Revenge of the nerds

SaaS-pocalypse is probably overstating it. Changing the pricing model for the lines of code which underly every software business to a subscription fee rather than a one-off payment remains one of the great strokes of genius. Moving servers offsite and calling it ‘cloud’ wasn’t a bad idea either. Capitalising these subscription fees and the expectation of extracting ever higher prices from locked-in customers into perpetuity has created vast pools of market value over recent years. Whether the sharp falls in share prices of technology businesses and those perceived as most exposed to AI disruption presents an opportunity, or is merely sucking some air out of an overinflated balloon, depends on your perspective. Key to this question is the issue of business duration.

Inherent in the pricing of most businesses is an expectation of durability. In paying a multiple of earnings before interest and tax of 13 or 14 times (an ungeared return of 7-8% and equivalent to a PE ratio of around 17-18 times at normal levels of financial leverage), a shareholder should earn a reasonable equity return without requiring profits to grow any faster than the overall economy. There is one proviso; the business needs to last a long time. The reason bonds are safe is because someone promises to give you your capital back as well as providing a return. Equity holders don’t receive the same promise. Lots of short-term growth and low requirements for capital have become highly sought attributes, with companies able to deliver them attracting eye-watering multiples. The heroic assumption is that lots of growth and no capital employed have no trade-off with business duration. 

As a shareholder in any company, one of the first questions we think you should ask is a basic one. What do I own and why do I have the right to an ongoing stream of cashflows? When the assets of the company are mines, real estate, plant and equipment or tangible financial capital, things are reasonably easy to get your head around. When it’s lines of code and a customer base paying handsomely to access them, things become a touch trickier. Companies such as Wisetech Global (ASX: WTC), Pro Medicus (ASX: PME) and Xero (ASX: XRO) have all developed excellent products. Profits are already high relative to the costs of developing these products/lines of code and AI is ensuring the same products could be developed today at much lower cost. The conundrum facing investors today as Wisetech Global announces 30% cuts to its workforce is why customers should be expected to pay ever higher prices for lines of code when the costs to develop are falling. 

Similarly, as many companies have realised the extent to which their business has become hostage to egregious pricing from technology providers, the potential to use AI to reclaim ownership of technology development looks set to provide greater challenge for the assumed pricing power. 

After the ‘SaaS-pocalypse’, the rough valuations of a few of the major domestic technology companies are shown below (based on most recent full-year earnings). Both Wisetech Global and Xero made acquisitions in 2025 (Xero paid US$2.5bn for Melio and Wisetech paid US$2.1bn for e2open), both raising some questions for investors, however, the 2025 earnings are reasonably clean. None are even vaguely close to the 13-14 times EBIT which would offer investors a reasonable return assuming levels of growth similar to the economy and long duration. Approaching valuation from the other angle, should we assume the 2025 earnings of all 3 companies below were sustainable in perpetuity (a perhaps heroic assumption), we would derive valuations of around $4bn each for Wisetech Global and Xero and a little over $2bn for Pro Medicus. The $10bn or so in additional value which investors are imputing in the value of each of these businesses is effectively the price for additional growth, which again, must be sustained in perpetuity. ‘Apocalypse’ has perhaps been redefined in recent times as meaning ‘extremely optimistic’ rather than catastrophic.

Interestingly, on the issue of business duration, Torsten Slok of Apollo produced a great chart on the tenure of companies in the S&P500. While acknowledging the myriad reasons as to why business duration might be falling, the increasing proportion of ‘asset light’ companies in the benchmark and the potentially more aggressive process of ‘creative destruction’, either through takeover or displacement by new business models, seems likely as a potential reason for the sharp reduction in durability. One way or the other, the assumption that all businesses are similarly durable and multiples should simply reflect expectations of excess or sub-par growth in the short to medium-term, seems to us a fatally flawed one. ‘Asset light’ is beguiling when rapid growth comes at little cost, when growth disappears or revenue declines the safety net of ‘asset heavy’ can have a little more appeal.

Ever keen for new acronyms, ‘HALO’ (heavy assets, low obsolescence) investment strategies have been the counter to the AI disruption trade. While the durability of many of these businesses together with the discounted multiples traditionally attributed to more cyclical earnings streams have always placed these investments firmly in our comfort zone (we are more than happy to accept a few ups and downs in earnings if we receive better than average business duration in return), sharp rises in valuation nearly always impacts future return prospects. The pattern of returns over the February reporting season saw many materials businesses build further on the strong returns of recent months.

While the Rio Tinto (ASX: RIO) talks with Glencore have faded into the background, enthusiasm for copper, gold and other precious metals has not. Though the Pilbara iron ore engine rooms continue to deliver strong results for both BHP (ASX: BHP) and Rio Tinto, copper continues to fuel investor excitement. Successful investment in commodities , whether as a shareholder or the CEO of a public company, usually requires keeping a level head on long-term prices when the commodity price charts begin to head into the stratosphere. The track record of CEO’s isn’t great. We have always found dimensioning the implied price/tonne of sustainable production a useful tool in determining whether valuations are becoming stretched. Whilst a shortcut, and potentially very misleading for short-life high cost assets, the high quality, long duration copper assets owned by the majors such as Escondida, Oyu Tolgoi and South Australia are likely to be at least as durable as the average industrial business. 

During boom times, investors invariably seek exposure to ‘pure plays’, as they race to maximise exposure to leverage from rising commodity prices. 

The chart below highlights the rough per tonne valuations investors are currently paying for these assets. Some, such as Sandfire Resources (ASX: SFR), while similar in market pricing to these of majors such as BHP, are much shorter life and lower quality. Numbers north of US$100k/tonne of sustainable production implied in current market capitalisation compare to costs for brownfield expansion projects at around US$20k/tonne and greenfield expansion at around US$30k/tonne. Delivering a 10% return on capital (very low for assets in risky jurisdictions which are not perpetual in nature) when an investor pays US$100k/tonne for an asset requires a sustainable profit per tonne of US$10k. Simple maths would indicate this requires a sustainable margin of almost 80% even if one assumes the current elevated copper pricing of around US$13k/tonne is the ‘new normal’. By contrast, exposure to BHP’s copper assets, backing out iron ore valuations which assume sustainable pricing at around US$70 iron ore, sees copper exposure through the diversified majors at a far more reasonable per tonne valuation of around US$40-50k. To cut a long story short, copper excitement is seeing valuations for pure plays move into territory we’d describe as perilous. Exposure through BHP and Rio Tinto, while no longer cheap, remains reasonably priced as long as one assumes they avoid the temptation to pay US$80-100k/tonne for copper assets of others. We are very happy the Glencore talks have faded into the background.

On the precious metal front, metrics suggest investors are even more excited. Whatever way we looked at the deal BHP executed with Wheaton Precious Metals in receiving US$4.3bn up front for the silver streaming rights from Antamina (Peru) while still retaining 20% of silver revenue, it looked persuasive from a BHP perspective. This didn’t stop the Wheaton share price rising on the announcement. Nothing like a win, win transaction! Time will normally urn one of these perceived winners into a loser, however, in releasing capital from a higher risk jurisdiction at implied silver prices which were largely unheard of before 2025, we are far more comfortable being the seller.

While reporting season was again notable in the obsession with incredibly short-term data points and wild overreaction, the sharp rally in the banking sector, led yet again by CBA (ASX: CBA), proved both a surprise and a headache for many domestic investors, including ourselves. As gold bugs continue to revel in the monetary debasement narrative and the imminent demise of bonds and the financial system, bank investors do not seem on quite the same page. As pure exposures to the monetary system, our economic expectation that banks and financials should see them negatively, rather than positively correlated with gold has proven misplaced. Earnings momentum remains a powerful aphrodisiac. Nevertheless, in objectively assessing performance within the sector, CBA remains the hands down winner. 

As highlighted in the metrics below, it is clear why mean reversion investment strategies haven’t worked. 

Despite a meaningful lead in ROE and being the only bank to create meaningful economic value through growth, CBA’s gap over peers has widened rather than closed. Despite very high market shares CBA continues to hold or gain market share. None of this sways us from our view on its limited investment attraction at prices anywhere near current levels. Purchasing a 14% ROE business at nearly 4 times book value, with profits supported by an almost total absence of loan losses remains a decidedly unattractive investment prospect. We remain perplexed as to how ‘risk control’ in a portfolio management context can entail having more than 10% of an equity portfolio exposed to these valuation metrics.

Replete with the usual array of well-presented and informative economic charts, the CBA data also told the tale of the operating environment for consumer exposed stocks. Significantly improving spend on essentials was reflected in solid results from both Woolworths (ASX: WOW) and Coles (ASX: COL). Having been crash tackled on receiving the Brad Banducci hospital pass, Amanda Bardwell has presided over strong and rapid improvement in Woolworths business performance. More satisfied customers, more competitive prices, lower costs and improved sales momentum; there wasn’t much to criticise. Similarly, whilst the Coles share price fell victim to trigger happy momentum investors, there was little to criticise in business performance, albeit liquor continues to highlight the perils of sales declines for retailers. Operating leverage can work rapidly in the wrong direction. While we remain perplexed on the extent to which Woolworths and Coles remain the focus of ACCC attention despite making half the margins of Bunnings and selling much of their fresh food at incredibly low margins whilst being picked off in higher margin categories by the likes of Chemist Warehouse, they remain highly durable franchises with prodigious logistics capability. Have I mentioned we quite like durability.

Discretionary retail was the other end of the spectrum. Whacked with the momentum stick. Though spending growth remains reasonable across most age cohorts, long-term investors quickly turned to the only page of the investor presentation of interest, the sales update for the first 6 weeks of 2026. Nick Scali (ASX: NCK), Lovisa (ASX: LOV), Temple & Webster (ASX: TPW) and Domino’s Pizza (ASX: DMP) were amongst the victims. Concerns over earnings durability, operating leverage and a backdrop of consumers squeezed between unproductive government spending and a lack of appetite to address housing affordability (by controlling demand rather than insisting it’s a purely supply-side issue) leaves us cautious on the sector despite some apparently cheap valuations.

Our significantly increased exposure to the healthcare sector over the past year or so met with mixed results over reporting season. Though our investment in Ramsay Healthcare (ASX: RHC) has often left us feeling like Monty Python’s Black Knight (missing a few arms and legs), incoming CEO Natalie Davis has taken significant strides in recovering from the European hospital-pocalypse begun by her predecessors. While distributing the Ramsay Sante shares which house the French and Scandinavian operations will probably do nothing other than shift some shares with little or no value into the hands of shareholders, it will simplify the business and remove much of the debt. $10bn of market capitalisation and a touch over $2bn of net debt against wholly owned assets buys 47 owned hospital sites and a business which delivered $420m in underlying EBIT for the half. 

At margin levels which remain depressed in both the UK and Australia, multiples of 14-15x EBIT (assuming a little over $800m in annualised earnings) and plenty of hard-asset backing leaves us in very comfortable valuation territory.

At the other end of the spectrum, our investment in CSL (ASX: CSL) has unfortunately started in the Black Knight vein. While the manufacturing plants and plasma collection network which underly the Behring business, which dominates the value of CSL, are ‘hard assets’ and crucial to the earnings power of the business, they provide little safety net for investors at the current enterprise vale of around $85bn. The misguided acquisition of Vifor, a challenging environment for the Seqirus vaccine business and a more competitive landscape for Behring have significantly tarnished a former market darling. Our primary concern is satisfying ourselves on the sustainability of current earnings as the multiple of around 14 times EBIT, whilst not outrageously cheap, requires little in the way of excess growth in the future to offer investors a reasonable return. Our expectations for future pricing of CSL’s products are far more conservative than history, and while tariff pressures, declining Chinese albumin volumes and immunoglobulin pricing pressures are making life tough at present, these challenges are also the catalyst to address excess costs which have crept into the business through the good times. We remain very confident in business longevity yet vigilant on the steps the company is taking to restore its pre-eminent position as industry-wide tailwinds are unlikely to be the panacea for recovery.

Market Outlook

While about 90% of the world’s data has apparently been collected in the past 2 years, it is not clear this is supporting more considered and thorough valuation of companies. Observing the torturing of earnings call transcripts for signs of negativity and positivity and scouring the world for data sources which might provide a microscopic advantage in forecasting positive or negative earnings momentum over the next 6 months leaves us ever more demoralised on the direction of investment analysis. In providing capital to companies able to sensibly assess opportunities for new investment and execute them in a disciplined and cost-effective manner, we do not feel all the answers are likely to be found in high frequency data sources. We are strongly of the view that determining and understanding which data matters rather than merely collecting more of it, offers great potential in delivering solid investment returns in the future.

Similarly, as volatility and index hugging promote ever more perverted definitions of ‘risk’, we remain confident in the payoff for portfolio construction which seeks to understand and promote genuine economic diversity through better understanding underlying business drivers rather than the overconfidence which often accompanies narrow and concentrated portfolios. While valuations remain relatively elevated and economic prospects ever more clouded, clear thought and some common sense should still be a useful accompaniment to healthy doses of AI.

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