Artificial Intelligence

Artificial Intelligence (also known as 'AI') refers to the simulation of human intelligence in machines that are programmed to think, learn, and problem-solve. Far from the sentient robots of science fiction, AI in the real world is a powerful set of tools designed to perform specific tasks. It's a broad field that includes sub-disciplines like Machine Learning—where systems learn from data to improve performance without being explicitly programmed—and Deep Learning, which uses complex neural networks to handle more abstract tasks. For investors, AI isn't just a buzzword; it's a transformative force that's reshaping industries. It enables companies to analyze vast oceans of Big Data, automate complex processes, and create new products and services. Understanding AI is becoming crucial for evaluating a company's long-term prospects and its ability to compete in the modern economy.

For a Value Investing practitioner, the hype surrounding AI can be a distracting noise. The fundamental questions, however, remain the same as they have for a century: Does this technology durably improve a business's earning power? Does it widen its competitive defenses? AI should be viewed not as a magic wand, but as a powerful tool. A company that merely says it “uses AI” is not automatically a good investment. The real magic happens when a company integrates AI into its core operations to create a tangible, lasting Competitive Advantage. The goal is to separate the companies that are genuinely leveraging AI to build long-term value from those that are simply “AI-washing” their marketing materials to catch a ride on the latest trend.

AI is fundamentally changing how companies operate and compete. For an investor, the key is to identify how a business is using AI to strengthen its fundamental position.

A strong business is like a castle protected by a deep, wide moat. AI can be a powerful tool for widening that Economic Moat.

• Network Effects: Companies like Meta or Google use AI algorithms to make their platforms stickier. The more you use their services, the more data the AI has, the better the service becomes, which in turn attracts more users.
• Cost Advantages: AI can automate supply chains, optimize manufacturing, and handle customer service inquiries, drastically lowering a company's operating costs and boosting its Operating Margin. This allows the company to either enjoy higher profits or undercut competitors on price.
• Intangible Assets: A company that develops proprietary AI models trained on its own unique data has a powerful, hard-to-replicate asset. This data advantage becomes a core part of its moat.

AI is a massive driver of Productivity. By automating routine tasks, it frees up human employees to focus on creativity, strategy, and complex problem-solving. This isn't just about cutting costs; it's about unlocking new potential. Furthermore, AI is a catalyst for Disruptive Innovation. It's the engine behind self-driving cars, advanced medical diagnostics, and personalized financial services—entirely new markets that are creating a new generation of winners and losers.

Sifting through the AI hype requires a disciplined approach. Instead of getting caught up in futuristic stories, focus on tangible evidence of value creation.

Many CEOs love to sprinkle the term “AI” into their annual reports. Your job is to be skeptical. Ask critical questions:

• How, specifically, does AI improve the company's product or service?
• Is there evidence of this in their financial statements, such as growing revenue or expanding margins?
• How does the company's AI strategy fit into its broader Capital Allocation framework? Is it investing rationally for a clear return?

During the gold rush, many fortunes were made not by the miners, but by the merchants who sold them picks, shovels, and blue jeans. The same logic applies to AI. Instead of betting on a single, risky AI application, you can invest in the essential infrastructure that the entire AI industry relies on. These companies include:

• Semiconductors: The designers and manufacturers of the specialized chips that are the “brains” of AI systems.
• Cloud Computing: The providers of the massive data centers and computing power that companies rent to train and run their AI models.
• Specialized Software: The companies that create the platforms and tools for developing and deploying AI.

Even the most promising technology comes with risks, and AI is no exception. A prudent investor must weigh the potential against the pitfalls.

The excitement around AI has pushed the Valuation of many related stocks into the stratosphere. Remember the dot-com bubble: a revolutionary technology doesn't guarantee a good investment return if you overpay for it. No matter how compelling the story, the price you pay determines your return. Always insist on a Margin of Safety.

The race for AI dominance is intense and expensive. Today's leader could be tomorrow's laggard as technology evolves at a breathtaking pace. Look for companies whose competitive advantages are resilient and not based solely on a temporary technological edge.

Governments worldwide are beginning to grapple with the implications of AI. Future regulations concerning data privacy, algorithmic bias, and job displacement could create significant headwinds for certain companies. These potential risks should be factored into your analysis of a business's long-term sustainability.