Peter Hodson: The robots aren’t ready to take over yet
Screens displaying the logos of OpenAI and ChatGPT. Photo by Lionel Bonaventure/AFP via Getty Images Let’s call this Artificial Intelligence Week since three giant companies all had significant news on the so-called next big thing.
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Access articles from across Canada with one account Share your thoughts and join the conversation in the comments Enjoy additional articles per month Get email updates from your favourite authors Microsoft Corp., which has invested billions in OpenAI LLC, has now added that company’s ChatGPT to its Bing search service. Alphabet Inc., after having multiple all-hands-on deck meetings to analyze the threat of Microsoft moving first into the area, announced BARD AI, its answer to ChatGPT, though it’s just in test mode for now. And Chinese company Baidu Inc. announced its Ernie bot.
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Artificial intelligence has been a theme for some time, but it now looks like it is going more mainstream. In honour of this, we are going to let the robots write this column — just kidding, sort of. We decided to ask ChatGPT about red flags when looking at stock investments. In keeping with our theme, we asked for five red flags. The robot’s responses are highlighted below, and we will provide our commentary and grade its performance. Hopefully, we won’t be putting ourselves out of a job here.
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Question: So, ChatGPT (Mr. ChatGPT? Ms.?), please give us five red flags when analyzing an equity investment.
High debt: High levels of debt can increase a company’s financial risk and reduce its ability to generate profits.
The bot nailed this one. High debt can absolutely destroy a company at times, and you need to know the debt risk if you are buying an investment. The debt-maturity schedule is also important. Having large debt maturities during a weak period in capital markets can be very hazardous to a company’s health. We will give the robot an A+ on this answer. We consider balance-sheet strength one of the most important factors when analyzing an investment.
Declining revenues: Consistent declines in a company’s revenue can indicate a weakening business and potentially lower future earnings.
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Another win for the robot. As growth investors, we will hardly even look at a company whose revenue is in decline. If a company cannot grow its sales, it may have a very hard time growing its profits. In a high-inflation environment like today, a company with declining sales is even more of a red flag, since sales should be growing by at least seven per cent or so simply to match inflation. If not, the company is moving backwards.
Now, the AI bot didn’t discuss valuations here. A company with weak sales can sometimes still be an interesting investment if it is priced right — that is, a bargain-basement valuation. We will dock the robot for not mentioning valuation, but it still gets an A on this answer.
Negative earnings: Negative earnings can indicate that a company is struggling to generate profits and may be at risk of financial trouble.
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This AI answer is OK, but it hardly provides much information. Many growing companies can be great investments without being profitable. Often, good companies will sacrifice profitability until they can gain enough market share. Many of today’s best companies spent years losing money before seeing huge success. Some context is needed here. We would never simply ignore a company just because it was unprofitable. This answer only gets a C-.
Weak competitor performance: If a company’s competitors are underperforming, it can be a red flag for the industry as a whole and the company’s future performance.
ChatGPT improved a bit with this answer. Studies have shown that sector allocation is more important to investment performance than stock selection. If you are thinking of investing in a company, you need to check to see how the industry is doing first. It is very hard for companies to swim against the tide of an industry that is struggling.
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This answer is solid, but leaves out an important fact: at times, a company can indeed do better than its industry. It may have a better product, service, cost structure or something else that sets it apart. The stock of a company that is massively outperforming its peers can be a huge winner, as its valuation may be very low since the industry is struggling.
The combination of an outlier winner and a low valuation can be very profitable for stock investors if they can find such a company. Still, we would never buy a stock without checking on the company’s industry and competitors, so the robot gets a B+ here.
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Article content Poor management: A lack of strong and effective leadership can lead to poor decision-making and negatively impact a company’s performance. This can be evidenced by issues such as high turnover rates or a history of questionable business practices.
This is a decent enough answer from ChatGPT, but is pretty subjective. We don’t think any executive deliberately tries to make poor business decisions, but it happens. It can be a red flag, but it can also lead to false signals. For example, as we learned above, a poorly managed company’s stock can surge if it is in the right sector or captures investors’ imaginations (such as when there is a sector bubble). It is easy to advise investors to avoid bad management, but the reality is far more nuanced.
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Article content Also, many investors will see a stock decline and simply assume the company is mismanaged. This is not always the case. As we saw last year, great companies can still see their stocks decline, sometimes a lot, under certain market/economic conditions. ChatGPT only gets a C for this answer.
Overall, not a bad showing. We don’t think the robots are ready to take over yet. But AI can certainly be a useful tool when investigating topics and analyzing trends. Another useful arrow in the quiver for investors.
Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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