Key Takeaways
- Morningstar’s latest research find attractive opportunities remaining with the artificial intelligence sector.
- European AI stocks have a long way to go to catch up with their US counterparts.
- While AI is central to the modern economy, the main risk is not to the financial system but to investment returns.
James Gard: We’re here at the Morningstar Investment Conference. I’m delighted to be joined by Michael Field, who has just come off the stage, presenting on opportunities in artificial intelligence. So, the good news in your presentation is that there are still opportunities in AI and you don’t think there’s a bubble. More importantly, there are hidden gems that investors are probably not aware of.
Michael Field: Absolutely. So, you hit the nail on the head. We don’t think there’s a bubble. Valuations are attractive right now and indeed you touched on the hidden gems part there. What our reports highlighted was stocks that AI fund managers are not investing in because they’re missing and that’s what we highlighted.
Gard: So, looking at the amount of stocks that are widely held, so there’s nearly 80 in the US and eight in Europe, what’s it going to take to get fund managers to invest more heavily in European stocks? What’s the catalyst for that level of increase in allocation?
Field: So, I think they’re going to have to find those opportunities. Those opportunities have to exist in the first place, and there are some. There are some actual pure plays in Europe with regard to ASML ASML, for example, the Dutch stock or ARM Holdings which is technically a UK stock as well. So, we do have AI plays in Europe, but I think it’s going to take a whole lot of development from the companies themselves to actually attract that attention from fund managers.
Gard: Would it take an increase in share prices to get fund managers’ attention here?
Field: Yes, certainly. I think the big difference as well, you mentioned the opportunities in Europe relative to the US, but what we didn’t talk about is size. You talk about Nvidia NVDA, they’re the largest company in the world. So, to get to a level of where they actually present themselves to fund managers in a very attractive way, we’re way away from that at the moment in Europe. That’s their main takeaway there I think.
Gard: Sure. And will index allocation help? If it gets bigger, then they get a bigger weight in the index?
Field: Absolutely. This is the main thing. And we spoke a lot about concentration risk and things like this last year. So certainly, fund managers are looking for a reason to find other opportunities and to diversify as best they can. So, if this is possible, then I think that’s a great thing.
Should Investors Target the AI Producers?
Gard: Sure. So, I just wanted to pick something out from your report and presentation. You mentioned producers versus suppliers. Investors should be looking for the producers, AI producers not the suppliers, not the picks and shovels people but the pure play.
Field: The problem is that there’s very few producers. So even in our report we found three pure play producers and around 20 pure play suppliers. So, I’m not saying you have to just invest in those three stocks. Absolutely not. But we’re saying “why wouldn’t you invest in those three stocks?”
Gard: Thinking of sort of pure play AI, is it a desirable outcome for investors to own a pure play? Is it better to target the pure play and is it ideal for these companies to transform themselves into pure play?
Is AI Really in a Bubble?
Field: What I would like investors to take from our message and what we said on stage was that there are pure plays out there and if you’re afraid of them because you think the valuations are sky-high or we’re in a bubble, we’re removing that fear for you. We’re saying that actually, “look, here’s the fundamentals, those pure plays are actually the best value that we see in the market.”
Gard: Sure. Yeah, I mean, it is quite interesting that you’re marrying up valuation with opportunity there. So, it’s not like, sorry, you missed the boat on these ones. These are the best ones. Unfortunately, you can’t have those because they’re too richly valued.
Field: And I think the picture is changing all the time as well. I mentioned on stage about Alphabet GOOGL. They released earnings last week and our analysts upped the fair value estimate by 30% in a day. So, we’re not dealing with old school slow-moving stocks here. It’s something that moves quickly and the valuations with them move quickly. So, things can go from being not very attractive to being highly attractive in quite a quick fashion.
Gard: Sure. I find it interesting that your report sort of has a kind of five-year view and says that in five years’ time this is a percentage of revenue that these companies will have. Are you also thinking: Is it realistic to take a 10 or 20-year view with AI stocks?
Field: I think that would be very nice and very comforting to be able to do that. But no, I think the problem is and what we’re seeing already is that even when it comes to AI disruption, it’s very hard to get any sort of visibility on that. I think it’s a stretch as is to be asking analysts to look five years into the future with your companies. I think anything beyond that and the security of that knowledge goes down as well.
AI Arms Race: Which Stocks Win?
Gard: If you think of AI in terms of an arms race, the biggest tech companies, surely, they’ve got the deepest pockets and they can just buy AI exposure. But you mentioned in your report the idea of a false friend which is the kind of flip side of the hidden gem. So, you mentioned Apple AAPL as an idea of potentially a false friend here, as one you think—“well, surely, they’re going to be an AI winner,” but that might not be the case.
Field: Dealing with the deep pockets part first.
Gard: Yeah, sure.
Field: Yes, certainly. The more money you can throw at something, the better you’re going to do with it. The only exceptions to that being that we saw with the DeepSeek moment we had last year where it suddenly emerged that some of these companies had overspent relative to what someone else can build a similar product for. That’s a danger investors have in their minds when they’re investing in AI now.
And I think when it comes to false friends, specifically with Apple, I think the point we had was that 40% of fund managers hold Apple, and they believe it to be an AI play. And what we’re saying and what our analyst is saying is, “no, this is actually a company that sells iPhones and iPhones are around 60% of its revenue.” So, we’re saying, “yes, it’s investing in AI and that’s great. But if you think for a second that this is a pure play in AI, it’s not.”
Gard: I think that’s very interesting, and the idea that investors can’t be too complacent. They’re just like, well, surely Apple and the Mag 7, all of them will be successful. I wanted to pick out something in terms of the spending as well. You’re not worried about the level of spending going on in tech companies in terms of Silicon Valley and their spending on AI.
Field: So, I think it’s always a concern and when they announce half a trillion or more spending on something, you have to question, is that the best use of cash or are they really going to get the return on that? And ultimately, the ante is upped, right? Anytime they do this, the payoff has to be bigger. And that’s still the concern for investors. But what gives us comfort is that they are seeing revenue growth come through. They are seeing earnings growth come through. And they are seeing their order books expand. And ultimately, you have to build the infrastructure to be able to fulfill those orders. So, then it makes sense to us that they are spending that cash. That gives us some comfort at least.
Gard: Sure. And I do think earnings season has been positive for a lot of these companies in terms of the initial results from this AI spending. It isn’t just frivolous spending. So, the most recent earnings season was encouraging to you in terms of AI spending investment?
Field: Yeah, absolutely. I think one of the—like apart from the fact that they showed us what they’re doing right now and about the earnings growth to back things up on revenue growth, I think the big takeaway from earnings season is that these companies now have got better visibility not just about this year or next year, but they’re actually telling us about 2028 already. And I think that is what the difference is giving investors some real reassurance, and they’re saying, “OK, this isn’t just this year or next year down the line. This could be a three-year story at the very minimum and investors are saying, OK, if it’s at least a three-year story, then I’m more willing to back this than I was two months ago.”
Gard: Sure. So, it isn’t just a case of “we’re spending loads of money, and at some point, we expect it to come good.” Is that the visibility you were talking about?
Field: Yeah, it’s the reality of it, right? Seeing an actual tangible results has given people more comfort.
Is AI Too Big to Fail?
Gard: I wanted to pick up on something you mentioned in your report about one of the benefits of AI or what are the kind of positives for investors. And you think AI is now treated as a critical national infrastructure. And I wonder if there’s an element of too big to fail in this. Is there kind of moral hazards attached to the importance of AI to societies and economies? And I hate to say—is it the new banking sector? But if it becomes too important, it has to succeed and is the state somehow going to get involved in it?
Field: I think certain developments like Mythos and things like this enhance that risk certainly. But I think we’re a long way off from it becoming a critical infrastructure like banking is, right, where society will fall down if it isn’t held up. I think things like concentration risk certainly are increasing. The fact that it’s a third of the S&P 500, if the Mag 7—I know that’s not all AI, but if AI failed, the whole concept failed within that, obviously that’s a huge chunk of everyone’s savings and pensions and everything else to go. So, I think that’s probably the bigger risk in the short term.
Gard: If you think of investors as human beings and citizens as well, they are worried about the disruption, but you’re also saying, “well, look, AI is a good investment opportunity.” Is it safe to think to have two things in your head, which is, one is, “I’m worried about disruption, but also I will stake my retirement planning or financial future on the success or otherwise of AI?”
Field: I think this is what the key takeaway is, right, the winners and the losers. We’re saying, “if there’s AI disruption, someone is losing out and someone actually has to gain on that on the flip side of things.” And that’s what we’re trying to identify. We’re trying to identify those winners as well that investors can get the exposure to them to make up for those disruptions that we just talked about.
Gard: Brilliant. Well, thanks so much for your time, Michael. Much appreciated.
Field: Thank you.
Gard: For Morningstar, I’m James Gard.
Download the latest Morningstar report, “Opportunities in Artificial Intelligence,” published in May and written by Michael Field and Kenneth Lamont.
