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Summary
This blog explores how AI is driving exceptional earnings growth across markets, with benefits extending well beyond technology companies. However, investors are becoming increasingly selective, rewarding businesses seen as AI winners while penalising those perceived to be at risk from disruption. The result is a widening gap between winners and losers, making diversification and risk management more important than ever.
I don’t know how to put this, but AI is kind of a big deal
Reviewing the figures from latest quarterly earnings season have once again been eye-opening. Maybe eye-watering is a better adjective: FactSet reports that the MSCI North America had 45 percent year on year net income growth. Really that level of growth has only tended to occur in recovery periods, like after the global financial crisis (GFC) or in the Covid re-opening boom, not generally as a result of some new booming business line – and the growth hasn’t just been financial engineering, revenue growth has been tracking in at 15 percent year on year, with broad contribution across sectors.
Boy, that escalated quickly
We know the culprit this time: if you were in any doubt that it was going to be impactful, once again we see the result of AI demand on corporate earnings. The ‘obvious’ winners like Microsoft (sales +18 percent year on year, earnings +30 percent year on year) continued to do their thing, but we also saw a broadening out into other AI beneficiaries. Sandisk, a manufacturer of solid-state disk drives has just experienced a 700 percent quarter on quarter revenue increase, as people started realising they would need to save down the results of their AI work somewhere.
While there has been chatter from other companies too, this quarter was one in which we really could see the impacts of AI in those places you might not expect. Caterpillar, famous for its bright yellow diggers, reported a >70 percent year on year adjusted profit per share growth – driven by? You guessed it! Data centre demand for their power and construction solutions. And even though there are relatively few directly-AI-related European companies, it’s also been a good time on the Continent.
60 percent of the time, it works all the time
The thing is, even though the market is getting some really astronomical earnings reports, that’s sometimes just not been enough. Consider this: Alphabet reported a 213 percent earnings surprise and yet the share price went down 7 percent. Intuit, an accounting/business software developer (and formerly a market darling) has not reported for this quarter yet but has generated a median year on year growth of 61 percent in the last four quarters, with expectations that the coming two quarters will experience 100 percent earnings per share (EPS) growth. Meanwhile, its stock price is down around 50 percent year to date!
What this is really saying is that the market is very discerning about what it wants to reward. Alphabet’s issue was to do with very high AI-related capital expenditure plans, while in Intuit the market has lowered the valuation multiple it is willing to pay for earnings in a company it thinks has the possibility to be fatally disrupted by AI-generated replacements.
People know AI. It’s very important
These examples reflect that the AI theme can affect a huge range of companies, and with such significance that it can be difficult to manage through. One comment from a manager at JP Morgan reflected the Intuit example, highlighting the market has almost discounted stocks where the range of outcomes gets too wide – and that hopefully when that range narrows, that more traditional valuation discipline will be reasserted.
We have also highlighted in this blog the market impact of the AI theme, and the stock-level concentration that is occurring in many regions. As a way to try and manage this, managers are looking to incorporate AI as an explicit risk factor to be managed within portfolios – a global manager had produced a breakdown of their stocks into AI winners (broken down by subsectors like ‘power’ and ‘compute’) as well as AI losers.
Stay classy, investors
If this earnings season has reinforced anything, it is that AI is increasing both the opportunity set and the uncertainty facing investors. The potential rewards are enormous, but so too is the dispersion between winners and losers. In that environment, investing becomes less about accurately predicting the future and more about managing a wide range of possible futures. As portfolio managers, our job is not to identify the one company that will dominate the AI age. It is to build portfolios that can benefit if today's winners keep winning, while remaining resilient if the next phase of the story turns out to look very different from the last.
Key takeaways
- AI is boosting earnings growth across a growing range of sectors, not just big tech.
- Strong results don't guarantee share price gains, as investors are increasingly focused on how companies will be affected by AI.
- Managing risk matters as much as spotting opportunities, with the gap between AI winners and losers continuing to widen.
Sacha Chorley
Portfolio ManagerSacha is a portfolio manager of the Quilter Investors Cirilium and Creation Portfolios. Prior to joining Quilter Investors in 2011, Sacha worked at Broadstone with their team of economists before moving into asset allocation and fund manager research.
Sacha is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. Sacha has a degree in Maths from the University of Bath.
