There is no hotter area to invest in today than artificial intelligence, or AI as it is commonly known. Ever since OpenAI’s ChatGPT took the world by storm, investors have been racing to find winners from this explosive trend.

Corporate leaders, meanwhile, have been scrambling to prove to investors that they are harnessing the technology to drive revenue growth, improve operational efficiency, and more.

In first-quarter 2023 earnings in the US, company reports mentioned AI and related terms more than twice as often as they did a year ago, a recent  study showed.

Consultancy McKinsey believes 70% of companies will be using at least one type of AI by 2030, and investment bank Morgan Stanley forecasts the AI industry will generate $1 trillion in annual revenue by 2050.

What is generative AI?

It is a type of artificial intelligence technology that produce types of content, including text, images and audio.

S&P RALLY FUELLED BY AI GAINS

AI fervour this year has been responsible for all of the S&P 500’s gains, according to new analysis by Société Générale. The investment bank’s research shows that without the gains of ‘AI boom stocks’ the S&P 500 would actually be down 2% this year, rather than up 8% (when the research was released earlier in May).

That is not entirely surprising when you consider stocks of companies perceived as AI winners – Nvidia (NVDA:NASDAQ), Microsoft (MSFT:NASDAQ), Alphabet (GOOG:NASDAQ) and others – have been on an absolute tear.

Nvidia’s share price has more than doubled this year (+121%), while Microsoft has rallied 33% since it invested $10 billion in OpenAI back in January.

Morgan Stanley analysts believe the current AI excitement could be more than just hype. ‘When we consider tech diffusion with real market impact potential, generative AI is a serious contender,’ says Edward Stanley, Morgan Stanley’s head of thematic research in Europe.

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What is generative AI?

It is a type of artificial intelligence technology that produce types of content, including text, images and audio.

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JPMorgan named AI as one of its hot themes for 2023, saying that with the emergence of ChatGPT, and other generative AI-powered chatbots, the future of work is set to be disrupted.

‘We believe we are on a secular trajectory towards the workforce, particularly the younger Generation Z, entering what we call the “multi-earner era” – one where workers pursue multiple earning streams rather than a single job.’

Shares investigated the opportunities available to retail investors in February, and as we said then, ‘despite all the hype, AI is still in its infancy and faces years of further development, and investors have time on their side.’

We concluded at that point that an investment fund with a focus on the wider AI world was the best way to invest, and that view still stands.

However, there are investors who prefer individual shares over funds and this article provides examples of companies embracing AI.

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The expert’s view: Trevor Green, head of UK equities, Aviva Investors

‘I believe we are at a similar stage as to when the internet came on the scene. The difference to when the internet arrived was that we didn’t have mega cap technology companies boasting unlimited budgets to invest in it, which we obviously have now.

‘But I caution that just because Apple, Google, etc have the head start and the big budgets does not automatically mean they will be the winners in this space in 10 years’ time when we look back. I believe there will be other less well-known companies at this stage who are winners.

‘There is a divide between companies that have been investing in AI for years and those that are playing catch-up and it is key as an investor to identify which camp companies are in. Take Sage (SGE) which reported last week and hardly mentioned AI in its results statement because the company has been using it for years and didn’t feel a need for sensational announcements.

‘Investors should not underestimate ChatGPT4 which is ground-breaking and is likely to result in a big reduction in call centre staff, for example. However, I would argue that in some/a lot of instances AI is not leading to job losses but freeing up those employees for other more productive roles, lowering the need for recruitment drives in organisations.

‘Remember the key launch was version 4 of ChatGPT and that was only 14 March 2023. We are still in the early days in all of this.’

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IMPACT OF AI

The scope for AI to drive corporate profitability and free cash flow by lowering labour costs and/or making its workforce more efficient, could have profound implications for company market valuations and share prices, both winners and losers.

‘We are already seeing businesses across our portfolio leverage AI tools to streamline the work delivered by their teams,’ says Stuart Veale from Beringea, manager of ProVen VCT (PVN).

Education is just one sector where analysts and fund managers see potential for an AI-driven seismic shift. ‘Currently there aren’t enough teachers, classes are too large, textbooks are expensive, private education is prohibitively expensive, and exams can be too blunt and stressful an instrument for assessing diverse students with differing abilities,’ says Steven Tredget, partner at Oakley Capital Investments (OCI). ‘AI removes all these constraints to the benefit of students.’

Tredget says the launch of AI-driven teaching assistant Syntea has received overwhelmingly positive feedback from developer IU Group and 120,000-plus higher education students.

These sorts of active examples prompted three researchers from NBER (National Bureau of Economic Research) to conduct a study to quantify the impact of AI on corporate valuations. Their work also identified companies set to benefit the most and least from ChatGPT, which was used as  an illustration.

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HOW AI IS CHANGING THE ADVERTISING INDUSTRY

AI is transforming the advertising industry at pace with the use of personalised adverts and chatbots, which can help consumers make buying decisions. Nick Waters, CEO of media marketing consultancy Ebiquity (EBQAIM), says the success is seen in the paid search market where AI is used to generate keywords and text that achieve stronger results than human input.

‘There have been tentative steps taken to apply AI to the development of longer form copy but this is yet to prove itself,’ he says. ‘We are still in the learning stage and testing possibilities at Ebiquity with useful progress in data cleansing and processing. We feel the application of AI to large data sets will enhance our ability to produce predicted outcomes at speed which will be an exciting development for our clients and ourselves.’

Daily Mirror newspaper owner Reach (RCH) has been using AI to publish articles on its local news and information sites. Last July, Reach launched an AI-powered audience engagement tool called Neptune Recommender. Page views through this tool now account for 40% of Reach’s page-view growth since the start of 2022.

Using machine learning and increased data points, Reach believes it can now suggest more relevant content to readers, keeping them on its platforms for longer and targeting them with more relevant advertisements.

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DOUBLE-EDGED SWORD

The NBER thesis was that generative AI tools could lead to an increase in some companies’ market values. That is because these technologies can boost free cash flow by affecting the workforce in two major ways.

First, workers might be replaced with less expensive AI technologies, which would boost free cash flow by lowering operating costs. Second, companies may find their employees become
more efficient by using AI to get things done better and faster. This improved efficiency can lead to higher profits and more free cash flow.

The study involved giving impact scores to sample companies, rating each on how exposed its workforce is to generative AI. They studied upwards of 20,000 tasks done by humans and used ChatGPT to figure out whether AI could achieve these tasks instead. They then grouped these tasks by occupation.

Next, they linked job roles to specific companies on the stock market, then cross-referenced their findings with recent earnings call transcripts. These companies were compared by share price performance and sorted into quintiles.

In short, they found that when ChatGPT arrived on the scene, it had a sizeable positive impact on the value of firms whose labour forces were more exposed to generative AI. Put differently, firms whose workforces can benefit the most from the use of ChatGPT saw their stock prices perform significantly better than those of firms that stand to benefit the least.

This outperformance amounted to 0.4% in daily excess returns during the two weeks following ChatGPT’s release. That is huge when you consider that a daily 0.4% excess return translates into more than 100% on an annualised basis, the research says.

Technology companies have a huge swath of employees whose jobs could potentially be replaced by ChatGPT. The NBER researchers also found industries with higher exposure tend to pay bigger wages, suggesting more workers in well-paid positions could see their careers transformed by the technology.

Industries with higher relevance also tend to have more employees compared to their capital, spend more on research and development, and have fewer physical assets.

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On the other side, firms with employees doing manual, physical tasks stand to benefit the least from ChatGPT. That includes food and drink providers Starbucks (SBUX:NASDAQ) and McDonald’s (MCD:NYSE), retailers Target (TGT:NYSE) and Walmart (WMT:NYSE) and transport companies, such as United Parcel  Service (UPS:NYSE).

This list gives investors a starting point for stocks to research. The goal should be to narrow the options to a handful of companies that seem like good bets to ride the ChatGPT and AI trend.

On top of the usual analysis of a stock’s fundamentals and valuation, it is worth investigating whether each company has plans to leverage generative AI to enhance workforce productivity and/or shrink its workforce costs. This may be part of the thinking behind recent announcements from Vodafone (VOD) and BT (BT.A), which plan to cut 11,000 and 55,000 jobs respectively over the coming years.

Also keep in mind that NBER’s study focuses on firms’ workforces but does not get into the product side of things. Generative AI has the potential not only to reduce labour costs and enhance employee productivity, but also to drive revenue growth by being integrated into existing or new products, and some companies have exposure to both, creating a potential double-whammy of value creation.

For example, creative design software firm Adobe (ADBE:NASDAQ) is one of the biggest potential beneficiaries should it choose to adopt generative AI internally and externally.

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SIX STOCKS RELEVANT TO THE AI THEME

C3.ai (AI:NYSE)

C3.ai is a software company focused on developing enterprise-scale AI solutions, with products used in industries as diverse as healthcare, industrial automation and finance. C3.ai offers clients a range of AI products, allowing users to either develop their own code or take off-the-shelf solutions.

The suite of services is ideal for firms looking to get up to speed with the opportunities AI offers in their respective sectors. Firms should realise AI is an arms race and failure to adapt could put their very existence under threat. This makes C3.ai’s off-the-shelf software packages an option for operational functions that do not require recruiting legions of IT experts to use them.

The business remains loss-making for now but investors have been chasing the stock hard this year, fuelling a 141% rally since January.

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UPSTART (UPST:NASDAQ)

Founded in 2012, Upstart is an AI lending platform that partners with banks and credit unions to provide consumer loans using non-traditional variables, such as education and employment, to predict creditworthiness.

Upstart’s revenues have come under substantial pressure this year with the US banking sector thrown into crisis by Silicon Valley Bank’s collapse and sale. Revenue for the three months to 31 March fell 30% quarter-on-quarter to $103 million, a third the size of its $310 million the year before, but the growth trajectory could recover sharply once financial stability returns.

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BAIDU (BIDU:NASDAQ)

Analysts think the Chinese company is a great play on rampant AI growth, with multiple catalysts looming for the company.

Baidu started out as China’s answer to Google, and it remains a significant player in internet search, but its focus has broadened to cloud services are more recently, AI.

It has developed a rival to ChatGPT called Ernie with a plan to incorporate generative AI into its search engine and other products. It currently waiting for Chinese government approval to launch Ernie.

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PEARSON (PSON)

The education publishing group is to use generative AI enhancements across key products. Pearson is hoping its AI strategy will attract a new student audience (and more subscriptions) who might ordinarily be tempted by chatbot learning through ChatGPT.

For example, in Pearson+, users will have access to a generative tool that automatically summarises the content of videos in simple bullet points and auto-generates quizzes.

It has developed proprietary predictive algorithms which assess trends in demand for skills and occupations globally, and recommend career and learning pathways for consumers, enterprises and governments.

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RELX (REL)

RELX says the first AI-linked tools have been around in the legal world for more than a decade. However, the industry is now exploring the capabilities more seriously.

RELX’s recent financial results highlighted further diversification into higher growth analytics and decision tools.

For example, it is using AI to speed up the complex and time-consuming legal research process, allowing lawyers to do ‘billable’ work faster. Lawyers can then spend more time doing other duties like advising clients or performing other work.

Its Lexis+ AI system can provide legal summaries in seconds and it can also generate briefs and contract clauses.

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META PLATFORMS (META:NASDAQ)

Regular users of Instagram and Facebook might wonder why they have been spending more time on the social media networks recently. That might be down to actions by the company which owns these platforms.

Meta has been using AI to suggest what it hopes are more relevant short-form videos for users. Increased engagement should equate to more exposure to advertising. Forty percent of Instagram content is now AI-recommended.

The company has also built custom computer chips to help with AI and video-processing tasks.

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