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NewsMaterial3 min readDisconfirmAI Editorial

Baillie Gifford Investment Specialist Thomas Hodges: AI Narratives Have a Half-Life; The Company Flywheel Is the True Benchmark

Thomas Hodges, an investment specialist for the SAINTS fund under Baillie Gifford, outlines the 'flywheel' framework: when AI narratives cause software company stock prices to fall, the benchmark is not the narrative itself, but whether the company can continue converting earnings into cash, reinvesting effectively, and paying growing dividends. He cites retaining Paychex, adding to positions in Amadeus and Intuit, and selling Diageo as examples of discipline and judgment in action, while acknowledging that this framework has yet to deliver the capital growth shareholders expected.

2026-11-09

In the first quarter of 2026, the market was swept up by the 'software is dead' narrative triggered by AI tools, causing Paychex's share price to plummet despite the company continuing to deliver encouraging operating results. By the third quarter, financial reports from companies such as Accenture proved that mature enterprises were not being eliminated by AI, but were instead helping clients adopt the technology. The narrative began to lose its potency. Thomas Hodges, an investment specialist for the SAINTS fund under Baillie Gifford, describes this process as the 'half-life of market narratives'—narratives are initially powerful, absorbing attention and shaping investors' perspectives, but their effectiveness gradually decays as new information emerges. He believes that many narratives are directionally correct but built on 'half-truths,' skipping over key details such as proprietary data and the depth of workflow integration.

The alternative framework proposed by Hodges is the 'compounding flywheel': a company grows its earnings, converts those earnings into cash, returns a portion to shareholders through dividends, and reinvests the rest; provided that reinvestment yields attractive returns, it generates further earnings and cash flow, creating a virtuous cycle. Unlike narratives, which tend to fade, a successful flywheel can become stronger over time. SAINTS' investment research revolves around nine questions, with the core inquiry being: Is the company's flywheel still turning? Regarding Paychex, they judged that its extensive financial data, established customer relationships, and deep integration into workflows are difficult to replicate, and that the company is developing AI tools to automate client tasks—advantages that the market had underestimated.

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However, discipline must not turn into obstinacy. Hodges distinguishes between two types of judgment: when AI concerns depress valuations, if long-term prospects remain intact, the decline creates buying opportunities—SAINTS added to its positions in Amadeus and Intuit in early 2026; when evidence demands a change of mind, one must exit decisively—Diageo saw weakening consumer demand, increased investment requirements, and pressure on free cash flow, ultimately leading to a dividend cut, prompting SAINTS to sell. He admits this was their mistake: failing to respond decisively enough to signals of deteriorating fundamentals. A long record of dividends or a high dividend yield is only attractive if you have confidence in the long-term economics of the business.

Hodges also acknowledges a frustrating fact: although SAINTS holdings generate twice the free cash flow of the global market average, achieve return on investment 70% higher than average, and grow dividends faster than the market, the fund has not delivered the capital growth shareholders expected over the past few years. Share price returns from 2022 to 2026 were -7.2%, 12.8%, 6.5%, 2.2%, and 11.2%, compared to the FTSE Global Index's returns of -3.6%, 11.1%, 20.2%, 17.4%, and 18.7% respectively. Whether the flywheel metrics serve as diagnostic tools or merely post-hoc descriptions remains unanswered. His conclusion is that correctly identifying a technological revolution is very different from identifying who will benefit from it, and the value of the flywheel framework lies in forcing investors to continue asking whether cash flows are still growing after the narrative has faded.

Sources

  • bailliegifford.com↗
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