The next three years of the AI rally will come from these stocks
on Livewire| Original source: https://www.livewiremarkets.com/wires/the-next-three-years-of-the-ai-rally-will-come-from-these-stocks
Note: This interview was taped on Friday 15 November 2024.
There is no doubt that artificial intelligence, the story of 2023, has also been a leading narrative in 2024. But despite Nvidia trading on a trailing P/E ratio of 66 and main rival AMD having a trailing P/E ratio of 119 (!), it's clear the demand for these game-changing stocks is still alive and well.
One such firm that believes the AI rally has even more legs to run is Goldman Sachs. In a note entitled "AI stocks aren't in a bubble" from September 2024, Goldman's Peter Oppenheimer noted that tech earnings have far outpaced the rest of the market and so have earned their right to be this valuable.
Source: Goldman Sachs
But, Oppenheimer also pointed out that it is also an opportune time to look away from the Magnificent Seven.
“Investors should look to diversify exposure to improve risk-adjusted returns while also gaining access to potential winners in smaller technology companies and other parts of the market, including in the old economy, which will enjoy the growth of more infrastructure spend,” Oppenheimer said.
“Eventually the market for the original technology tends to consolidate into a few large winners, and the growth opportunity shifts to secondary innovations or products and services that follow the original technology,” he adds.
Those secondary innovations or products can be referred to as the infrastructure providers in the AI megatrend. After all, the data has to be crunched somewhere! And in this case, it has to be crunched in a factory that is often very hot, requires a lot of power, and needs a ton of equipment. These are the AI "enablers".
But now the "enablers" have seen such a big run, the next leg of this story, according to David Winborne of Impax Asset Management, will be told in the AI "implementers" category. These are the companies that are racking up huge CAPEX now but will see their application bear fruit in the years to come.
To find out more about Winborne's thesis and one stock he is backing with this theme in mind, watch this episode of The Pitch, presented by Livewire's Eddie Orchard.
David Winborne, Impax Asset Management
EDITED TRANSCRIPT
What is your process for filtering 2,000+ stocks into the few that will make it into the portfolio?
Winborne: This was the key bit of thinking that went into the global opportunity strategy when we seeded the strategy. So the strategy was seeded back in January 2015, and we had to think about a way to screen this vast investment universe for attractive sustainability opportunities. Essentially, the process we developed over the last 10 years, was a proprietary tool that we developed called the Impact Sustainability Lens.
What the sustainability lens attempts to do is attempts to highlight attractive opportunities at the sub-sector level within the market. And what I mean by that is there are essentially 11 big sectors out there: consumer staples, discretionary, utilities, industrials, and so on. They branch out to 160 sub-sectors, and what we do within the Impax team, is go through all those 160 sub-sectors to try to understand the balance of opportunities and the risks that might be present in each of those different sub-sectors.
Not surprisingly, some of those sub-sectors have a huge amount of risks and not so many opportunities. Others have great opportunities and fewer risks.
On the risk side, one thing we look at is supply chain dependency. Now, supply chain dependency really appeared as an issue during the COVID period because global supply chains really just ground to a halt back in March 2020. That highlighted a lot of lack of resilience in many industries. One I would highlight would be the auto components sub-sector. The automotive industry is probably the most globalised industry you could imagine. There's something like 16,000 components that go into a car.
As the CEO of one of the auto components companies who we invest in has said to me, you can't make a car with 95% of those components. If there's a problem anywhere, the whole industry has an enormous amount of problems. So the auto components sub-sector would be a subsection with a higher risk for supply chain dependency.
Another [industry] that I think is quite interesting is apparel manufacturing. If you think of apparel manufacturing, particularly in the fast fashion industry, a lot of those supply chains in terms of where the clothes are manufactured are spread across India and Southeast Asia. The manufacturing conditions are incredibly opaque. We don't have any real feelings about what's going on there. That would be another subsect that has a high risk for that particular area of supply chain dependency.
All this just helps us map out where to focus our investment energies and we try to really focus on higher opportunity areas and avoid some of those higher-risk ones as well.
Are there any sectors you outright avoid? (e.g. Mining)
The mining sector, I think, is quite an interesting one because if you are involved in the mining sector as an investor from a sustainability perspective, I would term that to be more of an impact investor. You are looking to make a change in that company to make it more sustainable. If you drill down deeper and look at things like the environmental standards, some of these companies will probably come under increasing scrutiny over time. These things include pollution and waste externalities for mining practices. The reason why we're interested in what that means is, not necessarily altruism, but it's because we think that these issues will come home to roost over the coming five to 10 years.
What is a major thematic opportunity you are eyeing at the moment?
Winborne: I'll zoom in here on the AI opportunity because that's really capturing investors' imagination at the moment. The way that I would frame the AI opportunity within sustainable investment is that it comes in two main parts.
The first is the area that I would turn to be AI enablers. And what I mean by that are companies that essentially provide the building blocks to enable the AI infrastructure to be built. There are two subcategories there. One is digital infrastructure. These are the companies providing data centres, semiconductor chips, and the machines that make the semiconductor chips or semiconductor chip designers.
But then arguably just as important is the physical infrastructure. When you're building out a data centre, you need huge amounts of heating, ventilation and air conditioning equipment. You need huge amounts of voltage equipment, connectivity, equipment transmission, and distribution equipment.
So all of those companies in that enabler bucket, be they digital or physical, have been the focus of investor interest so far. We have significant exposure there within the Global Opportunities fund and also our Environmental Leaders fund.
The second layer, which I think is a really exciting one going forward, is the layer of AI implementers. And what I mean by that are the companies that benefit from the application of AI across their businesses essentially. So once this technology is vetted down, who's going to be using this technology in their operations?
There's a huge number of different case studies from the companies I speak to where I can see a clear part of them using AI productively in their business. And none more so, I would say, than the logistics industry because if you use AI in the logistics industry to optimise things like route planning to make sure your trucks do the drop off at the right time, you save a huge amount of fuel as a result of that.
Why is that such an important thing? Well, one, from a purely pragmatic point, it saves these companies a huge amount of fuel in terms of their trucking costs. But of course, the other broader benefit is you save a huge amount of carbon as well as energy.
So, as I believe might happen over the next couple of years, investor interest will transition towards the AI implementers. We have significant exposure to those companies that I think are key beneficiaries in terms of AI implementation. So I'm very excited about what that opportunity might bring over the next two or three years.
Can you take us through an example of such an AI-implementing company?
Winborne: For me, one of the most exciting areas there is industrial software companies. And why they're so interesting is if you take one company in our broad investment universe called Autodesk (NASDAQ: ADSK). Autodesk, as you might know, is a provider of CAD [computer-aided design] tools.
If you have any architect friends, you'll know this is the standard design tool that's used in the industry. It's been the industry standard for decades now. What is interesting here is that, if you look at the penetration rates of IT spending in the broad building manufacturing sector, it's an incredibly under-penetrated field.
What I'm excited about is that as you implement AI solutions into these CAD design tools, you can improve the whole design process. If you're designing a particular building, you can use AI to optimise the way that the air conditioner should be on the wall, or the lighting should be to optimise every element. You can save a huge amount of energy as a result of that. I think there's a really big implication there in terms of energy efficiency and also resource efficiency.