Artificial intelligence (AI), and particularly generative AI, is currently one of the most disruptive forces in business, permeating virtually every sector of the economy and promising to usher in new levels of productivity. Morgan Stanley’s Global Investment Office sees AI as one of the most important investment themes of the next decade and estimates that it will rapidly grow to a $3 trillion industry in the next several years.
Megatrends: How to Invest in the AI Boom
Dec 22, 2023
Artificial intelligence is set to become a $3 trillion industry in the next several years. Where can investors find opportunities?
Denny Galindo
Key Takeaways
- Investors looking to capitalize on AI’s rapid growth should consider stocks of dominant larger companies that are quickly integrating the technology.
- Many of these companies are harnessing AI to improve efficiency, introduce new services or roll out enhancements that can help reduce costs and boost revenue.
- Companies that supply the critical inputs needed for the development and use of AI, such as semiconductors, are also likely to benefit.
- Investors should pay close attention to AI beneficiaries with low valuations relative to how fast their earnings are growing.
"Generative AI” refers to unsupervised and semi-supervised machine learning algorithms that can use existing text, images, audio or video to create new content. Generative AI tools can, for example, have human-like conversations, compose music and edit computer code.
Where can investors find compelling AI opportunities? Thus far, many investors have focused on a handful of mega-cap tech stocks known as the “Magnificent 7” as the main beneficiaries of advances in AI. But given how wide-ranging AI’s impact will likely be, we believe there are far more companies that stand to benefit, across sectors ranging from Consumer Discretionary to Health Care and Financials. Here’s a look at the types of companies our strategists are watching.
Leaders May Keep Leading
Many of the economic benefits of AI are likely to accrue to companies that are already leading in their industries. Specifically, large firms with dominant market share, recurring revenues and “sticky” customers are positioned to use AI to amplify their already considerable competitive advantages. These companies often have customers who cannot easily switch to rival products and thus may be more willing to try their AI product—and even pay more for it—because it is from a company they already know and trust. Companies that move quickly to integrate AI into their business models are more likely to avoid disruption and widen their lead.
Four Types of AI Leaders
Among these likely AI beneficiaries, investors may want to pay particular attention to companies that fit at least one of four categories.
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1Margin Expanders
These companies are using AI to reduce costs. Generative AI tools that help software companies write code, for example, may help them lower their often-sizable Research & Development costs and more rapidly introduce new products and features. Professional services companies are also using AI to realize savings: For example, one leading tax-services provider uses AI tools to help its accountants process significantly more returns in the same amount of time, without having to hire additional professionals.
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2Trailblazers
Companies in this category are rolling out new AI-powered products or services to boost sales or create new revenue streams—often targeting existing customers who may be reluctant to switch providers. There’s precedent for this strategy: Recall that in the 1990s, many people first tried web browsers from their existing operating-system vendor, and in the 2000s, customers tried video-streaming from their DVD delivery service. An example today is a leading online meal-delivery service that is developing a new generative-AI phone-answering system to take orders and make add-on suggestions. This helps increase order sizes, as well as reducing missed opportunities from the 20% of customers who say they would still prefer ordering by phone instead of online.
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3Price Raisers
These industry leaders are introducing AI-based enhancements to justify charging more. They include a leading video-conferencing provider whose new AI “companion” will help users catch up on missed meetings by generating summaries. Similarly, a company that provides e-commerce tools for retailers has added generative-AI features to help clients write product descriptions or answer their operations questions, such as how to create a holiday sale. Such value-added features can make it easier for these companies to justify higher prices, particularly in industries where customer frustration has been growing over routine price hikes with minimal perceived improvements.
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4Input Suppliers
These companies provide the “building blocks” of AI technology, including data-management tools, data centers and the equipment needed for advanced chips manufacturing. As organizations add the computing capacity necessary for AI, global semiconductor companies are among the most likely beneficiaries, with surging demand for chips helping drive record profitability. But they are not the only ones. Investors may also want to watch select companies that provide the infrastructure and tools for businesses to develop or use AI, such as companies that specialize in data management for corporate IT departments and client-to-cloud networking services for data centers.
Mind the Risks and Be Selective
While AI is likely to usher in long-term growth in many industries, investors should be mindful of a potential bubble in the near future. There have been recent hype cycles around some new technologies, such as cryptocurrency and work-from-home technology, that have fizzled out to some degree. It may take a while before investors see big productivity improvements from AI, and companies that overpromise could fare poorly.
There is also the risk that AI will actually reduce what economists call “efficient scale,” making it so inexpensive for smaller companies to compete that it effectively erases the size advantages enjoyed by larger players. Lastly, new regulations and legal battles over issues such as copyrights and intellectual property could smother AI development.
Investors should be selective. Pay particular attention to likely AI beneficiaries that are favored by equity analysts and sport comparatively low valuation multiples relative to how fast their earnings are growing.
For a list of 25 stocks that our strategists believe are attractively priced and likely to benefit from growth in AI in the next several years, ask your Morgan Stanley Financial Advisor for a copy of the October 20, 2023, AlphaCurrents report, “Building an AI Army.”
Your Financial Advisor can share specific investment recommendations that may help you position for rapid growth in AI.
Risk Considerations
Virtual Currency Products (Cryptocurrencies)
Buying, selling, and transacting in Bitcoin, Ethereum or other digital assets (“Digital Assets”), and related funds and products, is highly speculative and may result in a loss of the entire investment. Risks and considerations include but are not limited to:
· Digital Assets have only been in existence for a short period of time and historical trading prices for Digital Assets have been highly volatile. The price of Digital Assets could decline rapidly, and investors could lose their entire investment.
· Given the volatility in the price of Digital Assets, the net asset value of a fund or product that invests in such assets at the time an investor’s subscription for interests in the fund or product is accepted may be significantly below or above the net asset value of the product or fund at the time the investor submitted subscription materials.
· Although any Digital Asset product and its service providers have in place significant safeguards against loss, theft, destruction and inaccessibility, there is nonetheless a risk that some or all of a product’s Digital Asset could be permanently lost, stolen, destroyed or inaccessible by virtue of, among other things, the loss or theft of the “private keys” necessary to access a product’s Digital Asset.
· Investors in funds or products investing or transacting in Digital Assets may not benefit to the same extent (or at all) from “airdrops” with respect to, or “forks” in, a Digital Asset’s blockchain, compared to investors who hold Digital Assets directly instead of through a fund or product. Additionally, a “fork” in the Digital Asset blockchain could materially decrease the price of such Digital Asset.
· Digital Assets are not legal tender, and are not backed by any government, corporation or other identified body, other than with respect to certain digital currencies that certain governments are or may be developing now or in the future. No law requires companies or individuals to accept digital currency as a form of payment (except, potentially, with respect to digital currencies developed by certain governments where such acceptance may be mandated). Instead, other than as described in the preceding sentences, Digital Asset products’ use is limited to businesses and individuals that are willing to accept them. If no one were to accept digital currencies, virtual currency products would very likely become worthless.
· Platforms that buy and sell Digital Assets can be hacked, and some have failed. In addition, like the platforms themselves, digital wallets can be hacked, and are subject to theft and fraud. As a result, like other investors have, you can lose some or all of your holdings of Digital Assets.
· Unlike US banks and credit unions that provide certain guarantees of safety to depositors, there are no such safeguards provided to Digital Assets held in digital wallets by their providers or by regulators.
· Due to the anonymity Digital Assets offer, they have known use in illegal activity, including drug dealing, money laundering, human trafficking, sanction evasion and other forms of illegal commerce. Abuses could impact legitimate consumers and speculators; for instance, law enforcement agencies could shut down or restrict the use of platforms and exchanges, limiting or shutting off entirely the ability to use or trade Digital Asset products.
· Digital Assets may not have an established track record of credibility and trust. Further, any performance data relating to Digital Asset products may not be verifiable as pricing models are not uniform.
· Investors should be aware of the potentially increased risks of transacting in Digital Assets relating to the risks and considerations, including fraud, theft, and lack of legitimacy, and other aspects and qualities of Digital Assets, before transacting in such assets.
· Morgan Stanley Smith Barney LLC or its affiliates (collectively, “Morgan Stanley”) may currently, or in the future, offer or invest in Digital Asset products, services or platforms. The proprietary interests of Morgan Stanley may conflict with your interests.
· This material has been prepared for informational purposes only, based on publicly available factual information. It does not provide individually tailored or general investment advice whatsoever. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Investors seeking to evaluate particular investments and strategies in Digital assets must seek the advice of their independent advisors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
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Asset Class and Additional Risk Considerations
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.
Artificial intelligence (AI) is subject to limitations, and you should be aware that any output from an IA-supported tool or service made available by the Firm for your use is subject to such limitations, including but not limited to inaccuracy, incompleteness, or embedded bias. You should always verify the results of any AI-generated output.
Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Disclosures
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