AI software investment trends: from Tesla to market realities
16 October 2024
Flashy AI demonstrations may grab headlines, but the true investment opportunity lies in companies developing and implementing practical AI software solutions. Our data shows a clear shift towards software outperformance, particularly in targeted application areas and services.
Bottom line
As the AI landscape matures, we expect this software-centric trend to accelerate, as the value added shifts from the infrastructure building to the application implementation. Stay focused on tangible results and be prepared for the next wave of AI-driven growth in the software space.
What happened
Tesla's recent AI Day event showcased their latest humanoid robot prototype, Optimus. While the demonstration fell short of the groundbreaking reveal many anticipated, this event exemplifies a broader trend we've observed in the AI landscape: the gap between hype and market realities. As we previously noted, the true value in AI lies in the software applications that drive practical, scalable solutions.
Impact on our Investment Case
AI software full throttle ahead
Our investment thesis, outlined in our June article, remains robust: software is becoming increasingly significant in the AI investment theme.
Recent market data strongly supports this view: since the beginning of June, the SPDR S&P Software & Services ETF (XSW) has outperformed the Philadelphia Semiconductor Index (SOXX) by an impressive 9.6%, with the SOXX stagnating barely above the positive performance mark.
This divergence underscores the shift from hardware to software in AI investments, and specific software segments have shown remarkable strength. Data-related segments within our AI & Robotics investment universe experienced a strong increase (+23% for Data Exploitation, +15% for Data Management), while AI Platforms, both generalist and specialized, rose by +16% (e.g. AI Platforms in Digital Marketing Tools surged 10.6%, cloud-based Cybersecurity Workloads rose 12.5%).
While pure infrastructure plays have underperformed, segments bridging infrastructure and applications - such as Data Analytics and Database Management tools - have shown resilience.
The strategic importance of AI adoption and the complexities companies face in implementation imply that success in AI investments requires a discerning eye. Focus on companies demonstrating clear AI integration with tangible benefits, as seen in standout performers like Palantir Technologies Inc (part of our portfolio).
Not limited to our investment universe
Another interesting data point is the good performance of Software Services stocks, reflecting companies' need for expert guidance in navigating the complex AI landscape. This brings some paradox for AI stocks, as companies take a cautious approach in order not to dilapidate their IT investment budgets, especially as those same budgets had been put to serious use to modernize IT infrastructure following the pandemic. But we see this as a strong commitment to heavy spending for years to come.
Finally companies leveraging AI applications in sectors like financial services (e.g. Affirm Holdings Inc, Q2 Holdings Inc, both in our portfolios), betting & gambling (e.g. Genius Sports), and education (e.g. Duolingo Inc) have seen their stocks post strong performances, highlighting the value of AI in data-rich, pattern-dependent industries.
Much more to come
While our call may have been slightly early, the trend is now unmistakably ongoing and poised to continue. 2Q24 earnings calls showed that spending will not decrease soon, as every company understood the critical advantage of AI as a competitive differentiator and is now focusing on how best to use it. And despite the relative surge of software vs. hardware, relative valuation multiples still have room to grow before returning to their historical levels.
Our Takeaway
The AI investment landscape is evolving rapidly, with software applications emerging as the true value drivers. Investors are finally gravitating towards software applications, particularly in verticals where AI deployment is most advanced and ROI is easily calculable (e.g., Cybersecurity, Online retail, Financial services).
As we move forward, we anticipate the focus to increasingly shift towards the applications side across various sectors, potentially catalyzed by generative AI technologies. This development is likely to trigger a broader adoption cycle, benefiting the entire AI ecosystem from infrastructure to applications. In conclusion, while hardware innovations like Tesla's Optimus robot may capture headlines, the real investment opportunity lies in the software realm. As we focus on companies that leverage AI to solve real-world problems and deliver measurable value, Atonra investors can position themselves to capitalize on the next phase of the AI revolution.
Companies mentioned in this article
Affirm Holdings Inc (AFRM); Duolingo Inc (DUOL); Genius Sports (GENI); Palantir Technologies Inc (PLTR); Q2 Holdings Inc (QTWO)
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