How to invest in the AI revolution
Big-tech is leading the artificial intelligence race, but there are plenty of smaller companies well placed for what's to come.
Mentioned: MongoDB Inc (MDB), Spotify Technology SA (SPOT), Unity Software Inc (U), Roblox Corp (RBLX), Darktrace PLC (DRKTF), Adobe Inc (ADBE), Baidu Inc (BIDU), Salesforce Inc (CRM), Meta Platforms Inc (META), Alphabet Inc (GOOG), Hitachi Ltd (HTHIF), Microsoft Corp (MSFT), Netflix Inc (NFLX), NVIDIA Corp (NVDA), Oracle Corp (ORCL), SAP SE (SAP), Siemens AG (SMAWF), Synopsys Inc (SNPS), Tencent Holdings Ltd (TCEHY), Tesla Inc (TSLA)
With around 200 million active monthly users, ChatGPT, the artificial intelligence chatbot, is said to be the fastest growing consumer application of all time.
It’s been on a meteoric rise since launching on November 30, taking just five days to reach one million users – the fastest in history – and received 1.8 billion visits in April, up from 266 million in December.
Microsoft is an early leader in the AI race through its investment in ChatGPT. Picture: AP
Microsoft (MFST) has invested billions of dollars to partner with ChatGPT’s creator, OpenAI, a private company that specialises in artificial intelligence, specifically large language models.
But ChatGPT is only the beginning of the generative AI revolution – which is a broad term for technology that can use what it’s learned to generate images, videos, text, and audio.
Numerous other companies have also staked their claim in the generative AI market, including Google’s (GOOG) Bard, Baidu’s (BIDU) Ernie Bot, and Salesforce’s (CRM) Einstein GPT. Even Morningstar has launched its own AI-powered chatbot in the US, called Mo.
Companies providing the technology and data services required to power these generative AI models are also booming. ChatGPT chipmaker Nvidia (NVDA) this week reported better-than-expected first quarter sales and forecast second-quarter revenue to be 64% higher year on year. Morningstar raised its fair value estimate for Nvidia by 50% on the result.
According to PitchBook data, the generative AI market is predicted to reach $42.6 billion by 2023 and exceed $98.1 billion by 2026.
So, where can investors look for exposure to the AI revolution?
Big tech leading the race, but not everyone will be a winner
Microsoft is an early leader in the artificial intelligence race, and given the environment of high inflation and rising interest rates is making it harder for startups to get off the ground and scale, GQG Partners chief investment officer Rajiv Jain says the large cap names are likely to be winners from this revolution.
But they won’t all benefit equally, says Antipodes founder and chief investment officer Jacob Mitchell, pointing to a potential ‘cannibalising’ of Google-parent Alphabet’s revenue model.
“There’s 200 million monthly average users on ChatGPT. The number of queries is averaging around 8% of desktop search queries, so it's already grown to be roughly 8% of Google's desktop search query market. So you've got a competitor that’s arguably taking away eyeballs from standard search,” he said during a panel discussion at the Morningstar Investment Conference.
“Clearly Alphabet responds with Bard, but Bard could actually be cannibalising their existing profit pool, and as of yet, these companies haven't really worked out how to monetise that.”
Google has released its own AI chatbot, Bard. Picture: AP
Mitchell favours mega caps that are able to deploy AI within their existing software platforms.
“Many of the mega caps are going to be able to do that because they've got the internal software, hardware skills, and they have relatively unique datasets and the ability to monetise and upsell is really easy for a company like Microsoft or Oracle (ORCL), SAP (SAP),” he says.
“And we own those stocks, we think they're still reasonable valuations relative to the quality of their businesses.”
Morningstar senior equity research analyst Dan Romanoff says combining the world’s most popular productivity software—Microsoft 365—with the world’s most advanced foundational AI models should create a powerful force in the software industry.
“We think this has elevated Microsoft to be one of the prime beneficiaries of the AI boom, with early access to OpenAI’s models and the exclusive attachment to OpenAI through Azure,” Romanoff says.
“Microsoft is already moving quickly to infuse its portfolio with OpenAI’s advanced AI, including Microsoft 365, GitHub, Bing, and other solutions. We think this AI pervasiveness will enhance customer switching costs and the company’s network effect, rendering Microsoft’s wide economic moat even wider, in our view.
“Still, we caution investors on the AI hype for Microsoft, as the company’s immense size makes it difficult for any new product to dramatically move the needle on valuation, in our view.”
3-star Microsoft is trading in a range Morningstar considers fairly valued.
Select smaller players well placed
With more than 400 startups purely focused on AI, Jain says its near impossible to predict who will emerge as the ultimate winner.
But Francyne Mu, portfolio manager at Franklin Templeton says one thing is clear: these large language models will require huge computational power.
Francyne Mu and Jacob Mitchell during a panel discussion at the 2023 Morningstar Investment Conference. Picture: Morningstar
Looking at it this way, Mu says companies will require semiconductor chips that are capable of processing that demand.
“So for us, we're taking a position in Synopsys (SNPS), which provides the software in electronic design automation to help these semiconductor companies design better chips in order to enable this generative AI and to move forward in this space,” Mu said at the Morningstar Investment Conference in Sydney.
Data management provider MongoDB (MDB) is another company she likes.
“More and more the information that's coming in, the data that's coming in is unstructured, you've got video files, you've got text messages, and these models have to try and work with that data in order to generate and predict what the next word is or what have you,” she says.
“MongoDB provides software, document-based database management, which will help to be able to pick up on these data pieces much more efficiently over time.”
MongoDB holds a 4-star rating from Morningstar and is trading at a 15% discount to its $335 fair value estimate.
The themes defining AI innovation
Morningstar quantitative research analyst Prashant Srivastava says public companies that create products and solutions related to generative AI can be classified into five themes:
“This theme centres on the development of decision-making systems and workflow optimisation,” he says.
“For instance, Tesla (TSLA) is using algorithms in combination with sensors, cameras, and synthetic data to actively pursue self-driving technology. And Salesforce is incorporating this innovative technology to improve customer relationship management and streamline user workflows.”
2. Content creation
Srivastava says this theme revolves around the development of unique and innovative content, including music, text, and art, with the aim of transforming the way we consume and interact with it.
“Adobe (ADBE), for example, is exploring ways to use this technology to create, edit, and enhance digital content through its Photoshop and Adobe Experience Manager tools,” Srivastava says.
“Similarly, Roblox (RBLX), Tencent (TCEHY), and Unity Software (U) are collaborating to create highly realistic virtual characters that can be used in video games, virtual reality, and other contexts.”
“Companies involved with this theme aim to personalise user experiences, particularly in the areas of content moderation, digital assistants, and recommender systems,” he says.
“This makes user experiences more intuitive and customised.”
“Similarly, Meta (META) is also focused on content moderation as part of this theme.”
4. Generative design
“This theme focuses on creating tools that generate designs, models, and prototypes for applications including architecture and graphic design,” Srivastava says.
“It helps reduce time and cost needed for creating and testing prototypes, resulting in faster time-to-market and reduced manufacturing overhead.”
Industrial conglomerate Siemens (SMAWF) – which sells components and equipment for factory automation, railway equipment, electrical distribution equipment, and medical equipment – is focusing on industrial automation.
Srivastava says Hitachi (HTHIF) is focusing on optimising manufacturing and supply chains to minimise wastage for clients.
5. Platform and solutions
The mega cap players Alphabet, Microsoft and Nvidia fall into this category, as they invest in and develop their language models.
“The theme centres on building platforms, interfaces, and solutions that other businesses can use to create their own applications and products, promoting widespread adoption across businesses of all sizes.”
He says Darktrace (DRKTF) – which uses machine learning and AI algorithms to neutralise cyber threats – also falls under this theme, as it works toward building threat-prevention solutions that enable fair usage of Generative AI.