Cathie Wood and her team at Ark Invest see advancements in artificial intelligence (AI) propelling a $14 trillion industry in enterprise software by 2030. AI has the potential to improve productivity across just about every industry and profession. And that's led Wood to revisit some of the biggest companies in AI for her Ark Next Generation Internet ETF (ARKW 0.45%).
The actively managed ETF added shares of Microsoft (MSFT 1.82%) and Meta Platforms (META 0.43%) for the first time since March and July, respectively. Microsoft now accounts for about 1% and Meta about 1.1% of the fund's portfolio.
The addition of both of these "Magnificent Seven" companies is interesting for Wood and her team because Ark typically rebalances positions when a stock outperforms or underperforms. However, both Microsoft and Meta have performed in line with the Ark Next Generation Internet ETF since they were last added to the portfolio.
Here's why Wood and her team are buying shares of the two AI giants, as well as why you might consider adding them to your holdings.
Image source: Getty Images.
Microsoft is emerging as a complete AI company
Satya Nadella has truly transformed Microsoft into an AI company in just one year.
After increasing the company's stake in OpenAI, Microsoft positioned itself as the leading cloud provider for artificial intelligence developers. That's seen in the strength of its Azure revenue growth relative to its biggest competitors, Amazon and Alphabet's Google.
Azure revenue grew 29% year over year in the most recent quarter, with management pointing to AI as the big contributor to the growth. By comparison, the larger Amazon grew its Amazon Web Services revenue just 12% year over year last quarter, and Google Cloud revenue improved 22%.
What's more, Microsoft is in a prime position to capitalize on the $14 trillion opportunity in AI-powered enterprise software Wood and the team at Ark Invest see materializing through the end of the decade. It already has a massive enterprise software business, and it's getting bigger. Office Commercial products sales increased 15% last quarter.
Now, Microsoft is pushing its Copilot service to provide generative AI solutions in all sorts of verticals, from clinicians filling out patient notes to sales teams managing their customer relationships. It eventually sees just about every knowledge worker using its Copilot software.
In the meantime, the company is a cash-generating machine. It produced $30.6 billion in cash from operations last quarter, and it's now sitting on $144 billion worth of cash. That's a lot of money available to invest in advancing its AI capabilities.
The stock trades for 33x analysts' 2024 earnings expectations. While that's a bit pricey, Microsoft deserves the premium, considering its net cash position and its strong growth potential fueled by AI.
Meta's massive AI advancements are finally starting to pay off
Meta has been investing heavily in artificial intelligence for over a decade. Machine learning algorithms have been behind its feed rankings for Facebook and Instagram since moving away from chronological timelines. They recently got a boost with the release of Reels, which rely heavily on recommended content instead of content from personal connections.
More recently, however, Meta made major advancements in generative AI. It released its Llama 2 large language model over the summer, making it open source for developers. That's allowed independent engineers to take what Meta's built and make further advancements in performance.
To its credit, the Llama 2 model performs extremely well. It's even outperformed OpenAI's GPT-4 on some benchmarks. But what makes it stand out above the competition is that it's very efficient.
In other words, it's a lot less expensive to train the model and run applications using Llama 2 than the competition. That can mean a world of difference for businesses looking to use an AI model for a large user base, and they'll likely pay Meta for the benefit of using its efficient model. (While Llama 2 is open source, businesses with big user bases must pay to license it commercially.)
Meta isn't just developing Llama with the hopes large developers will pay to use it. It's its own biggest customer.
It released several new AI features for users in September at its Meta Connect conference. The highlight was its new set of chatbots, which have their own personalities and celebrity likenesses. It's working to release a studio for businesses to develop their own generative AI-powered chatbots for customers, boosting the use of its business messaging features and click-to-message advertisements.
Meta also uses generative AI to help marketers create new advertisements. It can change colors, images, and ad copy, generating dozens of variations for a single advertisement, and can then quickly test each variation on Facebook and Instagram and determine which works best. That can boost ad performance, making Meta ads worth a lot more for marketers than competing platforms.
Meta is one of the least expensive stocks of the Magnificent Seven stocks despite its strong price performance in 2023. The stock trades for less than 20x analysts' consensus 2024 earnings. Considering it's sitting on some of the most advanced AI, it's a surprise Wood and her team at Ark Invest aren't buying even more at this price.
