NOTW #4: Is Generative AI The Disruptive Force Many Believe It To Be?

Articles of the week, market commentary, and more

Hi reader,

The indices were flat this week, and I don’t have much to comment on their performance, but I thought it would be a good idea to discuss generative AI.

Before going with the market commentary, let me share the articles of the week.

Articles of the week

I published two articles this week. The first one was the third deep dive I have published to date, exclusive for subscribers. This company is down around 50% year to date (it’s typically volatile) but I believe the current weakness comes from short term temporary pressures (I discuss why in the deep dive).

Subscribers are currently voting to choose the next deep dive which will be uploaded in a couple of weeks. Feel free to subscribe if you’d like access to all the content:

The second article of the week was completely free. I aimed to answer the following question: “What is a high-quality company?”

I also shared a discussion with my good friend Drew Cohen from

Speedwell Research

where we have a discussion about this topic. You can watch it on YouTube or listen to it in Spotify:

If you enjoy the content of the podcast feel free to subscribe/follow the YouTube channel/podcast. The next episode has already been recorded and will be uploaded in two weeks.

Market Overview

The indices were pretty flat this week despite significant volatility:

I don’t have much to discuss regarding the market this week, but I thought it might be interesting to share my views regarding generative AI, which has been in the headlines for quite some time.

Many initially believed that generative AI would wreak havoc across the software industry. Several months into all the innovation, and we are still far away from these disruption fears bearing fruit. Granted, generative AI has made the incumbents react to a new stimulus that was absent before, and it’s still early to judge whether it will indeed be disruptive.

One of the things that I believe many people miss when discussing AI is distribution. In most cases, it’s not about the best model but about the model that adds the most value to the most people, and you need distribution to achieve this. With multibillion-dollar businesses having the money and the talent to pursue generative AI, it seems fairly evident that they will be able to compete in generative AI models with the “disruptors.” This seems especially true considering that the rhythm of innovation will most likely slow down eventually, giving incumbents time to keep up. What incumbents have that disruptors don’t is distribution and, importantly, the ability to embed generative AI into their workflows. The disruptors that are popping up might have an appealing offering for non-professionals who don’t care about workflows, but workflows are all enterprises and professionals care about and these tend to be the monetizable users.

I received the following comment on Twitter this week regarding this topic:

Openai will eventually make Photoshop obsolete. Adobe's lackluster quarterly forecast reinforced concerns about rising competition for the company's creative suite, including Photoshop. ADBE valuation is just insane. ADBE's price target $300.

Several things don’t seem right here; let’s look at them one by one…

• OpenAI will eventually make Photoshop obsolete: this is a fair concern, although I don’t believe this will happen. I do understand, though, why some people might believe it will. I have shared in several articles why I believe Adobe can win in AI, and it all comes back to workflows, where Adobe is the clear leader. Note that Adobe is already offering OpenAI’s Dall-E across its workflows, understanding that it’s not the generative AI model that brings the differentiation. Adobe covers the entire content supply chain thanks to the combination of its creative and experience clouds, and nobody comes close to this combination.

• Adobe's lackluster quarterly forecast reinforced concerns about rising competition for the company's creative suite, including Photoshop. This is simply not true, and it demonstrates the person who said it is trying to justify his theory using misleading information. Adobe was one of the few software companies that managed to beat and raise in the current environment. Management even claimed that generative AI is proving to be a tailwind (thus far).

• ADBE valuation is just insane. ADBE's price target $300. I will not comment too much here because this is obviously an arbitrary price target, and I don’t think the valuation is “insane.” The company was trading at a 3% SBC-adjusted FCF yield before earnings, which is not crazy for a company of this quality.

All in all, while I obviously can’t see the future, I think it’s pretty obvious that humans tend to exaggerate disruptive threats at the beginning when there’s little information to assess the threat. I am not saying that generative AI will not be a disruptive force in the future, but I am pretty sure it’s not the disruptive force many claim it is thus far. AI will most likely “change the world,” but this change will likely come slowly, and I wouldn’t be surprised if the incumbents come out on top of yet another “disruptive threat.”

Recall that many also claimed that the transition to the Cloud would substantially lessen the switching costs of software businesses. In the end, it proved to be a clear tailwind for such businesses. Maybe it’s more a case of many of the leading software companies not having any current replacements. If you want to create and distribute digital content at scale, maybe Adobe is the best option. I don’t think supply in software is as abundant as many people think it is.

The industry map was mixed again:

Source: Finviz

The fear and greed index improved slightly but remained in fear territory:

Source: CNN

This is all for this week,

Thank you for your trust in Best Anchor Stocks and have a great day,

Leandro