With artificial intelligence playing an increasing role in many businesses, Morningstar Inc. has laid out opportunities and risks for allocators who want exposure to AI stocks.
“Artificial intelligence, or AI, has become far more sophisticated in recent years, creating both disruption and opportunity,” stated Morningstar’s 2024 wealth outlook report. “It brings risk, but there will be winners. We seek to support investors in their understanding of this space.”
According to Morningstar data, AI semiconductor companies generated $47 billion in revenue, and AI software companies generated $68 billion in revenue in 2023. Morningstar expects these numbers to grow to $143 billion and $137 billion, respectively, by 2027.
AI Ideas for 2024
According to Morningstar, there is opportunity in the “next rung” of AI adopters, even without focusing on the big AI players. The report recommended investors avoid high valuations, which are common for many of the top tech and AI companies at the moment. Instead, Morningstar pointed to smaller firms that can strengthen their products with AI and do not have such valuation risk. “As competition rises, we could see disappointments,” Morningstar analysts wrote, noting that overvalued AI stocks may not perform as well as up and coming competitors.
According to the report, the 10 tech and AI stocks most commonly held in big-data exchange-traded funds and mutual funds globally are the so-called Magnificent Seven stocks, plus a few more:
- Nvidia Corp.;
- Microsoft Corp.;
- Alphabet Inc.;
- Amazon.com Inc.;
- Advanced Micro Devices Inc.;
- Tesla Inc.;
- ServiceNow Inc.;
- Meta Platforms Inc.;
- Taiwan Semiconductor Manufacturing Co.; and
- Snowflake Inc.
Risks in AI
Morningstar’s report also listed several potential risks when investing in AI.
Regulation and Safety – AI companies are under scrutiny from governments and regulators around the world. These regulators have concerns about data, privacy and copyright issues. Regulations will likely be regional, and big policy changes are likely to be implemented in 2025.
Valuation – “Even fast-growing businesses can be poor investments if investors overpay for shares,” Morningstar’s analysts wrote. “It’s also important to keep in mind that the largest portion of a growth company’s value is derived from cash flows generated many years in the future. Companies that develop durable competitive advantages are more likely to sustain long-term free cash flow growth and could warrant richer valuations. …. A lot has to go right for the primary AI stocks to continue to deliver, which could happen, but the risk-to-reward can deteriorate if investors overpay.”
Concentration – Investors should acknowledge the uncertainty AI brings when considering position sizes.
Obsolescence – Some companies’ products and services could become obsolete or less relevant because of AI. Some AI companies could fall behind, as not every firm has the resources to build large foundation models, as OpenAI and others are doing.
Related Stories:
Will AI Compromise Security for Institutional Investors?
Asset Managers Ponder Investments in AI as Security Risks Compound
How Asset Managers Can Harness AI to Boost Profits, per EY
Tags: AI, Artificial Intelligence, Morningstar