Artificial Intelligence & Internet of Things Stocks

Hello friends,

A very happy independence day to all of you. May the coming year bring you the financial independence too through windfall gains from the market.

Recently, Shital, our stocks group mate and a Sr. Manager at Axis bank, posted a list of a few companies dealing in the field of AI for investment consideration. I had briefly touched this under automation in the last blog on auto ancillaries. The field of data science involving Internet of things, artificial intelligence and machine learning is expanding at a rapid rate and sooner than later will cover almost all walks of our everyday lives. In fact, it is already all pervasive. I therefore thought it deserves a deeper look to identify and analyze the frontrunners in this field since the growth and in turn the money making opportunities in this field could be mind boggling. Thanks to Shital for being a trigger for this piece.

A little preliminary about AI, IoT and machine learning. The field of data science is an umbrella that covers all these fast emerging branches of computer science.

• Data science is a field that deals with data processing, analysis and extraction of insights from the data using various statistical methods and computer algorithms. It is a multidisciplinary field that combines mathematics, statistics, and computer science.
• Internet of things: (IoT) is a network of physical objects or people called “things” that are embedded with software, electronics, network, and sensors that allow these objects to collect and exchange data, analyze data and make decisions. Smart cities, driverless cars, google assistant, smart homes are some of the examples of IoT.
• Artificial intelligence simply put is machines, particularly computers programmed to perceive the environment and think and work like humans. Google remembers your browsing history and shows you ads about similar products, e-commerce sites like amazon and flipcart do the same. Siri voice assistant, Tesla cars, Netflix, Nest (intelligent thermostat to control temperatures, switch off lights to save energy), Pandora (intelligent music provider as per your tastes), Boxever (travel – suggests micro moments and new ways to make memorable journeys) are all AI applications. AI necessarily is one important component of the IoT.
• Machine Learning is a subset of artificial intelligence, which focuses on using statistical techniques to build intelligent computer systems in order to learn from databases available to it. Currently, machine learning has been used in multiple fields and industries like medical diagnosis, image processing, prediction, classification, bank software to spot unusual transactions, email filters and learning association etc.

With increasing smartphone penetration across geographies, AI & IoT have already become an integral part of our daily lives and it won’t be long till these penetrate and influence our entire living. There is a debate going on if this is good or bad for the mankind but it is likely to stay regardless. Should you wish to learn more about these sciences, visit the website Data-flair.

There are quite a few companies in India using one or more of these techniques increasingly these days. The sectors these companies are operating in are auto, finance, IT, Industry automation and so on. Currently there are a only a few companies using AI, IoT exclusively but many companies have some part played by AI & IoT in their operations. As it is likely to be an in-thing in the years to come, I will not be surprised to find companies that have nothing to do with AI but boasting of the same as happened during 2004 dot.com bubble. Even in this study, there is no clear data available as to how much of the revenue of the companies considered is coming from AI & IoT as the companies have different systems of segment reporting. But it is safe to assume that these companies, being the frontrunners, will embrace the technology more and more. The big ones, top ten IT companies, especially TCS & Wipro have quite a bit of AI, IoT, ML and data analytics in their products and platforms. But those are mainly application software companies and therefore not considered in the present analysis.

Currency factor: It can be seen from the data that most of the companies derive their revenues from services/products exported, major chunk to USA. These also include revenues earned by offshore subsidiaries. The earnings are usually in USDs but all the expenses are necessarily not in USDs. Inflation in the US briefly touched 5% in 1990 and thereafter it has always been lower. In the last ten years it remained range bound between 1-3%. In comparison, average inflation in India for the corresponding period was 6.4. So logically the greenback is likely to appreciate 4-5% every year against the rupee. It may be a little complex than that but inflation has a substantial effect on the exchange rate. So the IT industry has been riding this perennial tailwind.

The Pandemic affected lot many sectors very hard but the IT and pharma were the sectors that were actually benefited. The lockdowns helped reduce employee expenses, improve margins and attract more business as digital became a key word. Going forward, many companies might adopt the WFH model on a permanent basis, thus saving huge cost on infrastructure.

“Never invest in a business you cannot understand.”

Warren Buffett

Now do we understand the AI/IoT business or for that matter even the IT business? We know IT businesses are mostly services, they don’t need much capital, they are debt free, they generate lot of free cash, So book value & ROCE are not relevant here, they pay good dividends, they have US visa issues, they have a lot of employee attrition and they are great wealth creators. This much understanding should be good enough. As for the AI/IoT/ML & Data analytics, we do understand these terms as defined above and their practical applications. But, when I started collecting data and dug deeper in the web sites, annual reports and management analyses, I encountered the terms ditgital engineering, product engineering, cloud transformation, business process management and so on which are as much spanish to me as to many of you. However, without going deeper in to the technical aspects, common sense tells us that these things are likely to grow multifold and believing in the wisdom of Mr. Market, we will ask to be excused by Mr. Buffett this one time and get in to these stocks.

“If you’re considering a stock on the strength of some specific product that a company makes, the first thing to find out is: What effect will the success of the product have on the company’s bottom line?”

Peter Lynch

Another difficulty here. The companies report their revenues in industry segments like BFSI, Retail, healthcare, media etc. It is well nigh impossible to find out how much these specialized branches are contributing to the toplines and bottomlines. Most of the companies initially started as pure IT services companies and later diversified in the special branches. Out of 27 stocks analyzed here, only one (Mastek) reported 8% revenues attributed to AI & IoT out of total general IT business. We may have to as well ask Mr. Peter Lynch to excuse us here in absence of reliable data. So now let’s have a look at some of the stocks employing AI/IoT/ML/Data analytics. This data is from the company websites, annual reports and investor presentations. Financial data is from screener.in

The stocks highlighted in green are using this technology to the maximum extent and some of them are concentrating on just one industry viz. Oracle finance in financial services, Bosch & KPIT in automobiles, Subex in communications, Affle in mobile advertising etc. So these might have advantages in terms of market share. Unfortunately I couldn’t dig up details market share information.

Almost all the stocks had stellar runs post the Pandemic and are quoting near their lifetime high prices. It is probably a case of too much too soon. However a lot of investors now are sitting on overall comfortable gains which provides good comfort. The economy is expected to emerge out the pandemic blues and surge ahead. The overall market sentiment is now extremely positive. A few of the AI/IoT stocks have shown tremendous profit growth in the last few years and in particular in the last one year. The stocks are highlighted deep green and light green shades in terms of their financials and valuations. Deep greens denote very good financials with moderate valuations and light greens very good financials with stiffer valuations. KPIT demerged business in automobile sector has come into existence only in 2019 and therefore sufficient past data is not available. But this stock I believe is one of the best in view of the rapid developments in autonomous and electric cars.

It is often difficult to choose from a host of good available stocks. In such a situation, this Peter Lynch advice comes handy.

“The best way to handle a situation in which you love the company but not the current price is to make a small commitment and then increase it in the next sell-off.”

Peter Lynch

Happiest minds, Intellect design arena, Subex, R systems, Sasken & Cigniti Tech are picked up in both the business and financial evaluation (Considering valuations also which is valid only for the current time). I have attached here more importance to PEG for valuations rather than PE (Refresh your valuations concepts here should you need) because the PEs of many companies are distorted due to Pandemic induced business disruption this year. Oracle finserv, Tata Elxsi, Affle, KPIT, Mastek, Saksoft & Ksolves too are worth considering, especially the small ones (Mastek, Saksoft and Ksolve). Some of these are sure to turn multibaggers in the years to come.

I myself have Tata Elxsi, Persistent, Cyient, Sonata & Eclerx from the above list in my portfolio which have given me handsome gains in the last year & half. It may be worth to add a few more with moderate PEs and PEG values close to one or less.

Market update: As I write this, the Sensex has crossed 55000 levels and the BSE small-caps index is hovering just below 27000 after briefly crossing that level. These are all time high figures. There was a brief two days correction last week but the bulls regained the lost ground in no time. The pendulum has swung back from March-20 gloom as Mr. Market has a habit of overdoing both fear and greed. But has it swung back to the full or has still some distance to go? The questions doing the rounds are; Are we approaching a bubble situation?, Should we sell or at least book partial profits? Will the economic recovery play out as anticipated to justify the current valuations?. The answers are not easy to come. Selling now is as difficult as was buying in March-April 2020. Its like being caught between the Scylla and Charybdis though in hindsight these decisions may look straightforward. I myself lost some good profits in Tata Elxsi, Persistent & Sonata upon partial selling on high valuations and can’t stop fretting over it. I have pressed the pause button since. I intend to watch how things unfold over the next three quarters before undertaking any serious offloading unless the situations warrants otherwise.

Having said that, however, a safer approach is to take some money off the table. It might rob you of some future profits but a bird in hand is always better than two in the bush. General opinion is that though there is a lot of frothiness in the market, we are still a little distance away from the bubble but approaching that territory fast.

A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons.

Warren Buffett

We don’t want to learn those lessons the hard way. Do we?

The small-caps: There are thousands of companies listed under the small cap category. But only a few are likely to break the mould of a small-cap and upgrade to a midcap, or potentially even a largecap in the long term. These by nature are inherently risky but a few of them invariably have capability to turn multibaggers over the years. There are examples in this analysis itself. Tata Elxsi, Persistent & Coforge have multiplied their market cap four to six times in three years and are in midcaps zone now. Peter Lynch is a great advocate of small-caps. This is what he writes about them

“If you find a stock with little or no institutional ownership, you’ve found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you’ve got a double winner. When I talk to a company that tells me the last analyst showed up three years ago, I can hardly contain my enthusiasm. It frequently happens with banks, savings-and-loans, and insurance companies, since there are thousands of these and Wall Street only keeps up with fifty to one hundred.”

Peter Lynch

All successful companies initially started as small-caps and some of them went on to become very large companies rewarding the investors beyond their wildest dreams. There are examples galore, Infosys, HDFC, Asian paints, MRF being few names that spring to lips. Infosys rewarded their employees and investors equally well and they had crorepati tea boys serving tea still to young engineers much less wealthy than them. It becomes extremely important to hold on to winners like these for long periods of time, typically ten years or more to really gain through their journey. Cosmo films is one such stock at an infant stage of this journey. (You can read more about this stock here).

Often some stock goes without movement for years and then suddenly it erupts like a volcano. Its like a Chinese bamboo plant. Like any plant, the Chinese Bamboo tree requires nurturing, water, fertile soil & sunshine. In the first year, there are no visible signs of activity or development. In the second year, again, no growth above the soil. And the third and fourth, still no signs. Patience is tested and one begins to wonder if the efforts will ever be rewarded. Finally in the fifth year – voila! There is growth. And what growth it is. The Chinese bamboo tree grows 80 feet in just six weeks. So if the stock is fundamentally strong, there is wisdom in holding it for a long time.

Hope you like the discussion. Do revert with your comments, suggestions and queries.

Often the journey is more interesting than the destination

bhushan

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Happy investing

bhushan