Will artificial intelligence bring genuine profits?

Tim Richardson CFA, Investment Specialist

Artificial Intelligence (AI) promises to transform the way we work. Some enterprises will adapt to AI to grow earnings and/or reduce costs, whilst others will see their business models disrupted. Investors should prepare for the changes that are starting to sweep through the global economy.

“Software is eating the world, but AI is going to eat software.”
– Jenson Huang, Co-founder, President and CEO, Nvidia Corporation

What is AI?

AI has been defined as “the process of machines receiving, analysing, and combining information in a way that allows them to perform tasks typically performed by humans”¹.

Generative AI uses unprocessed data to deliver valuable outputs when prompted. An example is ChatGPT, a large language model trained by OpenAI which creates content and answers questions. Generative AI is expected to accelerate the introduction of AI in many businesses, performing functions such as:

• Recommendation delivery – streaming services, restaurant suggestions, cross-selling at on-line checkouts, robo-advice
• Automatic speech recognition – transcribing and summarising meetings
• Customer service virtual agents – message bots answering routine questions
• Image identification – analysing digital images and videos to derive valuable insights
• Automated financial securities trading – high frequency trading platforms

How will it impact the economy?

AI is expected to transform the way businesses operate across the global economy.

Customer service will become more immediate and personalised, but no longer require human intervention. Appointments will be scheduled, e-mails answered immediately, orders placed and 24/7 multi-lingual customer support provided.

Businesses will automate labour-intensive tasks that previously required employees to understand natural language and analyse data. This will enable companies to redirect resources to higher value work and/or reduce costs.

It is critical investors understand these trends. Like other transformative technologies – such as personal computers, the internet, and the smart phone – some companies will adapt to AI better than others. This will bring wide dispersion in companies’ earnings and share price growth.

What are the AI opportunities?

While the AI ecosystem will take time to fully take shape, companies are already adopting the technology to optimise their business models and create new products across sectors including:

• Semiconductor developers – Nvidia is the market leader in developing the advanced chips needed to train generative AI systems such as ChatGPT. Advanced Micro Devices competes in the data centre and gaming markets. Broadcom is established in the 5-G mobile network.
• Chip suppliers – Taiwan Semiconductor Manufacturing Company (TSMC) manufacturers and tests chips on behalf of developers such as Nvidia and brands such as Apple. ASML is the only supplier worldwide of extreme ultraviolet (EUV) lithography systems required to produce the world’s smallest chips.
• Cloud computing – AI is enhancing data storage, servers, and online software. Microsoft’s public cloud service Azure is a market leader, currently generating US$56 billion in annual revenue and growing 25% annually. Amazon Web Services (AWS) also provides cloud computing services.
• Smart phones – having introduced Siri, Apple is rapidly introducing more AI features into the iPhone. Sophisticated language checks consider the context of words rather than just spelling and grammar. The photo app now recognises users’ pets. AirPods use Adaptive Audio to adjust to lower the volume when a user speaks. The ChatGPT app is now available on the iPhone – with 30% of any revenue accruing to Apple of course!
• Design – Adobe’s generative AI tool Sensei AI is available to business users across Adobe Experience Cloud applications. It expects to benefit from increased content volumes as AI reduces costs and time to deliver tailored content.
• Autonomous driving – Tesla is making its cars fully autonomous. Images from sensors and cameras are analysed to anticipate movements and make decisions, requiring vast data to train its algorithm. It is currently collecting situational and driver data from its existing vehicles, establishing a competitive advantage.

What should investors do now?

It would be unwise to construct an equity portfolio based on forecasts of the future AI environment.

However, investors should recognise that AI brings exciting opportunities to create customer value which can drive earnings growth by:

• Establishing market leadership within a part of the AI infrastructure
• Developing AI-enhanced products that meet consumer need
• Integrating AI technology to reduce costs and enhance service delivery in a wider range of businesses

The impact of AI should be integrated into stock analysis to identify those business models adapting well to the evolving AI environment and those at risk of being disrupted by challenger brands.

Interestingly, the early winners are mainly large established businesses with strong brands and the financial resources to commit very large sums to developing unique AI products. While their share prices have recently risen sharply in many cases, the increase in future profit forecasts actually leaves them trading on lower multiples of forward earnings.

This helps validate AI as a transformative technology. Businesses that establish compelling value propositions at critical points in the AI value chain have the opportunity to deliver sustainable earnings growth that delivers long-term shareholder value.

¹ Christopher Pappas, CEO and Founder of eLearning Industry, “What is Artificial Intelligence?” 2023