The Physical Side of the Digital Economy

September 2026 Client Letter

There is rarely a shortage of things for investors to worry about. Lately, the list seems especially long. Wars and geopolitical tensions remain unresolved. The federal debt continues to grow. Interest rates and inflation remain concerns. Stock valuations in some areas are elevated. And after several strong years for the market, it is reasonable to wonder how much further stocks can run.

These are legitimate concerns, and we spend plenty of time thinking about them. But we also think it is important to distinguish between the headlines that dominate the daily news cycle and the underlying fundamentals that ultimately matter to long-term investors.

I began working in the investment business in 1992, and I cannot remember a two-year period I have found more interesting than the one we are living through today.

That doesn’t mean it has always been comfortable. During the trade turmoil in the spring of 2025, the headlines were relentless. I remember waking up too early one April morning and deciding that I simply wasn’t going to begin another day reading about tariffs. Instead, I began my mornings by focusing on company-specific developments and earnings rather than the day’s biggest stories.

Back then, what I was seeing from the companies themselves often looked considerably better than what I was reading on the front page.

And that remains true today.

For many of the companies we follow, earnings continue to grow. Revenues are advancing. Companies continue to invest in their businesses. And perhaps most encouraging, that growth is spreading across a broader range of businesses and sectors.

Helping drive that broadening is the most significant technological development of my investment career: artificial intelligence.

But perhaps not in the way many investors initially imagined. What began primarily as a technology story is increasingly an industrial one as well.

AI may exist in the digital world, but building it happens in the physical world. It requires semiconductors and servers, but also data centers, cooling systems, electrical equipment, and enormous amounts of energy. The hundreds of billions of dollars being invested by the world’s largest technology companies do not simply remain within the technology sector. That spending becomes revenue for businesses throughout the industrial economy.

It is an investment cycle reaching across corporate America.

Earnings Are Doing the Heavy Lifting 

The recent earnings results help explain why we remain encouraged.

Second-quarter earnings have been strong. According to FactSet, S&P 500 earnings increased approximately 34% from a year earlier, excluding unusually large investment gains reported by Alphabet and Amazon. Revenues increased 15.5%, the strongest growth since late 2021.

Perhaps more important than the magnitude of the growth is its breadth. Earnings for the 493 companies outside the Magnificent Seven increased 31.8%, their strongest growth since late 2021. Ten of the S&P 500’s eleven sectors reported earnings growth, while revenues increased across all eleven. Technology companies continue to produce exceptional results, but they are no longer carrying earnings growth alone.

A stock market rising primarily because investors are willing to pay increasingly higher prices for the same amount of earnings would give us greater reason for caution. But that is not the environment today. Since the end of June, the S&P 500 has advanced approximately 3%, and analysts’ forward earnings estimates have increased more than 7%. As a result, the market’s forward price-to-earnings ratio has declined slightly while stock prices have risen.

In other words, earnings have recently been doing more of the heavy lifting.

This does not mean stocks are inexpensive. Valuations in some areas of the market remain elevated, and we continue to pay attention to the price we pay for the businesses we own.

But there is a difference between a market supported principally by enthusiasm and one in which businesses continue to grow their revenues and earnings. Today, we are seeing evidence of the latter.

From Digital Evolution to Industrial Buildout

One company’s capital expenditure becomes another company’s revenue.

We can see that process occurring in the results of companies we own for clients. Dell is a good example. Many investors still associate Dell primarily with personal computers. Today, the company is an important supplier of the physical equipment needed to put artificial intelligence to work. Dell provides servers, storage, and networking systems that allow advanced chips to operate together inside increasingly complex data centers.

In its most recent quarter, Dell booked a record $61 billion of AI orders and generated approximately $16 billion of AI server revenue. The company finished the quarter with a $95 billion AI backlog, providing another indication of the scale of investment taking place.

Importantly, much of this investment may not be one-and-done. PwC estimates that the servers, storage, networking equipment and other computing hardware inside data centers may need to be refreshed every four to six years. As computing technology advances, today’s equipment is likely to be replaced by newer and more capable systems, potentially extending this wave of investment well beyond the initial construction of the data centers themselves.

And all of that computing equipment requires electricity. A data center filled with the most advanced servers is of little use without the power needed to run and cool them.

Eaton makes equipment used to manage, distribute, and protect electrical power. In the second quarter, organic sales in Eaton’s Electrical Americas business increased 18%, while its rolling 12-month orders increased 41%. Even with that strong sales growth, Eaton’s backlog finished the quarter 33% higher than a year earlier.

Demand is not merely showing up in forecasts for future data-center construction. It is working its way into orders, backlogs, revenues and earnings at established industrial companies.

And Eaton is hardly alone. Vertiv provides power and cooling systems, Amphenol supplies connectors and interconnect systems, Emerson participates in automation and electrical technologies, Sterling Infrastructure helps build physical facilities, and Cummins provides power-generation equipment.

This is why we believe it is becoming increasingly difficult to separate the technology economy from the industrial economy. The spending that begins with artificial intelligence is flowing to companies that manufacture equipment, build facilities, and supply the power needed to make it all work.

The digital evolution is reaching factories, construction sites, electrical grids and power plants.

How We Are Participating

Our portfolios reflect the scope of this investment cycle.

Technology remains an important part of what we own. Our current equity strategy includes companies such as Nvidia, Broadcom, Dell, Micron, Microsoft, Oracle, and Analog Devices.

Our exposure also extends well beyond technology. In Industrials, we own companies including Eaton, Vertiv, Amphenol, Emerson, Cummins and Sterling Infrastructure. Utilities such as Southern Company, NextEra Energy and Duke Energy provide additional exposure to the growing need for electricity.

Energy is another important part of the picture and includes companies such as Chevron, Valero, Kinder Morgan, Phillips 66 and Williams.

We don’t view these as unrelated investments. Rather, they allow us to participate in different points along the same chain—from computing and data centers to electrical equipment, industrial systems, energy infrastructure and power generation.

Over time, the opportunity may broaden further. As businesses across the economy begin using artificial intelligence in their day-to-day operations, the technology may help employees accomplish more with the same resources. If that occurs, the benefits of AI could eventually extend well beyond the companies building the infrastructure to many of the businesses using the technology.

Compounding Through Change

The technologies driving the economy are constantly changing. The basic principles of long-term investing are not.

Recently, one of my sons and I watched the documentary Becoming Warren Buffett. I was struck by how often Buffett returned to the subject of compounding. Here was one of the most successful investors in history, well into his 80s, repeatedly emphasizing one of the simplest principles in investing: own productive businesses and give them time to compound.

What also struck me was that his fascination seemed to be as much with the process itself—watching businesses grow and compound over long periods—as with the wealth that process ultimately created.

Dividends are an important part of compounding. Companies can return a portion of their profits to shareholders, who can reinvest those dividends and allow the income and number of shares they own to grow over time. Companies can also reinvest a portion of their earnings themselves—building new facilities, developing new products, increasing capacity, or making acquisitions. Many successful companies do both.

What matters over time is that capital is put to productive use. When businesses can earn attractive returns, reinvest intelligently and return capital to shareholders, today’s earnings can help create greater earnings and income tomorrow.

We think this is especially relevant to the changes taking place today.

We can see that principle throughout our portfolios. Eaton traces its history back more than a century. Emerson has been operating since the 1890s. Cummins was founded in 1919. These are hardly new businesses chasing the latest investment fad. They are established companies using capabilities developed over decades to participate in new opportunities created by an evolving economy.

That is one of the great advantages of owning successful businesses for long periods. We do not need the world to stand still. New technologies, competitors, and opportunities will continue to emerge.

Our objective is to own businesses capable of changing with them.

When businesses can continue growing and adapting while putting capital to productive use, time can become one of the investor’s greatest allies.

Industries evolve. Businesses evolve. Technologies evolve. Compounding continues.

Bringing It Together

None of this means we are complacent about the risks facing investors.

Valuations in some areas of the market remain elevated. The federal debt continues to grow. Interest rates and inflation remain important considerations. Geopolitical conflicts can quickly affect markets and the economy. And the significant sums being invested in artificial intelligence will eventually need to generate adequate returns. No investment cycle continues indefinitely.

But we think it is important to distinguish between developments that make investors uncomfortable and those that actually change the investment outlook.

A frightening headline does not necessarily change the earnings power of the businesses we own. What would concern us more would be a sustained deterioration in corporate earnings, meaningful downward revisions to future earnings expectations, and weakening business investment and order books.

For now, that is not what we are seeing.

There will be setbacks along the way. There always are. But successful long-term investing has never required every headline to be good or every risk to disappear.

We don’t know what next month’s headlines will bring. We don’t need to.

Our focus remains on owning financially strong businesses with the ability to grow earnings, pay and increase dividends, reinvest intelligently and adapt as the economy changes. We believe that remains a sound approach to investing for the years ahead.

As always, we welcome the opportunity to discuss your specific financial situation. If you have questions or if anything in your financial life has changed, please call us at (800) 843-7273. We are always glad to have that conversation with you.

Warm Regards,

 

 

 

Matthew A. Young 
President and Chief Executive Officer