AI has become the acronym of the moment. Short for artificial intelligence, the rapid adoption of this technology over the last several years has garnered plenty of media attention and water cooler discussion. As with past tech breakthroughs, pundits and proponents are debating whether AI is the killer app that makes our lives easier or just the latest investment fad that will burn out, leaving many profitless companies in its wake.
Leelyn Smith CIO Brian Dorn has been following the debate and conducting his own due diligence on the companies and industries driving AI development. In this article, he offers his perspective on the evolution of AI and how best to participate in what he views as a secular investment trend.
What exactly is AI?
AI is essentially the ability to replicate human intelligence through computer science. Computers accomplish this “learning” by processing vast amounts of information and identifying patterns that allow it to carry out human functions and make predictions about our future behavior from past behavior.
Generative AI entered the lexicon in late 2022 with the public rollout of the chatbot ChatGPT and marked a step change in the applications possible through AI. While AI can perform tasks based on pattern recognition, Gen AI can create new content, such as written text and artwork, from the data its programs—called large language models (LLMs)—have analyzed. Gen AI learns at a much more powerful rate than its predecessors, allowing it to closely mimic a person’s writing or conversational style as it analyzes more data from that individual.
What is the history of AI?[1]
The term artificial intelligence was coined in 1956 by American computer scientist John McCarthy and the earliest chatbot, a computer able to communicate with humans, appeared in 1964. A form of artificial intelligence generated codes during World War II for the German army and another, developed by noted British computer scientist Alan Turing, deciphered those codes.
Despite those early breakthroughs, it has taken years for technology to catch up with the concept. By the 1990s, a supercomputer developed by IBM defeated a world chess champion, and improved programming and processing led to the understanding of human language in a chatbot. This advance led to the creation of Apple’s voice recognition assistant Siri in 2008 and Amazon’s Alexa in 2014. AI innovation has accelerated ever since, from virtual customer service assistants to personally targeted advertising, with Gen AI the latest and most significant breakthrough.
AI is made possible by the enormous information processing capabilities of computer science. Also known as machine learning, AI is powered by its ability to amass large amounts of data, analyze the data to detect patterns, and then replicate that ability across other data. The main reason AI is booming today is because we finally have the computing power and chip technology required to fuel the technology.
How is Leelyn Smith investing in AI?
The influence of AI is being felt across the stock market, from the well-known mega cap technology and communication services stocks to health care, utilities, and even natural gas pipelines. We view AI as a secular trend best approached in phases. Over the short term, household names like Microsoft, Amazon, and Google are benefiting the most from AI in terms of market share and positive revenue impacts on their businesses. Beneficiaries in the next phase of AI adoption are likely to be semiconductor, health care, robotics and related industrial automation stocks. Longer-term, however, the winning sectors, sub-sectors, and specific companies are less clear.
As prudent investors guided by our moat investing framework, we will not abandon our fundamentals, quality, and diversification requirements to take undue risks in companies that could be long-term AI beneficiaries. Instead, we will remain patient and consider such stocks when they possess characteristics sound enough to pass through our framework. In short, we are willing to give up some of the speculative gains that may be available today to own more stable companies in the AI space over the long term. We believe this approach will position us best to participate in AI development over the coming market cycles.
That said, we are embracing AI today. For example, one of our current holdings is Nvidia, the biggest beneficiary of the Gen AI boom from a market value perspective and a moat stock that has been building its business around this moment. Nvidia’s graphic processing unit (GPU) semiconductors have been a game changer, enabling the processing capabilities required to run large language models. The company started investing in the AI revolution 10 years ago by developing its GPUs and software for AI applications together, creating a durable moat. Other firms are beginning to make inroads, but Nvidia has a big lead on its competitors, as witnessed by a string of quarterly revenue and earnings results that have substantially beaten Wall Street forecasts.
We also own other technology companies with moat characteristics that have made AI a core part of their business. These include cloud providers with the computing power to make AI run, as well as digital platforms that can customize search results and better target ads through AI.
Taking a comprehensive view of AI impacts, we also own companies in the industries that will be critical to meeting the power demands of the data centers that house AI servers. These include electric utilities, renewable power producers, and even pipeline companies that transport the fuel needed to generate electricity.
What are the main risks of AI and how are we managing them?
The very nature of AI and its goal of replicating our human behavior creates entirely new risks, some with the potential to create social and ethical dilemmas. But those issues aside, as with any innovation, AI also carries traditional investment risks. Sticking with our investment framework and staying diversified across the 11 sectors in the stock market is our primary way of managing these risks.
Meanwhile, we can also draw on our experience in past periods of technology-fueled speculation, such as the late 1990s internet bubble, to inform our approach. We have learned to be cautious before buying into the hype associated with technological innovation. We are also mindful of how AI companies will be impacted by the risks of higher-for-longer interest rates and global geopolitical tensions.
Like the internet, AI is a real advancement that will impact our investment strategy and client portfolios for years to come. We plan to approach the promising opportunities created by AI as we do with all investments: by carefully analyzing each opportunity, focusing on company fundamentals, and gaining confidence in a stock’s moat status before committing capital.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
[1] The Timeline of Artificial Intelligence – From the 1940s (verloop.io)