When artificial intelligence creeps into television shows such as Westworld and Black Mirror and drives the decision about who gets drafted, you know it has hit the mainstream. Often, investors gravitate toward the Faang stocks to capitalize on AI, but Baron Growth Fund(BGRFX) assistant portfolio manager Neal Rosenberg suggests three other ways to ride AI's growth.
In a note to clients, Rosenberg cites Gartner’s forecast for AI-derived business value to hit $3.9 trillion by 2022—representing an annualized growth rate of 40% to show the opportunity for investors. But instead of owning Facebook (FB), Amazon.com (AMZN), Apple (AAPL), Netflix (NFLX) or Google parent Alphabet (GOOGL) to capitalize on the trend, he looks to software companies that have “tremendous expertise in their specific industry, understand their customers’ businesses, and provide highly tailored solutions.”
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Part of the attraction is that these companies sell their products through subscriptions, which provides annual recurring revenue that investors tend to favor. Their products are also often deeply embedded in customer workflows, making it harder to switch to someone else, and giving companies some pricing power. "These businesses are highly profitable at scale, with margins frequently exceeding 30%. With little capital expenditure needed, such companies create a virtuous cycle in which they can grow, generate cash, and reinvest back into their businesses," Rosenberg writes. "Amidst the backdrop of AI’s remarkable runway, these characteristics give rise to compelling investment opportunities."
Three stocks Rosenberg says fit that criteria:
* Aspen Technology (AZPN) provides automation technologies for process industries globally, including engineering and construction companies and petroleum and chemical companies. Its software is intended to help customers decrease costs, improve productivity and boost revenue. Rosenberg writes that Aspen's customers report savings of $100 for each $1 they spend with Aspen, which suggests Aspen has "durable" partnerships with its clients.
* Guidewire Software (GWRE) focuses on the property & casualty insurance industry, offering software that handles underwriting, claims and billing processes, as well as managing insurance data. Guidewire uses data customers share anonymously to create AI-enhanced analytics and applications, which makes its solutions that much more attractive to clients, Rosenberg writes. "The nature of vertical software tends to result in the market leader ultimately earning 30% to 70% market share, which enables leaders to harvest a huge amount of customer data to further improve their offerings," he adds.
* Veeva Systems (VEEV) focuses on the life-sciences industry, where it has a 70% market share of the industry's customer-relationship-management market after just a decade since the company's inception, according to Rosenberg. The company uses its dominance to get unique insights into customers, identifying strengths and weaknesses, and feeding that into AI-enabled predictive and prescriptive analytics, he adds.
