s a lot of people buying and selling securities and putting their information into that price. Indexing is not really the way to take advantage of that really. Factor investing is the way that you.

Caroline Woods: Do that well. Some would say tech stocks are looking pretty cheap right now. We have so many that are well off their 52-week highs. Yet you’re focused on names not in terms of AI infrastructure, but who will benefit from AI. At what point do you start focusing on some of those tech stocks on sale?

Peter Lazaroff: It’s a great question. I think if you are a short-term investor, short-term trader, you’re going to be looking at the price momentum. So catching a falling knife is is really quite a challenging task. And with the tech stocks, I think the way that they can correct course is through earnings. So when we get to our next round of earnings, you know you’re ultimately and I don’t mean this quarter, sorry, the next quarter’s earnings you might be able to put to bed some of the concerns that we had.

Peter Lazaroff: But when I think of overall overall market health this sort of pullback is extraordinarily healthy. We used to be worried about the concentration in the S&P 500. And yet if you look at Nvidia’s performance over the past month, compared to the rest of the S&P 500 or even the whole S&P 500 with it in it, where’s that concentration risk?

Peter Lazaroff: We were also concerned about? Michael Mauboussin published a paper a year ago that showed it. Hey, this market concentration issue isn’t really something that’s something to be afraid of. It’s just a normal characteristic of a bull market. And depending on how you want to define what a bull market is, I sort of feel like we’ve been in a bull market since 2013, you know, a secular bull market.

Peter Lazaroff: So any ups and downs we have, whether it’s in response to the headlines, with higher interest rates, I think those should be expected. We have 10% drops on average every 12 months and a 20% drop every 3 or 4 years. So I’m generally investing knowing that those are going to occur, not trying to avoid them, but just sort of planning on them and taking a longer view.

Caroline Woods: But you’re calling tech a falling knife, and we have to wait until next earnings season to really maybe get some confirmation that that’s the place to be. So does that mean that you think that we’re going to see more weakness from that space? And what does that mean for the overall market then?

Peter Lazaroff: So in funds where I’m owning overall market, I don’t have to make that decision. But if I’m looking to pick stocks, at least now we’re at a place where it’s cheaper than it was a week ago. And if you liked tech stocks two weeks ago or a month ago, you should really love them right now. Where does the pain stop?

Peter Lazaroff: I think it’s anybody’s guess. I think in a week something else can come up that totally changes it. One reporting, one earnings report from somebody who’s directly involved in the AI ecosystem could completely change the sentiment around it. But we’re having some negative sentiment in the space, and people have been hanging out there for quite a while.

Peter Lazaroff: And I think you see a lot of profit taking now.

Caroline Woods: And we’ve seen how fast some of these trades can unwind. So how can investors tell whether their portfolios might be too heavily exposed to AI?

Peter Lazaroff: I generally think that if you have more than like 5% of your portfolio overweight in a certain direction versus what the overall market is, you have made a bet. That doesn’t have to be wrong, but you just have to know, why did I make this bet? And what has changed today? So bad outcomes don’t necessarily mean that you made a bad decision.

Peter Lazaroff: It’s really sort of thinking through the process of what you want to do next. Some people are going to look at fixed income and say, well, gosh, I can earn a real yield of 3% now. Why not just throw my money there and.

Caroline Woods: Start 5%?

Peter Lazaroff: That’s right. And there’s some validity to that. But the long-term real return on stocks is still 7%. And I think you are forgoing some upside. I’m always going to prefer stocks over bonds. But in general, I think you do have some questions of what has worked in the past handful of years, particularly since the launch of ChatGPT at the end of 2022.

Peter Lazaroff: This might be that moment, that catalyst that many of us have been speaking about say, hey, it’s not all about those who are creating the product, but more of those who are going to leverage it.

Caroline Woods: As you mentioned, ChatGPT, obviously we have the Anthropic IPO coming up. Doesn’t sound like to me that you’re going to be jumping in at the beginning there.

Peter Lazaroff: No, I think in general the history on any IPO is pretty bad. You know, if you get access to the pre-trading price and you sell it on the first day, there’s some history that you can make a quick buck there. But long term, you know I think there people want to poke holes in something that’s wildly popular.

Peter Lazaroff: It’s more fun to sound negative on something. But as somebody who’s still bullish on the overall space, I you know, I think long term Anthropic is going to be a contributor to the overall market. And as a result, if I’m owning the overall market, I’m going to probably own some Anthropic through one of those total markets eventually.

Caroline Woods: Yeah. So, for the everyday retail investor who hears people like you say, hey, 10% corrections, those are healthy. We could have a 20% pullback and still be technically, although a bear market within a bull, I guess. Right. Or who has seen some of these thousand point swings that we’ve seen on the Dow? What should they be doing right now as they prepare their portfolio for year end, a seasonally positive time, and as we think about next year.

Peter Lazaroff: So I think if you’ve been following a similar strategy for multiple years or even a decade, at this point, you might want to look and see what is my international exposure at this point, valuations are not super predictive, and international valuations have been lower than U.S. valuations very long time. You might also find a lot of reasons of why would I want to invest outside the U.S.?

Peter Lazaroff: Look at all the problems they’re having. But that’s exactly what you want to do as an investor. Things are cyclical.

Caroline Woods: Invest where there are problems.

Peter Lazaroff: You know you’re trying to invest where things are cheap. Invest, where there’s fear, be greedy when others are fearful. That sort of classic, statement I think, plays true to international markets. But in general, I really do think that you’re going to see factor investing in particular becoming much bigger thing, for investors who perhaps, since the financial crisis, have only utilized index funds, have large exposures to the Qs or the tech area.

Peter Lazaroff: Certain, winners don’t win forever. And typically, when you look at the largest stocks, their performance after becoming some of the largest stocks tends to trail the overall market in the next 5 or 10 years. When that starts, nobody knows. But who knows? Maybe this is just the beginning of it.

Caroline Woods: And where internationally looks most attractive to you right now?

Peter Lazaroff: Well, if you like, I have an emerging markets is going to be your play because they have such large chip exposure. Europe is really tough to love because there is a lot of structural issues, with how they’re set up fiscally and how they really discourage innovation. You know, when people take failing in a startup as a badge of honor here in the U.S., but have it as a red mark for life and in Europe, that’s a hard environment to really, rally around.

Peter Lazaroff: And so I think you see fiscal issues in France where people get more concerned of are we having another PIIGS situation from the 20 tens era? It’s generally going to be, hey, this is a place even more where the factor approach is going to, pay off, in my opinion, but you’re maybe going to look smaller, you’re maybe going to look there for a little bit more tech diversification, versus a US index where we’re still pretty tech heavy.

Caroline Woods: Okay. And finally, just because you host a podcast, helping people kind of cut through the noise, what’s something noisier, a data point that people pay too much attention to and one that they don’t pay enough attention to?

Peter Lazaroff: I think the thing that people don’t pay enough to this, I can go right away is earnings. So anytime you’re worried about the market, the simple question you have to ask yourself is how is this going to impact earnings. And I think what happens is people’s the way that they’re obtaining information is they focus on the headline before they think about the implications.

Peter Lazaroff: And so on. The Long Term Investor podcast, you were constantly talking about these big picture ideas, as well as having guests on the show who also have different perspectives. So I’m not just the one who’s, opining on the power of earnings, but if you look at earnings and the S&P price over time, they are very, very closely tracking each other.

Peter Lazaroff: And so when earnings are bad, prices tend to fall. And when earnings are good or certainly expectations a better earnings are ahead. You’re going to see prices rise. I think whenever you can boil it back to how does this impact earnings, not just for this quarter but over the next year, five years, ten years, you’re going to find yourself in a better place with your portfolio.

Caroline Woods: Do you think Nvidia earnings can turn Nvidia around? Because those are always solid numbers but not always higher prices.

Peter Lazaroff: I’ll have to admit, there is a lot of stuff going on with Nvidia that I don’t understand in the earnings. And because you have and I’m not saying they’re circular investments from a negative perspective, I don’t want to come out, say I’m using anybody doing anything wrong. But I think what you’re doing is you have so many people paying for future compute that we think we’re going to need, and I do think it will materialize.

Peter Lazaroff: But we also have some assumptions out there where we need to have data centers where we can’t even get water to cool them. So I do wonder, and I don’t know how much that impacts Nvidia’s ability to sell chips, because if people can’t use the compute, have we overestimated that ability? I think that’s what you’re seeing in that price declines right this moment.

Peter Lazaroff: Price declines typically stop when you have a little bit more clarity about what the future is to hold. I don’t personally see any clarity there. So if by the time I see clarity, that probably means if there’s been a bottom.

Caroline Woods: For some other headlines playing out in the.

Peter Lazaroff: Video, well, that’s very true as well.

Caroline Woods: Yeah. All right. I think this is a great time to pivot to our rapid fire round of this or that. Quick questions, quick answers. No hedging. Are you ready? Let’s do it. Your first time playing here. AI’s biggest payoff: higher revenue or lower costs? Lower costs. Magnificent Seven or the rest of the market.

Peter Lazaroff: Rest of the.

Caroline Woods: market. Value or momentum? Wow. Value. Best value in the market right now?

Peter Lazaroff: Gosh, I think small, profitable, high quality stocks with positive momentum.

Caroline Woods: So small caps or large caps.

Peter Lazaroff: Will go small caps reluctantly.

Caroline Woods: U.S. or international. International individual stocks or ETFs, ETFs, stocks or bonds. Stocks fresh money. Invest all at once or invest gradually.

Peter Lazaroff: All at once.

Caroline Woods: So how much cash should you have in your portfolio?

Peter Lazaroff: None.

Caroline Woods: Market volatility. Opportunity or warning sign.

Peter Lazaroff: Opportunity.

Caroline Woods: Nvidia or Microsoft?

Peter Lazaroff: Microsoft.

Caroline Woods: Amazon or Alphabet? Alphabet. Alphabet or Apple?

Peter Lazaroff: Alphabet.

Caroline Woods: Williams-Sonoma or Home Depot.

Peter Lazaroff: Ooh, wow, that’s a good one. I’ll go Williams-Sonoma. I’ll go all in and.

Caroline Woods: Finish this sentence. The biggest misconception about investing in AI is.

Peter Lazaroff: That you have to own those who are building the models, or the chips, or the infrastructure.

Caroline Woods: The most overlooked investment opportunity heading into 2027 is.

Peter Lazaroff: Non-AI technology and other businesses that can leverage the power of

Caroline Woods: AI. Give us a boring name because yours haven’t been overlooked.

Peter Lazaroff: How about Manitowoc? They make cranes. They’re more construction based. Granted they could. They do benefit from some of the AI boom and infrastructure build out, but that’s always a name that I’ve been fond of.

Caroline Woods: Okay, the biggest mistake retail investors are making right now is.

Peter Lazaroff: Trading too much.

Caroline Woods: And one investment rule I’d never break is.

Peter Lazaroff: I’m not going to time the market.

Caroline Woods: All right. That’s Peter Lazaroff, chief investment officer, Plancorp. Peter, thanks so much. Really appreciate you playing along. Thank you for bringing your picks and sharing your perspective.

Peter Lazaroff: Yeah. Thanks for having me.