This article was produced in partnership with Macquarie Asset Management.
In 1950, British computer scientist and war-time codebreaker Alan Turing proposed a test to determine AI. His hypothesis was that if a human couldn’t distinguish between a machine and another person within five minutes, it indicated human-like intelligence in the machine.
Turing speculated that within fifty years, computers would be powerful enough to play this ‘imitation game’ so well that a human interrogator would have no more than a 70 per cent chance of correctly identifying the machine.
Today, the promise of AI is now becoming a reality, transforming industries and redefining the way we conduct business.
The AI journey has progressed to the extent that a growing array of leading companies across the world are exploring, embracing, and harnessing the opportunities afforded by this evolving technology.
As a fundamental global equity manager, Walter Scott can get ‘under the hood’ of some of these companies to uncover the potential long-term growth drivers for investors.
The ‘compute’ element
AI has supercharged the demand for semiconductors, with generative AI (gen AI) requiring substantially more computational power. This demand for leading-edge ‘compute’ – processing power – is particularly positive for Taiwan Semiconductor (TSMC) and Dutch semiconductor lithography company ASML.
TSMC is the world’s largest maker of semiconductors with Apple and Nvidia among its customers. The company’s competitive advantage that has maintained its market leadership lies in its pure foundry model, which eliminates potential competition with customers. It also has a record of strong execution, and has high levels of research and development spending.
AI-enabled devices (like smartphones and PCs) are expected to see a material increase in silicon required to manufacture those products, boosting demand across other parts of TSMC’s businesses.
The Walter Scott team recently had a rare tour of ASML’s “cleanrooms” – the moniker given to their manufacturing facilities due to the cleanliness required – in the Netherlands, witnessing the manufacture of extreme ultra-violet (EUV) and High NA – the next-generation EUV tools. Each of these tools are critical workhorses of leading-edge chip manufacturing helping chipmakers like TSMC reduce the process steps, costs and cycle time, i.e. the length of time required to produce a semiconductor chip.
With its monopoly EUV position, ASML remains a linchpin in the drive towards smaller, cheaper, more powerful and energy-efficient semiconductors. AI’s demand for advanced semiconductors is highly beneficial for ASML.
Developing the infrastructure
Beyond this ‘compute’ element, infrastructure companies provide the foundational technology and services necessary for AI development, deployment and scaling. These businesses enable client companies and developers to build, train and run AI models more efficiently, with Microsoft and Alphabet having developed leading positions in this area.
Microsoft’s Azure cloud computing platform in collaboration with OpenAI has democratised access to advanced AI, accelerating the development and deployment of state-of-the-art models such as ChatGPT, DALL-E and Codex.
Furthermore, AI will be built into every Microsoft cloud solution through its Copilot application. Copilot is an AI-powered tool to improve productivity and creativity across tasks such as ideas generation and preparing presentations. As a result, Microsoft’s management is confident that this will be one of the fastest growing business areas in the company’s history.
Alphabet is establishing a leading position in the AI investment and application race, rolling out its own Search Generative Experience – which will be part of Google – that will craft responses to open-ended queries, responding to prompts with images and text, offering improved user experience and precision.
Crucially, Google enjoys three significant advantages. In search channels, Google owns Android, which has over 70 per cent of the mobile operating system market. In its product suite, Google has nine consumer-facing products with over one billion users, all of which are free. And then there is the brand. Google is a verb and is synonymous with search, and advertisers have years of experience placing high-traffic, high return-on-investment ads with Google via its search platform, YouTube, AdMob, Maps, Shopping and Travel.
Harnessing AI
A growing array of companies are harnessing AI to enhance their products, services and profitability.
The AI ‘gold’ for these companies will be in generating incremental revenues, selling more products or services, expanding into new markets or developing new business strategies, or looking to improve the cost or capital efficiency of their operations. There is often a common thread to market-leading companies in that they tend to have more data and stronger digital capabilities, the trust of customers, more capital to invest, and have management teams which have been proactive in thinking about how to use AI.
Adobe, with over a decade of AI investment, recently announced the launch of Adobe Firefly, an AI-powered creative tool that will be integrated across its applications. Firefly uses gen AI and simple text prompts to create higher-quality images with better composition, photorealistic details and improved mood and lighting. Adobe expects this will provide users with an easier to use, more powerful and personalised experience.
Technological progress is rarely linear, and at Walter Scott we expect the same to be true for AI. There will be periods when the market will get overexcited in terms of usage expectations and the pace of adoption or monetisation, and for some businesses AI integration may be a slower burn than some of the more bullish proponents of the technology expect.
But how fast will the technology be adopted? How will it change our lives? And what AI-enabled products and services are we willing to pay for?
The next transformational AI wave will be dominated by a growing list of companies that are identifying real-world use cases for the technology. Consequently, as long-term investors, a focus of our fundamental analysis over the coming years will be on how companies are employing AI to reach customers, more efficiently and more profitably, and with better products and services.
Tom Miedema is an investment manager at Walter Scott.
