By Philip van Doorn
Money managers name stocks of companies that can benefit from the ‘third wave’ of artificial-intelligence deployment described by Nvidia CEO Jensen Huang
Artificial intelligence has been a dominant theme for investors during 2023, as data centers have installed the equipment and software needed to support corporate clients that are rolling out their own AI technology.
But when Microsoft Corp. (MSFT) CEO Satya Nadella and Nvidia Corp. (NVDA) CEO Jensen Huang spoke together at Microsoft’s Ignite 2023 conference on Nov. 16, they agreed that industrial companies will benefit massively from AI over the long term.
Looking beyond the current build-out of data centers’ AI capability that has fueled a tripling of Nvidia’s share price this year, four money managers discussed how investors should think about the coming industrial-AI wave.
Nadella, Huang and industrial AI
When asked by Nadella about the “arc … of AI innovation going forward,” Huang called generative AI “the most significant platform transition in computing history. It’s bigger than PC, it’s bigger than mobile, it’s going to be bigger than internet,” he said.
Huang described three “TAM expansions,” with TAM standing for the total addressable market for computing services:
The first wave includes startups, such as OpenAI, which made its ChatGPT function available to the public a year ago. This wave also includes the creation of what Huang calls “AI factories,” which are data centers dedicated to “running AI models and generating intelligence.” Huang called the second wave of the AI rollout the “enterprise generation,” which includes AI-enabled services, which he said have been kicked off by Microsoft Copilot.The third wave, he said, “is going to be the largest wave of all,” referring to heavy industry. “This is where Nvidia’s Omniverse and generative AI [are] going to come together to help heavy industries digitalize and benefit from generative AI,” he said.
“{W]e are barely in the first wave, starting the second wave,” Huang said. Nadella agreed.
For evidence that the first wave is ongoing, consider that Nvidia’s stock has tripled in price this year and that its sales for the fiscal quarter ending Oct. 29 were triple those of the year-earlier quarter. The company’s graphics processing units continue to dominate this equipment category, which is critical for data centers’ AI rollout. Analysts expect Nvidia to continue to lead the semiconductor industry for the pace of revenue growth through 2025.
The comments from Huang and Nadella raise the question of how investors can participate in the great expansion that Huang expects for the computing-services market, with a long-term focus on the third wave.
Money managers chime in
In interviews with MarketWatch, four professional investors discussed Huang’s description of the three waves of AI technology, the timing of the waves and where investors who want to take advantage of the trends should be focused right now.
Art Amador of EquBot
Art Amador is the chief operating officer and co-founder of EquBot, which is based in San Francisco and serves as subadviser for the AI Powered Equity exchange-traded fund AIEQ. He didn’t offer an opinion on Huang’s statement about the three waves of AI deployment, but he did name three industrial companies that scored high in an analysis of companies based on AI concepts, as described below.
AEIQ’s objective is long-term capital growth, and it invests across industries and company sizes. The fund’s investment-selection process begins with about 6,000 U.S. companies, which are narrowed down through an automated, data-driven process that incorporates AI and machine learning. The process makes use of four deep learning models to score companies by their financial health, news events, quality of management and macroeconomic conditions.
All the data is combined in an effort “to predict prices,” Amador said, adding that the fund “generally invests in mid- and small-cap companies.”
So the fund makes use of AI to narrow U.S.-listed stocks to a portfolio of 30 to 200 companies, but it is not designed specifically to be an AI play.
Amador said that separately from its selection of stocks for AIEQ, EquBot analyzed 50,000 companies globally to identify “150 with greatest exposure to generative AI, based on scoring of more than 60 AI-related concepts.” Among the 150, he said 16 were industrial companies.
He named three examples, none of which are held by AEIQ at the moment:
General Dynamics Corp. GD, a conglomerate that makes business jets, aircraft parts, nuclear submarines and other ships for the U.S. Navy and various other weapons systems. The company is headquartered in Reston, Va. It has a market capitalization of $68.1 billion and 106,500 employees, according to FactSet.Booz Allen Hamilton Holding Corp. BAH, which is based in McLean, Va., and provides management and technology consulting and other services to governments and companies globally. The company has a market cap of $16.7 billion and has 33,100 employees.TaskUs Inc. TASK of New Braunfels, Texas, which provides digital outsourcing services worldwide to various industries, including food delivery, ride-sharing, gaming and e-commerce. The company has a market cap of $1.1 billion and has about 49,500 employees in 13 countries, but mainly in the Philippines.
Matt Moberg of Franklin Templeton
Matt Moberg manages the Franklin Intelligent Machines ETF IQM, which holds 55 stocks of companies that support machine learning and that use automated processes. The fund’s top holding is Nvidia, which made up 9.9% of the portfolio as of Nov. 30.
Moberg said he believed Huang was “correct” in his description of three waves of AI deployment. He said that there were three groups of companies involved in the development, production and deployment of intelligent machines:
About $2 trillion in market capitalization for computer-hardware companies, which is “50 companies, [including] a lot of semiconductor companies, with Nvidia [accounting for] half.” Nvidia’s market cap is $1.16 trillion, according to FactSet.He calls the second group “infrastructure software,” which is dominated by “the big three”: Alphabet Inc. GOOGL, Amazon.com Inc. AMZN and Microsoft. Together, those three companies plus Alibaba Group Holding Ltd. BABA have a market cap of $6 trillion.The third group, which he says represents “another $2 trillion up for grabs” in market cap, includes over 100 companies that are “expected to add AI to their product sets and are able to improve their feature sets, or competitive advantages, by using AI on top, and hopefully monetizing it,” he said.
“Over the next decade you will begin to see it applied in the physical world. Automated driving will be part of it. We will see it more in robotics,” Moberg said.
Having Nvidia as the top position in IQM emphasizes Moberg’s belief that we are still in the first phase of the AI rollout. But he also believes that AI isn’t necessarily required for companies to make good use of automation and robotics.
For an example of “the general concept of bringing more robotics and data into our daily lives” without needing AI, he pointed to Axon Enterprise Inc. (AXON), which makes body cameras used in law enforcement.
Another of the fund’s top holdings is Intuitive Surgical Inc. (ISRG), which Moberg emphasized is using robotics in its surgical devices, but not AI. “Without a human mind behind it, it is nothing,” he said.
Looking ahead, Moberg said: “We will see large language modeling in the future combined with the robotics we have today – just as we don’t have fully autonomous driving today.”
Moberg said that the Franklin Intelligent Machines ETF’s portfolio reflects his belief that “you need to own companies providing the infrastructure and hardware that is needed” for the AI rollout. Here are the top 10 holdings of IQM, which made up 48% of the portfolio as of Nov. 30:
Axon Enterprise Inc. Ticker % of IQM
Nvidia Corp. NVDA 9.9%
Synopsys Inc. SNPS 5.4%
Cadence Design Systems Inc. CDNS 5.2%
Tesla Inc. TSLA 4.9%
Apple Inc. AAPL 4.9%
Intuitive Surgical Inc. ISRG 4.7%
ASML Holding N.V. ADR ASML 4.5%
Axon Enterprise Inc. AXON 3.0%
ASM International N.V. ADR ASMIY 3.0%
Taiwan Semiconductor Manufacturing Co. ADR TSM 2.9%
Source: Franklin Templeton
Rene Reyna of Invesco
Rene Reyna is the head of thematic and specialty product strategy for Invesco ETFs.
He explained that the Invesco AI & Next Gen Software ETF IGPT changed its strategy in August to track the STOXX World AC Next Gen Software Development Index. The index is made up of 100 companies “with significant exposure to technologies or products that contribute to future software development through direct revenue,” according to Invesco.
When deciding to change the fund’s strategy, Reyna said, “we saw a trend where hyperscalers, near term, seemed likely to win.” The company’s holdings are weighted by market capitalization. “If we look at a year in which AI has been top of mind, it stands out that the Nvidias of the world, with their market share, are leading the way,” he said.
The fund’s largest holdings include several hardware companies, such as Nvidia, Advanced Micro Devices Inc. (AMD), Intel Corp. (INTC) and Micron Technology Inc. (MU).
Reyna expects most “traditional AI” companies to be acquired and said that in addition to the hyperscalers such as Nvidia and Microsoft (which is not held by IGPT), the long-term survivors in the AI space will be companies with strong cash flow.
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