Redefining AI investment: Why value investing trumps ‘Picks and Shovels’ – Sean Peche
*This content is supplied by Sean Peche, Portfolio Manager at Ranmore Fund Management Ltd
First appeared on LinkedIn
Sean Peche challenges the common notion of investing in "picks and shovels" of AI, advocating for a value investing approach to capitalise on the actual beneficiaries of artificial intelligence. Peche argues that rather than investing in companies like Nvidia or Microsoft, which provide AI infrastructure, investors should focus on businesses directly benefiting from AI's transformative power. Drawing from a Salesforce Survey and examples like food retailers and banks, Peche highlights how AI can significantly impact revenue growth and cost reduction for companies with low profit margins. With insights into evolving market trends and considerations for investors, Peche offers a fresh perspective on navigating the AI landscape for optimal returns.
At Ranmore, value investing is the best way to "play AI".
The common thinking is the Mark Twain argument: "In a gold rush, it's a good time to be in the picks and shovels business".
And since Nvidia's chips and Microsoft's OpenAI are deemed the AI "picks and shovels", that's how investors are getting exposure.
BUT we think this only holds if:
a) you're unsure who'd find "gold."
b) you pay a fair price for a "pick and shoveller."
If you knew who'd find gold, wouldn't you rather own THAT business?
So, who is finding "AI gold"?
According to a Salesforce Survey in 2023, "82% of business leaders say generative AI will lower overall business cost, and 80% say generative AI will increase revenue."
i.e. most companies.
If AI can help cut costs, the beneficiaries could be companies with low profit margins.
Think about it – if operating margins are only 2%, then costs are 98% of sales.
That's a lot for AI to work with – cutting costs by 1% of sales could increase earnings by 50% in this example.
Except most quality/growth portfolios don't own businesses with 2% operating margins…
Take the food retailers, for example.
Those with loyalty card programs have vast amounts of data -that's "AI gold".
They know:
- what we buy
- when we buy
- where we buy
- how much we pay
They know how our buying patterns change over the month, our response to promotions, and even the weather at purchase.
AI is helping them drive revenue growth with personalised promotions and dynamic pricing.
This improves their demand forecasts, lowering wastage and logistics costs.
Better inventory control improves cash flow.
Now consider banks that many quality and growth investors also shun.
In contrast to Amazon, which only knows our discretionary spend on Amazon.
But banks know our income AND every $ of our spend.
On EVERY "platform" – Real "AI gold".
So banks are using AI to:
- more accurately price additional credit – increases revenue
- improve customer service via Chatbots and improve real-time fraud detection – lower costs
Maybe the market is waking up to this because Kroger's share price is up 25% this year, beating Amazon's +19%.
The MSCI World Banks Index is up 13% this year, beating Microsoft +12%.
Meanwhile, Apple and Tesla are down 11% and 30%, respectively.
Remember that Nvidia's largest customers are the large tech companies.
So Nvidia's revenue is THEIR capital expenditure…
Last quarter, MSFT's capex rose 58% y/y, and Alphabet's rose 45%.
So, if you think Nvidia's revenue will still explode, you better start worrying about their customers' "free" cash flow.
Disclaimer:
- Ranmore Fund Management Ltd is authorised and regulated by the UK's Financial Conduct Authority.
- The content of this marketing material is provided for information purposes only. It does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe or purchase shares, units or other interests in investments.
- Past performance does not predict future returns.
- Ranmore Global Equity Fund holds some select banks and food retailers, including Kroger. And none of the Magnificent '7'.
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