Investing in the AI theme for the long haul. How to pick the winners

Artificial intelligence has shaken up the investing landscape since the groundbreaking launch of ChatGPT in November 2022.

Since then, investors have poured money into all things related to AI as they hunt for the next big winners. In 2023, a group of major technology players dubbed the Magnificent Seven — Tesla, Amazon, Meta Platforms, Apple, Microsoft, Alphabet and Nvidia — contributed to a large chunk of the market’s rally.

Those tail winds continued into 2024, but even the winners eventually reach their limit. Indeed, some of this year’s highest fliers came down to earth on Friday, with Big Tech names dragging down the Nasdaq Composite by more than 2%.

“You have to do your work,” said Jay Woods, chief global strategist at Freedom Capital Markets. “You want to do the research, you want to know what you’re buying, you want to know the risks involved. In AI right now, there are a lot of unknowns.”

AI is poised to be a central theme as the technology transitions from early-stage winners to second-stage adopters. Portfolio and wealth managers say investors may want to undertake certain strategies if they’re looking for long-term plays in the space.

What to look for

There’s no secret formula to investing and picking artificial intelligence stocks, but investors can keep an eye on certain metrics and trends when weeding out the winners from the duds.

When investing in any new industry, Carol Schleif, chief investment officer at BMO Family Office, recommends that investors keep an eye on companies’ cash burn and how they are spending their money. Be attentive to the fine details, including how a company works through a backlog and how much money it devotes toward infrastructure.

When it comes to chip stocks, Schleif also recommends taking a look at government grants. The industry won big in 2022 when President Joe Biden signed the CHIPS Act into law. The measure allocated funds toward building out semiconductor production on U.S. soil.

Samsung Electronics is in line to receive funding from CHIPS for making semiconductors in Texas, while Intel has been awarded up to $8.5 billion from the measure.

“Focus on the underlying fundamentals, and are they moving in the right direction, [rather] than just last quarter’s earnings,” Schleif advised.

Investors should also avoid blindly chasing the hot winners that have benefited from AI enthusiasm. For Laffer Tengler Investments CEO and CIO Nancy Tengler, that means looking at some of the old-economy stocks embracing the new digital wave. She likes Microsoft and IBM, a pair of tech industry veterans.

When building any portfolio, financial advisors and portfolio managers stress the importance of diversification — and the same applies to AI.

An exchange-traded fund might be a good way to get that diversified exposure to a basket of stocks that could benefit from the AI theme, rather than sticking with one or two promising names.

Consider diversifying through ETFs

Selecting ETFs that incorporate dozens of names can be a lower-risk way to diversify, said Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland.

She highlighted the Global X Robotics and Artificial Intelligence ETF (BOTZ), the First Trust Nasdaq AI and Robotics ETF (ROBT) and the Global X Artificial Intelligence & Technology ETF (AIQ).

“That’s one way to get some exposure without putting the proverbial all the eggs in that one basket,” said BMO’s Schleif. “You want to be able to focus on a few different avenues such that you can withstand the volatility.”

Volatility can be a bitter pill, particularly for newer investors. Stocks tend to rise at first when a new theme hits the mainstream, but often suffer at some point from volatility and pullbacks, said Helen Dietz, a CFP and managing director at Aspiriant.

“The newer the trend, the more volatile the trend,” she said. “The corrections of those individual stocks, or those sectors, can be quite violent at times, which is not unusual, and the investing public gets scared out of that.”

To that effect, Nvidia’s shares suffered a setback on Friday when they tumbled 10% and posted their worst day since March 2020. The decline put a sizable dent into the chip stock’s year-to-date gains, but it remains up nearly 54% in 2024. Fellow AI play Super Micro Computer also took a nosedive that day, dropping 23%.

ETFs typically include a range of names and can vary in weighting. Though the BOTZ ETF and the Roundhill Generative AI and Technology ETF (CHAT), both currently lag some of this year’s popular AI winners. However, the underlying names are varied: BOTZ holds Nvidia and robotics play Intuitive Surgical, while CHAT’s top holdings include Microsoft, Meta and ServiceNow.

Schleif recommends looking for ETFs with high trading volume and backed by reputable companies. Investors should also be mindful of fees, which can take a bite out of returns if they are too high.

While the gains may fall short of the surge seen in stocks such as Nvidia and Meta, ETFs allow investors to obtain lower-risk exposure to the sector, Woods said. Longer term, investors can also use the leadership in these funds to consider picking out individual names further down the road.

“The old cliché is timing the market and then hoping you find that individual stock that can really be the big performer,” Woods said. “If you want to be involved, you want to be diversified and I think an ETF is the best way to do that.”