FMI Q4 2025 Shareholder Letter

Core Insights - The investment landscape in 2025 has been heavily influenced by the rise of Artificial Intelligence (AI) companies, leading to significant market gains across major indices, with the S&P 500 up 17.88% and the Russell 2000 up 12.81% [4] - There is a growing concern about a potential market bubble, as high-quality businesses have underperformed low-quality ones, particularly in the small-cap sector [6][7] - AI-related stocks have dramatically impacted the S&P 500, accounting for 45% of its market cap and 78% of its returns since the launch of ChatGPT in November 2022 [12][15] Investment Performance - FMI's portfolios have generated solid double-digit annual returns over the past three years but have lagged behind broader indices due to a focus on business quality and valuation [5] - The disparity in performance between high-quality and low-quality stocks has been stark, with low-quality stocks outperforming significantly in 2025 [6][7] Market Dynamics - The MSCI EAFE Quality Index has underperformed the MSCI EAFE by approximately 10% in both local and USD terms, indicating a broader trend of low-quality stocks outperforming in international markets as well [8] - The capital spending in the tech sector, particularly related to AI, has contributed significantly to U.S. GDP growth, accounting for 40%-45% through the first nine months of 2025, a stark increase from less than 5% in the same period of 2023 [18] Company Insights - Hayward Holdings Inc. is highlighted as a resilient small-cap company in the pool equipment market, with strong pricing power and a solid balance sheet, despite facing weak demand in the newly built and remodeled pool segments [26] - Accenture PLC is positioned to benefit from the AI boom, as its consulting services are increasingly in demand for enterprises adopting AI technologies, despite facing cyclical pressures [30] - Smiths Group PLC is transitioning to a more focused portfolio, improving its growth and profitability profile while maintaining a strong balance sheet [31] AI Impact - The concentration of AI-related stocks in the S&P 500 raises concerns about market sustainability, as these stocks have driven a significant portion of market returns and earnings growth [12][15] - The capital intensity of AI companies is increasing, with expectations that they will need to generate $2 trillion in revenue by 2030 to meet demand, which may not be achievable [21]