Canadian AI Sector: A Goldmine or a Minefield? What Investors Need to Know

Kinaxis Inc (TSX:KXS) is earning a goldmine worth of profits. But there’s a minefield in the AI space as well.

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The artificial intelligence (AI) sector is full of opportunity. As we saw with the rise of ChatGPT and the many AI stocks that rallied in its wake (Shopify, Microsoft, NVIDIA etc.), AI can lift stock prices. This year, interest rates increased and tech companies’ earnings barely grew. Despite these bearish developments, tech stocks nevertheless rallied. A likely culprit for this odd market performance is AI. The year’s tech momentum was driven by “AI winners” like NVIDIA and Microsoft, comparative AI laggards like Apple made smaller gains.

And what about the Canadian companies working on AI? Some of them are just as innovative as their U.S. peers, but none are quite as big as Microsoft yet. Nevertheless, their shares present an opportunity to investors – potentially, a real goldmine. Some AI investments, on the other hand, are more of a minefield. In this article, I will differentiate between the goldmine and the minefield in the modern AI sector.

The potential goldmine

The potential goldmine in AI exists in the companies that are building meaningfully new AI tools that go beyond the typical “GPT wrapper app.” Canada already has several such companies (Shopify is one), and this list will grow larger with time.

Consider Kinaxis Inc (TSX:KXS). This supply chain software company appears to be massively benefitting from AI right now. Over the last five years, the company grew its revenue by a 23% CAGR and EPS by a -4.5% CAGR. It was not a period of incredible growth, to put it mildly. But in its most recent quarter, KXS grew at the following rates:

  • Revenue: 21%.
  • Gross profit: 19%.
  • Net income: 354%.
  • Cash from operations: 59%.

The only thing that really happened between the previous period of negative earnings growth and current period of high earnings growth is the incorporation of new AI tools into Rapid Response. So there’s a case to be made that AI is the reason KXS is making more money now.

The actual minefield

The minefield that exists in AI is the hundreds of startups now being formed to develop AI, some with no clear plans to build actual companies. While some AI companies are impressive (OpenAI is a good example), the majority of them will likely turn out to be lemons. This happens whenever investors start throwing money at a tech trend indiscriminately. When investors spend money on things without researching them, it creates an incentive for people to posture at doing the ‘thing’ in question, in order to collect some of the money being thrown at it. Not everybody has the work ethic to make a billion founding the next OpenAI, but any educated San Franciscan can collect something like a million by claiming to be founding the next OpenAI, only to play Call of Duty once the money has come in. 2001 had its Pets dot com, 2021 had its bankrupt crypto exchanges, and 2023 will give rise to some losers as well. I don’t know which of today’s ‘unicorns‘ will turn out to be duds, but I can point to a few from the last big tech bubble:

  • FTX
  • Three Arrows Capital
  • Blockfi
  • Peloton
  • Zoom Communications

The first three companies on this list went bankrupt, the last two lost market cap. Enormous amounts of market cap: Peloton is down 96.5%. But it’s not quite broke.

The current AI spending frenzy is likely to result in some outcomes like those described above. It’s too early to say which AI companies will be duds for investors, but rest assured, there will be some. The incentive structure in the venture capital industry practically guarantees it. One Sequoia partner decided to give Sam Bankman-Fried his money because Fried dressed poorly and played videogames at a meeting! Silicon Valley’s obsession with “innovation” is so deeply ingrained that sometimes just looking like a stereotypical iconoclastic “tech bro” will land you a big payday.

The above may sound ridiculous, but it’s quite real. As this Harvard Business Review article illustrates, VCs do in fact blow large sums on mere ‘ideas.’ Stay safe, and you’ll avoid their clients’ fate.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has positions in Apple. The Motley Fool has positions in and recommends Shopify. The Motley Fool recommends Apple, Kinaxis, Microsoft, Nvidia, and Zoom Video Communications. The Motley Fool has a disclosure policy.

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