Key Takeaways
The AI opportunity is broadening beyond providers to adopters, creating potential opportunities among companies using AI to improve productivity and profitability.
Small- and mid-cap companies may see outsized benefits from AI adoption, as efficiency gains can have a meaningful impact on margins and earnings.
A broader AI opportunity set may increase the importance of active stock selection, as company-specific outcomes become more differentiated.
While every technological revolution evolves differently, the pattern of value creation often starts with
infrastructure providers and eventually migrates towards the end users of that technology over time. We
believe this trend we’ve seen with electricity, personal computers, the internet, and cloud computing
among others, will continue with the buildout and adoption of Artificial Intelligence (AI). Since the launch
of ChatGPT in November 2022, the first wave of AI winners has clearly been the chip manufacturers like
NVIDIA that provide the advanced GPUs powering AI models from OpenAI, Anthropic, Microsoft, Google,
X, etc. As data center demand has skyrocketed over the last few years, the suppliers and infrastructure
companies that provide semiconductors, semi-cap equipment, memory, networking, and energy to the
data centers have benefited from massive contracts and longer visibility into their bookings. This can be
seen in the investment returns of the Magnificent 7 (mostly hyper-scalers) since November 2022, and
more recently in the Russell 2500 Technology sector (which includes many AI/Data Center Infrastructure
beneficiaries) in 2026:
Source: Bloomberg, LSEG Russell
While the current cycle of data center investment could last several more years, we believe we're
approaching an inflection point where future opportunity (and investment gains) are shifting from
the providers of AI to the adopters of AI. The next cycle of winners of the AI wave should be enterprises
that adopt these growing AI capabilities to run their businesses more efficiently, through a reduction in
administrative costs, more efficient forecasting, supply chain optimization, etc. We believe companies in
most sectors will eventually benefit in some way from AI, but the highest concentration of AI adoption
beneficiaries will likely be Industrials & Manufacturing, Financial Services & Insurance, Healthcare
providers, Logistics & Transportation and Retail. We're not the only ones who feel this way, as Jeff Bezos
has reportedly raised a $100 bn fund to acquire industrial companies to adopt AI for automation. The
earnings benefit to AI adopters has just begun, giving investors an opportunity to place their bets early and
participate in the value creation from the world's latest technology wave:
below), will eventually expand to include a broader universe of companies, including industrials, health
care, consumer discretionary, etc.
reduction in administrative cost and time, supply chain optimization, more accurate pricing and forecasting,
improved customer acquisition and client service, accelerated decision making, and better asset utilization
and predictive maintenance. From a market cap perspective, it is well known that the drivers of the U.S. equity market over the last 10 years have been large cap growth companies (FAANG, now Mag 7) that have benefited greatly from the proliferation and advances of technology and are investing heavily into AI. Going forward, we believe the U.S. small and mid cap part of the U.S. equity market will disproportionately benefit from the adoption of AI to make their businesses more efficient.
One argument for investing in the U.S. small- and mid-cap universe to capitalize on AI adoption is to contrast
it with investing in today's AI winners. Continuing to invest in AI providers and infrastructure companies
effectively represents a relatively concentrated bet that the substantial capital spending programs of a
handful of large technology companies will continue to support the current investment cycle. By contrast,
investing in AI adopters allows investors to evaluate thousands of companies' efforts to deploy AI and identify
the businesses best positioned to improve operating performance and shareholder value. While enthusiasm
for the AI data center infrastructure buildout remains widespread, investors have increasingly begun to
question some of the financing arrangements and interdependencies emerging among NVIDIA and the hyperscalers supporting these projects. We believe the next phase of the AI investment cycle is likely to involve a
much broader set of participants, with significantly greater dispersion in company-specific outcomes,
creating a larger opportunity set for active stock selection.
Another argument for investing in U.S. small & mid caps for AI adoption winners is seen by comparing the
efficiencies that AI can drive across the market cap spectrum. While larger companies may realize greater
absolute dollar savings from AI initiatives, smaller companies may experience greater percentage
improvements in profitability due to their higher operating cost structures. The median Russell 2500 company
has 29.8% SG&A expenses vs. 10.2% for the median Magnificent 7 company: a 5% reduction in SG&A would
drive a larger earnings improvement for small/mid caps:
philosophy: one of CRM's strengths is our history and focus in the U.S. small- and mid-cap space, where
pattern recognition is a key tool to investing behind positive change that is underappreciated by others. While
the AI wave is clearly a new phenomenon, we have invested through many previous technology cycles (from
the personal computer revolution, to the dawn of the internet, to the proliferation of cloud computing) and
have studied the impact these technologies have on future business prospects. Put simply, we have seen
repeatedly how new technology aects companies both within and outside of the technology space. At this
point in the cycle, our history and experience tell us that investor neglect surrounding the prospects of AI
providers has largely faded, while significant neglect and opportunity remain among companies that stand to
benefit from AI adoption.
As we have seen over our 50+ years of investing in the U.S. small & mid cap space, new technology waves like AI can present a lot of change along with a lot of disruption. We believe AI has the potential to become another transformational technology cycle that creates substantial opportunities for active investors. Within CRM's portfolios, we have already begun to invest in numerous examples of AI adopters that we believe will benefit from the enhancements AI will provide to their business planning and operations: