Investing In Artificial Intelligence - Economic Growth And Stock Picking

by: Kenra Investors


According to many, Artificial Intelligence is going to reshape our economy and society.

AI is expected to double economic growth, but given the uncertain effects of economic growth on companies' profits, stock picking will be necessary.

The companies that are going to benefit the most are the giants with strong moats and whose position will be further strengthened by AI.

Internet giants that have large data sets at their disposal are the most attractive choice.

In this article, I am going to discuss the effects of AI on economic growth and society. Artificial Intelligence will bring great changes in the next decades and, according to experts, has the potential to trigger a new wave of economic growth. Being invested in the overall stock market won't be enough to take advantage of this trend, and stock picking will be necessary. I am going to share some thoughts on AI and its effects on some industries, and I am going to tell you which stocks I think are good choices to take advantage of this trend.

How Artificial Intelligence Can Change The Economy And The Society

Analysts believe AI is the next big thing for a very simple reason; in one way or another, it is expected to be the main driver of economic and productivity growth in the next two decades, or more. Artificial Intelligence was not born in recent times. It has existed and slowly grown for 70 years, thanks to the works of scientists such as Alan Turing, John McCarthy and Marvin Minsky. While scientists have worked in this field for decades, progresses in AI have more recently been propelled by advances in machine learning and deep learning. Machine learning is the field of study that gives computers the ability to learn without being explicitly programmed in order to analyze data and solve problems without the manual programming of specific functions. Deep learning is an area of machine learning, which has the objective of mimicking the brain by constructing artificial neural networks. Computers are trained to recognize sounds, patterns, images, texts, and so on.

In the last few years, growth in this field has experienced an enormous acceleration, thanks to two main factors: unlimited access to computing power and growth in big data. Public cloud computing has exceeded $100 billion in 2016, and is estimated to quintuplicate in the next 10 years. Global data has grown at a 50%+ CAGR since 2010, as more and more devices have become connected.

Artificial Intelligence is expanding at a great pace and permeating an increasing number of fields, including autonomous driving, healthcare, financial services, and security, to name a few. Consumers often don't realize that AI is everywhere around them. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Assistant, Amazon's (NASDAQ:AMZN) Alexa, Apple's (NASDAQ:AAPL) Siri, Microsoft's (NASDAQ:MSFT) Cortana, and Facebook's (NASDAQ:FB) M are only some of the examples of AI-powered applications that are available today.

But how will AI increase productivity and growth?

Several studies and hypotheses have been made on the future of our economy when AI will be a widespread instrument. The main concern is that AI may increase unemployment, as it will offer a more efficient alternative than human labor for several tasks. Nonetheless, a significant part of the economic growth from AI will come not from replacing existing labor or capital, but in enabling it to be used much more effectively.

Accenture on this topic wrote:

"The new AI-powered wave of intelligent automation is already creating growth through a set of features unlike those of traditional automation solutions. The first feature is its ability to automate complex physical world tasks that require adaptability and agility. Consider the work of retrieving items in a warehouse, where companies have relied on people's ability to navigate crowded spaces and avoid moving obstacles. Now, robots from Fetch Robotics use lasers and 3D depth-sensors to navigate safely and work alongside warehouse workers. Used in tandem with people, the robots can handle the vast majority of items in a typical warehouse."

AI is going to support an increasing number of services. It is powering enhanced search functions from Google and Baidu (NASDAQ:BIDU), Tesla's (NASDAQ:TSLA) innovation in autonomous driving, and more targeted customer recommendations from Netflix (NASDAQ:NFLX) and Amazon, and it is used in advanced image recognition and organization for Google Photos.

The social and economic benefits of AI are many. Let me give you a few other examples, starting from autonomous driving. The potential impact of driverless vehicles on the economy will surely extend beyond the automotive industry. Other industries would benefit from the increasing amount of free time resulting from the diffusion of autonomous driving. Mobile service providers, for example, are probably going to see rising consumption as drivers, free to use their devices while traveling, will spend more time surfing the Internet. This could create new advertising and selling opportunities. If you think I am exaggerating, consider that according to the AAA foundation for Traffic Safety, an American spends on average 17,600 minutes per year driving, which is equivalent to 48 minutes per day. Actually, this is a conservative estimate. According to a study done by the Harvard Health Watch, an average American spends 101 minutes per day driving.

The insurance industry is also going to change. Autonomous driving is a risk for insurers, as self-driven cars have shown lower crash rates and would lead to lower premiums. Warren Buffett and many investors/analysts see a significant risk for the insurance industry, and Tesla has already shown how the insurance industry can change as the number of self-driving cars increases. The company wants to bundle insurance and maintenance in the price of its cars based on the fact that Autopilot makes Tesla cars safer than traditional cars. On the other side, there are also some positives for the insurance industry.

Accenture on this topic:

"The insurance industry could create new revenue streams from the masses of data that self-driving vehicles generate. By combining vehicle data with other streams such as smart phones and public transport systems, they could not only build up a more complete picture of their customers, but also they could create new policies that insure total customer mobility, not just driving."

Whether the insurance industry will be damaged or not, the society will benefit from a dramatic fall in the number of accidents and traffic fatalities. Autonomous driving could also help give back independence to people who are not able to drive due to some disability. As we can see, even if we consider only autonomous driving, we can indicate numerous positive effects that will help the economy and the society.

Besides autonomous cars, AI is currently employed in many fields, such as healthcare, finance, security, defense, social media and several others. In healthcare, the use of AI is improving illness prevention through diagnostics and is aiding in treatments and surgical procedures. Digital health assistants bridge the gaps between doctors and patients to maintain patient care. IBM's (NYSE:IBM) Watson Health analyzes possible cancer treatments, and the company is developing a new platform for evaluating drug safety.

Before discussing how an investor could benefit from the growth in AI, let's have a look at what effects AI could have on the overall economy.

Artificial Intelligence and Growth

Artificial Intelligence is expected to drive a new wave of rising productivity, similar to what happened during the Industrial Revolution. In numerous economies, especially developed countries, increases in capital and labor are no longer able to drive decent levels of growth. Artificial Intelligence is seen as a new factor of production that can change the situation by transforming the basis of economic growth.

Accenture and Frontier Economics tried to quantify the macroeconomic impact of AI and wrote:

"Our results reveal unprecedented opportunities for value creation. We find that AI has the potential to double annual economic growth rates across these countries - a powerful remedy for slowing rates in recent years. (…) The key is to see AI as a capital-labor hybrid. AI can replicate labor activities at much greater scale and speed, and to even perform some tasks beyond the capabilities of humans. Not to mention that in some areas it has the ability to learn faster than humans, if not yet as deeply."

Numbers speak clear. If these are the effects, we can expect a new wave of economic expansion in the next 1-2 decades. But investors shouldn't pop the champagne yet. For those who don't know it yet, economic expansion doesn't necessarily increase stock returns. As a study from the University of Florida shows, the cross-country correlation of GDP growth per capita and inflation-adjusted stock returns is actually negative when long periods are analyzed:

"Economic growth comes partly from increased inputs of capital and labor, which don't necessarily benefit the stockholders of existing companies. Economic growth also comes from technological change, which does not necessarily lead to higher profits if competition between firms results in the benefits being passed to consumers and workers."

It's bad news, because it means we can't have a clear idea of the effects that AI-driven economic growth would have on companies' profits and on an investment in broad indexes like the S&P 500 (NYSEARCA:SPY) or in certain industries that may experience a productivity increase. If investors want to take advantage of the AI trend, stock picking is necessary.

What companies will benefit

AI will benefit the society and improve economic growth, although we don't know what effects it could have on employment. Anyway, investors who want to take advantage of this trend have to choose which stocks to hold, trying to pick the potential winners. I liked T. Rowe Price portfolio manager Paul Greene on this point:

"I don't think AI will be this technology that only a couple of companies end up benefiting from and take over the world. (…) I think it will be an enabling technology that helps everyone. Small businesses, entrepreneurs, and start-ups are already moving to use these public cloud platforms. But the big companies will benefit disproportionately because others will be using their platforms. Only a handful of companies now truly have the massive amounts of computing capability needed."

Let's make it clear; there are no 100% pure plays in this field. Artificial Intelligence will further advantage big companies with big moats for a number of reasons - a scarce talent pool, the importance of high-scale computing capacity, and the need for large proprietary data sets. Artificial Intelligence is never the main reason to invest in a company. Let's consider Baidu, the Chinese Internet giant. As I explained in my article "Investing In Baidu To Bet On Artificial Intelligence", AI can open new markets such as autonomous driving, and applications for financial services or healthcare, but it can also help the company's current businesses, thanks to the improvements in user experience. This helps the investment case because Baidu already has a strong position in the markets where it operates.

Alphabet is probably the industry leader in Artificial Intelligence, thanks to its computing capabilities and the enormous amount of data it manages, thanks to its dominance in search and numerous other widely used services like Maps, Gmail, and YouTube. Alphabet is not the only potential winner in this field. In general, we can say that search engine providers have a stronger position compared to the other players. Alphabet, Baidu and Russian search king Yandex (NASDAQ:YNDX) are clearly in a stronger position, thanks to their ability to collect vast amounts of data that can be used to enhance AI services. These companies' efforts in AI are growing fast. In 2016, Alphabet has launched more than 350 applications powered by machine learning across areas like search, maps, messaging and Google Play. Basically everything that Alphabet does can be improved by machine learning. Just to give some examples, Google Translate now converts a page scanned with a phone camera from one language to another while YouTube can give better recommendations and place targeted ads.

Microsoft and Apple follow the aforementioned search engine providers and operate in the AI field mainly through their voice assistants Cortana and Siri, although they are working on other projects. Microsoft's position in AI could benefit from its recent acquisition of LinkedIn, which gives it access to the largest set of professional jobs data available today. Nonetheless, CEO Satya Nadella is quite conservative:

"We should not claim that artificial general intelligence is just around the corner (…) I think we are on the right ladder this time... We are all grounded in where we are. Ultimately, the real challenge is human language understanding that still doesn't exist. We are not even close to it... We just have to keep taking steps on that ladder."

Nvidia (NASDAQ:NVDA) CEO Jen-Hsun Huang has a more optimistic view:

"We can now see that GPU-based deep learning will revolutionize major industries, from consumer internet and transportation to health care and manufacturing. The era of AI is upon us."

Nvidia is one of the leading players in AI for applications to autonomous driving and also sells its GPUs to Alphabet, Facebook, Microsoft and Amazon for their data centers. The company is growing fast and will continue to take advantage of this trend in the foreseeable future. Anyway, we should consider that growth in the data center may slow down in the next few years since Google, which currently buy lots of Nvidia chips, is starting to use more of its own chip called the Tensor Processing Unit. If we want to bet on Artificial Intelligence, Nvidia looks more risky than other companies for a simple reason - almost every major player in chips is trying to take its slice in the world of AI. A large number of startups are emerging and trying to develop new types of deep learning chip architecture. And as I said, even Google, which has never made its own chips before, is starting to compete with Nvidia.

Facebook seems to be a laggard when it comes to AI, but I am totally sure that the company will take advantage of the favorable trend. Data is to AI what food is to humans, and Facebook can count on the largest and deepest set of personal data of the globe, which is also protected by one of the strongest network effects you can find. Moreover, the company is one of the top recruiters in AI, which shows its involvement in this field.

Amazon will also take advantage of AI in different ways. For example through its autonomous delivery drones, which can make deliveries faster and more efficient, improving customer satisfaction, or through Alexa, which can be a growth driver as an increasing number of companies seek to integrate this digital assistant to enhance their own products. Moreover, Amazon's cloud computing service, Amazon Web Services, can make artificial intelligence available to third companies that lack the necessary technical expertise in this area, so that they can exploit the powerful data processing capabilities of AI to better satisfy their customers' needs. Amazon can also utilize browsing and purchasing data to provide tailored product recommendations and promotion, and currently uses AI to analyze purchasing habits and patterns in order to identify fraudulent transactions, similar to what PayPal (NASDAQ:PYPL) does.

The tech space is full of companies that are trying to take advantage of AI, which also include Intel (NASDAQ:INTC), Advanced Micro Devices (NASDAQ:AMD), Alibaba (NYSE:BABA), Twitter (NYSE:TWTR) and IBM to name a few.

In healthcare, Intuitive Surgical (NASDAQ:ISRG) is one of the leading AI players. The company developed its da Vinci surgical robot 15 years ago to assist surgeons in performing operations. Now a more advanced generation of surgical robots that is supported by AI technology is being developed by Intuitive, as well as through a joint venture between Google and Johnson & Johnson (NYSE:JNJ).

I would like to analyze each of these companies in detail, but I will do it in future articles. I will conclude by indicating the companies that I would choose to take advantage of the growth in AI. I think the best investments are Alphabet, Facebook and Baidu for the following reasons:

  • They have huge proprietary data sets at their disposal, and moats that are strong enough to protect them and let them expand over time.
  • They can find ways to use AI to improve their current businesses, but can also leverage their data to expand in other fields, as Alphabet and Baidu are doing in the field of autonomous driving.
  • These stocks have reported constant growth for years, high margins and benefit from positive secular trends in their core businesses, which are protected by wide moats. They trade at fair multiples that justify a long-term investment.

What stocks would you choose to bet on AI? Why?

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Disclosure: I am/we are long BIDU, FB, GOOG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short NVDA.