AI, robotics and industrial software are rapidly approaching a tipping point that could correspond with the greatest level of stock outperformance. How investors can position for a Second Machine Age.
- Technology investment is now transitioning from the consumer world to the enterprise world as traditional technology and software companies focus on industrial opportunities.
- This “Second Machine Age” centers around six developing technologies: Artificial Intelligence Software, Autonomous Vehicles, IoT Hardware, Industrial Software, Robotics and Semiconductors.
- These technologies combined could see annual growth of 17%, growing from $738bn in 2018 to $2.2trn by 2025, with the highest growth coming from AI Software (42%), Autonomous Vehicles (40%), and IoT Hardware (21%).
Many of the biggest ideas in technology over the past decade have centered on how people communicate, consume, transact and travel. Over the next decade, however, the most profound innovations—and investment opportunities—could be on factory floors, in operating rooms, at mining sites and energy facilities.
This is not a vague concept that may happen one day in a hypothetical world. It is very much here and now.
The world's economy is in the early stages of a Second Machine Age—sometimes called a “Fourth Industrial Revolution”—an explosion of new digital technology poised to transform manufacturing and industry as dramatically as the steam engine or telegraph.
“The current pace of technological change is breathtaking," says Ben Uglow, Morgan Stanley's head of research for the Capital Goods Industry. “This is not a vague concept that may happen one day in a hypothetical world. It is very much here and now, as real dollars are being committed, with tangible benefits in efficiency and productivity."
In their newest report, Investing in the Second Machine Age—Picking the Winners, Uglow and his research colleagues take an in-depth look at the six most relevant technologies—artificial intelligence software, autonomous vehicles, Internet of Things (IoT) hardware, industrial software, robotics and semiconductors—and identify companies best positioned to capitalize on this theme.
Together, the market for these data-era technologies is poised for compound annual growth of 17%, growing from $738 billion in 2018 to $2.2 trillion by 2025. Within these technologies, the teams estimated the highest growth could come from AI software (42%), autonomous vehicles (40%), and IoT hardware (21%).
Total Addressable Market (TAM) forecast to grow at
17% annual growth with AI Software leading
|2018||2022||2025||Compound Annual Growth Rate|
|Artificial Intelligence Software||15||63||180||42.1%|
|Industrial Internet of Things (IoT)||159||359||627||21.7%|
The analysts see this as one of the most important investment themes of this decade, but a tricky one to navigate. The companies—like the technologies themselves—are still in the early innings. While that makes picking winners among AI companies or robotics companies more challenging, it suggests that the best returns could be ahead.
Morgan Stanley analysts compiled their first comprehensive report on the Second Machine Age in July, 2018. In it, they estimated that the trend would drive an additional $1.6 trillion in annual IT investment over the next decade—40% of that in manufacturing—and lead to productivity gains equal to 5% of global GDP.
Now, one year later, the pace of change has already surpassed their expectations. Industrial companies are investing more on digital-era technologies and making them a focal point of their growth strategy.
“We are surprised by the investment leadership from industrial companies, where investment and mergers and acquisitions focused on new technologies outpaces every other industry," says Katy Huberty, Morgan Stanley’s head of research for the technology hardware industry, noting that manufacturing companies have accounted for the fastest data growth over the past two years.
Top 5 projects with largest spend increase in Morgan Stanley CIO Survey
(% Total Responses)
Consider a few applications that have been put in place in just the past year: One major tech company used its machine-learning algorithm to increase wind energy output by 20%; an iron-ore mining operation cut costs and boosted productivity with autonomous trucks; an automaker began production in a fully digitalized factory that, among other advances, uses some 2,000 connected robots to install parts.
“Within the next decade, it is probable that the majority of industrial facilities will deploy some form of artificial intelligence," says Uglow. “Manufacturing is set to become highly customized, with a 'lot size of one' being the norm. Consumers will specify exactly what they want on virtually any product—cars, shoes, sports equipment, dental implants, and even body parts."
The rate of adoption is now escalating. “Penetration of 20% tends to be the level at which growth accelerates, investors take notice, and stock outperformance becomes meaningful, followed by more muted growth and impact after 50% penetration, when a technology enters maturity phase," says Huberty.
In fact, strong parallels exist between data-era industrial technologies and mobile internet stocks in 2010, following an initial phase of adoption. Between 2010 and the cycle's peak in November, 2017, mobile internet winners cumulatively returned 350% vs. 80% for the benchmark S&P 500.
Investment is in early innings:
Mobile Internet Winners and Machine Age Champions
To identify companies at the forefront of this transition, Morgan Stanley analysts canvassed global teams across multiple sectors to identify criteria for success across all six major technologies. The categories are disparate, but four themes for success are consistent: ability to use data, vision & culture, domain knowledge and access to capital.
To further distinguish standouts, the analysts identified a fifth factor specific to each sector. In autonomous vehicles, for example, they looked at partnerships; while a key factor in A.I. software is a capacity to “test, learn, fail" quickly—but ultimately succeed.
Based on these criteria, they identified 61 global companies that are leaders in their core categories. Many are household names that developed or deployed digital-era technology for consumer applications and are now applying it to the industrial space. Roughly a third, however, are emerging companies focused on specialized applications, such as machine vision, surveillance equipment and industrial computing.
Among that roster, they further culled the investment universe by identifying 19 “champions" that score particularly high and are differentiated by such factors as a specific technology or domain leadership. This group has outperformed the MSCI World index by 107% since 2014; but with opportunities from a new age of industry in front of them, they may have plenty of room to run.
For investors, some recurrent themes among the champions can serve as guideposts: The importance of “test, learn and fail” approach, Cloud augmented by Edge computing, owning a step change in a critical engineering technology, government and policy support, differentiated management vision, and companies with a breadth of offerings that put them in a league of their own.
Adds Uglow, “Investors may want to cast a wide net when positioning for the Second Machine Age. Companies that are poised to be champions are in the right place at the right time, but they also have differentiated internal knowledge and strength to fully commercialize the opportunities ahead.”