MICHELE SANTANGELO: Investors take note: artificial intelligence is no passing fad

Artificial intelligence (AI) is the most talked about technology in financial markets today.  With its potential to revolutionise many industries, it is no surprise that investors are eager to gain exposure to companies at the forefront of the technology. 

In 2023 there has been an extraordinary surge in the share prices of listed companies with activities related to AI. Leading the way is semiconductor manufacturer Nvidia, whose share price has risen about 170%, putting it into the exclusive $1-trillion market cap club.  According to global research house BCA, all the 2023 returns of the S&P 500 index until the end of May can be attributed to AI stocks.  As investors, we must understand AI as an investment theme, considering its potential and the lessons learned from previous technological and investment trends.

What is AI?

AI can be described as a branch of computer science that creates intelligent systems capable of reasoning, learning, and acting autonomously.  Although AI is not a brand-new technology and has been evolving for decades, its development has accelerated in recent years due to advancements in computational power and the availability of big data.

Types of AI

AI has various branches, such as machine learning, deep learning, and computer vision.  However, it is the release of ChatGPT that has catapulted AI into the mainstream.  ChatGPT is a natural language processor (NLP), another branch of AI that enables systems to understand and generate human language. Companies have recognised the business imperative of AI integration and have highlighted their use of AI applications or their plans to develop them.  This is evident in the significant increase in the mention of “AI” during earnings calls of S&P 500 companies, more than doubling compared to a year ago.  

The various branches of AI systems are already in use in many industries with varying degrees of sophistication. Examples include:

• Robotics across industries such as agricultural tech, where tractors use AI imaging to spray pesticides on weeds in fields, avoiding spraying on crops; 
• Miners are using autonomous trucks to haul large loads across mine sites unmanned; 
• Financial institutions, including in SA,
• Retailers use AI to enhance product recommendations and to optimise their supply chains. Packing and warehousing are now mostly completed using AI-enabled robots and systems; and
• Telecom networks can monitor and fix network issues in real time using AI systems. 

The Future of AI

The broad adoption of AI is evident and extends beyond the areas mentioned.  While AI is already being employed, the capability and complexity of AI systems continue to advance rapidly. Looking ahead, we envision AI as leading a productivity revolution. AI will help companies to reduce costs and improve efficiencies by implementing automated systems and processes. Business decision-making will be enhanced as more extensive and complex data sets can be analysed, leading to robust conclusions across business segments such as pricing, marketing, research, and development. AI will also enhance customer engagement as fewer resources will be required to communicate with customers. The most exciting aspect of AI evolution is its ability to drive innovation by developing new products and services or by improving existing ones.

A Structural Tailwind 

The evolution of AI will be a structural tailwind for many companies and stock markets across industries.  Both margin improvement and revenue growth will drive this.  However, specific sectors are expected to reap more significant gains. 

• Biotechnology and healthcare: AI will accelerate this sector's drug analysis and discovery process. Typically characterised by long lead times, AI implementation will dramatically reduce the therapy development lifecycle.  Moreover, AI will enhance diagnostic accuracy and facilitate personalised medical treatment;
• Semiconductor design and manufacture: this sector will continue to experience increased demand, especially for companies producing advanced chips required for intensive AI calculations; and
• Cloud providers: these companies will play an integral role in the AI ecosystem and will continue to witness strong demand for their cloud-based services.

Sustainable  versus passing fads 

AI is one of many investment themes to be hyped as the next big thing.  Historically, many technologies have been touted as such, with varying degrees of success.

Notably, the internet has lived up to its promise, revolutionising global communication, business practices and entertainment.  Smart mobile computing has also achieved incredible success, with mobile devices becoming ubiquitous and fundamentally altering how people communicate.

However, several hyped technologies and products have failed to meet expectations: 

• Virtual reality (VR): despite being around for decades, it has not gained widespread popularity. Apple’s recent release of an impressive VR headset may struggle to gain traction, particularly when priced at $3,499; 
• 3D printing: this technology, with its potential to revolutionise manufacturing and even construct entire houses, has yet to achieve mass industrial adoption; and
• Nonfungible tokens (NFTs): these experienced a surge in popularity two years ago, with people spending exorbitant amounts on digital assets like Bored Ape.  Despite the innovative technology underlying NFTs, their values subsequently plummeted. 

While these technologies have since found their niche, the initial hype surrounding them far exceeded their real-world applications and profitability. 

AI has transcended the trajectory of a fad and emerged as a transformative and sustainable technology.  It remains crucial that proper fundamental analysis be carried out to determine whether lofty valuations are justified for a given growth profile.

There will be winners, but it’s essential to acknowledge that there will also be losers in the AI revolution.  Businesses that fail to adapt to the consequences of AI on their business models will be at a disadvantage.  Similarly, companies that lag in adopting AI into their processes will face challenges.  Investors must remain vigilant regarding their portfolio companies to determine if they will be on the winning or losing side of the AI revolution. 

• Michele Santangelo is a portfolio manager at Independent Securities.