T. Rowe’s Rizzo on Finding Technology Winners

made that easy but also highly concentrated. At the same time, we're entering a new phase of innovation driven by AI, where the next set of winners may look very different. Today, we're exploring what it means to actively invest technology in that environment to help us unpack that. I'm joined today by Dom Rizzo, a portfolio manager for the Troll Price Global Technology Fund tick our PRGTX and the trow Price Technology Etf tick your t Tech. Don thanks for joining me today.

great line. Good author's borrow, great authors steal, and I've stolen so much of my framework from the great investors at TIROW, whether it's a David Eisweer or Justin Why or David Jeru, David Wallack, or our MidCap value PM. So I think you have to kind of come up with your framework and cobble it together through making mistakes and building it out. So kind of with that background, you know, over time at TRO, I've been really fortunate.

I've covered hardware stocks, software stocks, payment stocks, small cap, MidCap, large cap, megacap us, Europe, Asia, and so I had to find a framework that kind of could do all geos, all regions, and all subsectors attack and that ended up being you know, looking for four things. Number one is what I call lynchpin technologies. These are the technologies that are mission critical to the success of their customers or make their users' lives dramatically better. The second, they have

to be innovating in secular growth markets. What does that mean? That means taking share and fast growing and markets. I'm sure we're going to talk about AI today. Probably the biggest secular growth market that I see is AI chips. You know, we're going from forty five billion dollars at AI chip spending in twenty three to five hundred billion dollars at AI chip spending in twenty eight to you know, a trillion dollars by twenty thirty or potentially earlier. So

you've got to be taking share in fast growing and markets. Third, and this is really important for kind of tactical trading, is I think stocks move when they have improving fundamentals, and so that's revenue that's accelerating, operating margins that are expanding, or free cash flow conversion that's improving. And then finally, you want to make sure you have a reasonable valuation. So in tech, I think the way you get burned is if you overpay and you can't compound from those

very high valuations. And so I would say, you know, twenty twenty one software stocks is a great example of that. Or actually, if you get pulled into a value chap. Right, So if you get pulled into a value trap and it's broken and it looks cheap optically, but it's never going to change. So I just want to make sure that the valuation we're paying is reasonable and that we

can compound there. So those four things lynch technologies innovating in secular growth markets with improving fundamentals have reasonable valuations, and I use that framework across both my strategies.

it's not that difficult to figure out those things. I think the thing that's hard is having this insight on improving fundamentals, which anyone who's hurt Dave Eyes were at hero Speak knows that I completely copied that from him, going back to this point about stealing, and that's the hard part. You need. You need to be able to have this great insight about revenue that's inflecting and why and so so right now, I'll give you an example.

We really like the CPU eco ecosystem names like a m D or Inteler ARM and that's because of an agentic world. CPUs become meaningfully more important to the orchestration layer and how how all these different ais work around an organization. Basically, the CPU increases barely materially in spending. So that's an insight that's going to result hopefully in revenue that's inflecting and and and that that's the thing that in the short term definitely either gets an idea

into the strategies or kicks them out. Valuation is always something we consider. The one thing I always caution the team is that you could have really outsized outcomes in tech.

And I'll give you an example. You know, when I did the anthropic round in the Global Tech Fund in in the summer, they were, you know, run raining roughly five billion dollars of ar R. No, no one in their right mind thought we would be close to twenty billion dollars of ARR by March, right, So, so you could have these outsized outcomes and then all of a sudden,

the valuation is actually far more reasonable. So, yes, valuation matters, but make sure you have an imagination and try to have an insight into that improving fundamentals.

rest of the market. The max seven of PEG is far, far less than the mag seven of the whole the peg ratio of the whole market. But what's the issue

with the mag seven. Of the seven of them, you know, six of them have increased in capital intensity, either through capex on their own balance sheet or you know, in the case of Apple, capacks on Google's balance sheet effectively, right because of their geminideal capital intensity is increasing for those companies, and then dollars are flowing into the semiconductor and semi capital equipment and you know, foundry ecosystem from the balance sheets of the most profitable companies in history.

So a debate we're that's raging internally right now. Is it revenue acceleration that matter, is it operating margin expansion, or is it free cash flow conversion? Which of those three is actually going to drive those stocks today as we sit here on you know, March thirtieth, it appears free cash flow conversion is what the market's considering. But you know, let's see after earnings in April, Yeah, makes sense.

the world is the Microsoft Office Suite. Well, guess what if you spend most of your day in chat gybt or Claude, is the Microsoft Office Suite actually the most enduring piece of software in the world or is it potentially chatgybt or a claud that may aggregate all the data that sits below it, and Microsoft Office may just be a pipeline into your AI that's walking around with you all day. So it changes so rapidly, and so that's why I love this Lynchpin word. And I kind

of came up with birth it by covering ASML. So I lived in London from twenty eighteen until twenty twenty three and I was our European tech analyst for part of that. And I love this concept that I really thought ASML was the most important company in the world, right, and I think we're actually kind of seeing it now. You know, chips are so important to not just AI build out but consumers, PC sparphones, defense, aerospace chips. Like

people say right now is the new oil. But I find it funny because you know, the memory stocks Samsung, Heinex, and Micron are going to generate significantly more free casual than all the oil stocks put together. Right, But you know they're they're bigger than oil, bigger than us deal, right, bigger than oil. But uh, the the lynchpin of all that, in my opinion, is this EUV machine from ASML, which I consider the most important machine in the world. And we don't have to get into the details of it.

So so I think finding this Finding companies that are mission critical to the success of their customers or make their users' lives dramatically better, results in more enduring outcomes.

But like you said right now, part of the fun and where I think active can really add, you know, tremendous value is figuring out which lynchpin statuses are becoming more enduring and actually which lynchpin statuses are becoming less enduring and why something into indices frankly can't really do and I think active investors can.

t T eq T tech. The right competitive set is QQQ right and you know, we could get into those details a bit. How does the name get into the portfolio? It's actually relatively simple. Does it fit my framework and is there huge alpha opportunities relative to risk? Right? And so that's how we do all of our bed sizing

as well. Is you know, often you have companies that have stupendous upside and I'll give you an example, like the optical stocks, but they're very very high beta, so Lumentum, Siena, Towers, Demi, these names are have had you know, fabulous performance over the past nine months, but have come with very very high beta, and so naturally they were actually you know, small to middle size positions throughout this previous run that we've had also have a little bit of a shorter

leash depending on that. So it's all risk adjusted alpha a risk adjusted performance, so it's all alpha potential that that that that really drives the position sizing. The other thing that I think about a lot is, you know your portfolio has stocks that are AI on, AI off, Semis on, Semis off, software on, software off, and you have to think about it in terms of overall construction.

And I'll give you an example. Uh, Volunteer is probably My biggest mistake since I took over the strategy this either one I you know, I just I couldn't get around the valuation. But the acceller the fundamentals were accelerating so dramatically, and the way we were designing software was changing so rapidly. Now, the way I slept that night is I always thought to myself, Okay, well, palenteer will add to my AI exposure, and I already have a lot of AI exposure, so I don't need even more.

So you have to always think about things in portfolio construction. But but you also have to go that and put it through the framework. So hopefully that gets me away to go. So I kind of want go back to valuation just a little bit. You know, how do you balance growth in valuation in a sector like this where narratives really dominate fundamentals And you know, I guess my bigger question is what does expensive actually mean in tech today? Well,

it's really funny narratives versus fundamentals. The thing about narratives is so technology investing is reflexive because talent is elastic, it can move from company to company. Right. The beautiful thing about silicon values everyone lives there. And the bad thing if you're a company in Silicon Valley is everyone lives there, right, so everyone wants to go work for the winners. They want to go work for open AI or anthropic or data bricks right now because they know

that that's a huge potential payoff for them. So narratives often become reality. And then you got to remember most of tech is not regulated, so things can change super rapidly, just fundamentally, right, and you could go from not being a growth asset to being growth asset. And then you finalize that with the fact that semiconductors, which are such a big portion of tech, maybe forty percent of the information technology services forty five percent of information technology services,

are inherently cyclical. Right. You have periods of other ordering and under ordering. You have periods of lead time expansion and lead time contraction. You have periods where bookings growth is the thing that matters versus earnings. And so I'll kind of counting your question with a question, which is is Nvidia expensive at fifteen times street earnings? You know, I think the debate that's raging in the market right

now is is that fifteen times earnings? Right? You know, are they really going to earn a double digit earnings number and is it going to grow from there? Or are we going to ask the cyclical pullback at a cruction. Now I know which side of the debate I end up on, which is very firmly in the side of not only are is the street earnings right? They may be actually be low, and I actually we're going to

go higher from here in terms of earnings momentum. But the debate that's raging right now in the valuation is not whether fifteen times is expensive or not. Is that it's that is that the right number to be using for Nvidia? So that's one on software. Software is a

little bit different. So software relative to SEMIS is at the cheapest level it's ever been historically today, right, I mean, there's never been a period you look at basically every metric EVY to sales, pe EVE to TROO free cash flow, which really matters in software because the stock based comp is so stupendously high. Software is cheap relative to SEMIS

versus every single metric you can look at. Now, I think that software has got more terminal value risk that it's ever had at any other period too, because AI is becoming the aggregator of aggregators, could commoditize the name like a salesforce or a workday or an Adobe really really quickly, even potentially, like we said earlier, the Microsoft Office franchise, it's under threw. And so I think valuation manners and manners most and it's extremes again for dero listeners.

Another Dave Ozer quote that I am blatantly stealing. And you have to have an imagination that can envision these different scenarios, have a cyclical framework, have an imagination and be able to do so. Yes, narratives do drive a lot of tech investing, but I'm actually not sure it's unjustified. Okay, no, fair enough.

I'll give you t tech as an example. If you go buy the Russell one thousand growth index today, north of fifty percent of your funds are going into seven names, right Like if you just buy the rust of one thousand growth, I think the number off the top of my head's like fifty two percent. So you know, we went back. You know, I think you guys have had so many great conversations about passive versus active and why is active

struggled historically in which active strategies have done well? And so number one, you have to believe, hey, I could generate alpha in these mags seven. I think it's completely possible, by the way, to generate alpha in the mag seven picking between those names. But that is a fundamental belief that you need to have Okay, So then I think a lot of people turn towards Nasdaq one hundred, right

and QQQ. But that's still like forty two percent. You know these seven names, right, it's it's it's still forty two forty three. I forget the exact number off the top of my head. What I tell my clients is I want to look smell act like a tech fund. So I need to own enough max seven to keep up. You know, we don't want to own to have a

situation where we don't own any in either strategy. And you know, obviously in the information tech strategy is more more infotech weighted, but like you have to have some strategy so you could do your asset allocation properly. I need to be able to pick between those seven names. But also I don't want my value to be derived from those seven names. So if you look at T tech, it's something in like the low to mid thirties is is MA seven. So that means seventy plus percent of

the strategy is named outside of that. So you need to own enough to keep up. If you have a situation where an Apple or a Microsoft do really well, and those two stocks in particular have fabulous downside capture. It's usually in down markets, right, and so if you don't own any that's you actually get really beat up

on the downside. So you have to have some level of exposure to those names, be able to generate alpha between those names, and then be able to find names outside of those max seven that could drive differentiated performance. And in my case that's it ends up being like ten ten stocks a year that end up driving it. Okay.

I'm telling you, whoever's listening, One Up on Wall Street should be the first book, and then go from there. So I find myself letting, letting my winners ride and cutting my losers. That being said, the framework saves me from myself at my natural inclination. So Lynchpin technologies innovating in secular growth markets with improving fundamentals have reasonable valuations.

I can have a stock that I love more than anything has been executing fabulously on my investment thesis, and either the team, the risk guy or increasingly the AI I will tell me, hey, fundamentals are getting worse. So Albert Albert and risk will say, hey, Dom, I know you know, but you have a very large position and the fundamentals are getting worse. Here the team will say, hey, it's decelerating, doesn't make sense. Or increasingly AI and we

can talk about AI and the investment process too. Fundamentals getting worse is the best reason to sell a stock, and you particularly want to do it when when when growth rates, in my opinion, are peaking. That being said, you want to let your winners run too, And and the question like with all great frameworks and all great rules, right. I used to have a teacher. I used to want

to start my sentences with butt. And then you know, I read a book I think it was Roaldall and he started a bunch of sentences with the word butt. And she kept saying, you can't do that, you know, you have you have to have a comma. And then but da da da da, And I said, well what about him? And she she goes, well, he knew the rules so he could break them. And and it's kind of like that with brainworks too, like when when do

you deviate slightly? Right? And and you know, when fundamentals are peaking, that's a great time to sell stocks.

types of beta. IgM and IXN are in the forty something that range, right, So that's global beta and expanded technology beta is a little higher than just kind of cheap information technology beta or QQQ type beta. Right, So there's a price of beta, and then can you deliver something to your clients as an active investor. That's the price of beta whatever that is plus your alpha potential And I love what you guys always say, plus some

hot sauce, right, like what is the hot sauce? And so that's how you have to get to fee construction and so overall for the average investor, just look at fees on a twenty five year basis, it's like fabulous.

The fees have come down, right, and it's probably resulted in this barbelll effect in the industry where the larger have gotten larger, and there's large players, and then they're small niche, and then everything in the middle kind of struggles, kind of like what's happened in a lot of different industries. I would actually argue that's just internet economics coming through the asset management industry. But that's a whole, a whole nother tangent. Right, So so what where do passive or

rules based fail. In my opinion, Let's take NASDAQ one hundred. Because it's so successful for so long, I completely understand why people use it as its main, the main allocating vehicle. NASZAK one hundred is simply the hundred largest names on the Nasdaq ex financial services. Okay, so right there, you don't get fintech, right, You'll never have a winner like an audience or a coinbase or a robin inherently, right,

you don't, you don't, you don't get fintech. Then you get twenty percent of NASDAQ one hundred that has nothing to do with technology and innovation, right. Costco, Marriott, Pepsi, Lindy, Walmart is moving from the New York Stock Exchange to the NASDAC. I think primarily to get into the queues, right, and and and get get a lower cost to capital.

You know, I'm sure there's other reasons too, but inherently, there's hundreds of billions of dollars behind the Nasdaq one hundred, and you know, you get this lower cost to capital as a result, and then you know, there there's maximum concentration, and then things like international often get thrown out with

the bathwater. And so I remember there are plenty of times where people say, why does it make sense to own any international and well, there's all these fabulous lynchpin companies, whether it's an ASML or TSMC, all around the world, and so so to only focus on the US market, you know, I think the US market is really amazing in so many ways, but I think there's these these great companies all around the world. So if I think about portfolio construction, how how these names are put in

mag seven concentration, the big get bigger. Now, now a few of the indices have capped benchmarks, right, so inherently the big can't get too big. But but I think there's a lot of things that go go into the construction, and so I think it's actually incumbent on the active industry to say, okay, this is the price of the cheap beta whatever that is, whatever beta you're offering, what is your alpha potential on top and can you price accordingly?

And then can you add any hot sauce, And like t EQ is a great example of potential hot sauce, we can add names that will never be in not never, but names that momentum. Is a fabulous example that we got really right over the past nine months or the six months or whatever it is, because you know, we had an insight on on optical. It's a very high beta name. It's a relatively small position, but that's a

that's that's an interesting idea conceptually. And privates is another really interesting area where you can add a lot of value outside of finding names that are not in those traditional pack seven so open AI anthropic data bricks, all of which are in TTEQ. And I think I'm the only strategy ETF that owns open AI. But you know know better than me.

basically all of economic growth will come from productivity. The last major productivity boom we saw in the US was the Internet, and that correlated with the Internet bubble, you know, quite strikingly. But there's also been railroads and electricity, and historically, if you look, productivity centered technologies come with speculative bubbles. Right, people get so excited because they're amazing. They're making your life so dramatically better. Productivity bubbles are not to be feared.

They're to be navigated responsibly via framework and to try to capture upside in one downside for clients. Right, people hear bubble, they think bad thing. I hear bubble and I think, oh wow, off a generation opportunity. Right, that sounds really exciting in many ways. If you have a framework that can help you navigate it electricity at it roughly one percent a year to US GDP growth for thirty two years. I think AI is going to smash those numbers. And I think we've actually already saw it.

You know, in Q three we add incredible productivity numbers almost five percent. Now numbers change quarter to quarter, whatever, But I think AI is going to unleash this massive productivity cycle in the US, which is what we needed, and that is going to result in you know, very rapid GDP growth, potentially a speculati bubble. So I think when I look at the stocks today, we've seen major moves in many of these names, but they've all been

earning streeven. So Nvidia is far cheaper today on a pe basis that it was in December of twenty two because the earnings growth has been so much bigger than the stock performance. And so the question is is that growth durable and we're going to see continued growth through the twenty thirties or not. Is the return on invested capital for the hyperscalers and the AI labs enough to

justify the spend. I think in many ways, this scaling law which is driving a lot of this cap ax may be a law of physics though, but basically, if you spend more money, you get more intelligence. You know. The exact equation, I think depends on where you're at the curve. But but but basically, you spend more money, you get more intelligence. I think that may be a law of physics that we discovered. The question remains, if

we spend more money, do we get more revenue? And so far I would argue the answers yes, right, Like Google Search grew seventeen percent year over year last quarter, Meta guide it to a thirty percent guide. We've seen open Ai go to you know, you know, well north of twenty billion dollars. A urr anthropic just behind it. Like, I think the answers yes, that we're getting the revenue

to justify the spend. But inherently, in the situations you're pulling forward now, going back to reflexivity, inherently the spend of the hyperscalers will be based on two things. One competitive market dynamics. Right, does is Microsoft worried about the office suite? Yes or no? If they are, they're going to spend more money. If they're not gonna, they're gonna spend less money. And number two geopolitics and exoger to shocks.

So my gut what ends all this and why I can't say we're an inning three, four, five six wherever? I mean? My gut is we're inning for or so, But but I don't know for sure. And the reason my mind could change, you know tomorrow, even though you know you always want to leave the ability to change your mind open is exogedive shocks could change the outcome.

And so if you see major spikes and energy prices that result on major consumer pressure that result in revenue declines at the hyperscalers, something you want to be cognizant of. If you result in major oil prices as a result of geopolitics that make the ROI C less compelling to go invest in the data centers, that's something you want to be aware of. But risk aware doesn't doesn't mean

take no risk. And I personally that the AI Bowl case is much bigger than those bear cases, but of course we're thinking about those at any given point.

deal sources can be organic as well. The reality of private investing is that the tails are much wider, and it's that power law on steroids. You know, if ten names drive my performance in my strategy, even less names will drive you know, the performance on on on the on the privates. That being said, I think there's this new area of the private market which looks very similar to public market investing to me, and it's these names like open Ai, Anthropic Data Bricks. I mean these companies.

You know, Sarah fryar At at open Ai was a public company CFO. Right, she was the CFO block and she's I mean she she is, you know, so so great for that organization in my opinion, And and I don't feel that different when I talk to open AI than I do to any of my public companies. And I would argue, actually that my framework stays exactly the same. Where I'm looking for lynchpin technologies, innovating in secular growth

markets with improving fundamentals, have reasonable valuations. I want to catch these companies right before that takeoff, and don't want to make sure I pay a reasonable valuation for them in the context of where they can be in three years. And I need to make sure that I have an appropriate imagination to do so. But that's incumbent on the

team and me to really stress different case scenarios. So I actually think the space between public market decision making and private market decision making is actually very similar in that late stage, you know, eighteen to twenty four months before becoming public, and I think that's exactly where where where we can build you know, I think a lot about where can we build differentiated business models. I think that's exactly where we can build a differentiated business as well.

intelligence of the public markets. I think I think the public markets are something to be respected, and there's a lot of noise, but often there's a signal in the noise of day to day price fluctuations, and so inherently you don't have that on the private side. But of course we consider you know, traditional valuation metrics in all of our our private investments, just like we do on our public investments. You have to have more imagination on

the private side. You definitely need to have more imagination. Again, right when I did and propic I have five billion dollars AR and the Global Tech Fund. Nope, I don't think anyone thought it would be be you know, pushing twenty No just on privates. Just one more thing. I think some of these companies are so special. I mean, I just really quickly want to talk about open AI

and and what a special asset that is. You know, here we have a company, whatever the numbers, is a you know, roughly a billion users, right, with a product that knows you so intimately. Right, chat GBT knows everything about me. And you know, if you ask Jack, GBT tell me everything about me. It gets get really it gets really close. It gets to my views as a father, right, it would get to how I think about investing, how

I think about life, how I think about compounding. I mean, it would it would really paint you a picture of Don Rizzo. This concept that they're not going to build the most profitable ADS business and history is is really

silly to me. Of course they are, and they're going to do it in an appropriate, thoughtful manner and take the time to do it in a way that's user friendly and doesn't require you know, everybody in the world spending twenty dollars a month on consumer subscriptions or two hundred dollars a month on consumer subscriptions, which frankly not everyone can do. Right. We know that for a fact, there's a price where it doesn't make sense for most

people to pay the subscription. And so if you could build a thoughtful advertising business that's very down funnel, right. You plan a whole vocation to Italy, you understand where you want to go, what you want to do, and at the very bottom of it says, okay, do you want to here, hey, booking Expedia, let's go bit on this,

just like in google'search. You know, I don't know if that's exactly how it's going to play out over time, but but I think there's a clear path there and then agents are really going to take off here in the next you know, twenty five months. Say, you know, I think this open claw innovation that we saw it. You know, Jensen had this quote at GtC where he said open Claw was the iPhone of tokens. And sometimes, you know, there's this old Kobe Bryant commercial where where

Kanye West says, what are you talking about? Kobe? What does that mean? And when you hear Jensen sometimes to talk, he says something and you say, what does that mean? Jensen? Open claw is the iPhone of tokens. Okay, what let's dissect it piece by piece and rationalized open Claw this amazing open source technology that allows a gentic workloads to take place on the consumer side or the enterprise was easy enough that it was like the iPhone and it's

going to result in massive token consumption. Oh, I got it right. Well, guests who open a I just hired. They just hired the the designer and developer of open Claw, and so I think that they're going to really build this magical agentic experience over time that will spend but it's the consumer and the enterprise.