How to invest in the rise of the machines

12 mins. to read
How to invest in the rise of the machines

As seen in the lastest issue of Master Investor Magazine. 

Seldom does a day go by without a new article in the media on robots, and in particular how they are going to steal our jobs. Some of these articles target a specific sector that will be disrupted by automation, such as driverless cars or robot factory workers. Pretty much all the articles adopt an alarmist tone, citing various studies that predict mass unemployment in the years ahead.

To add to the scaremongering, some highly respected figures from the scientific and business community, including Professor Stephen Hawking and Elon Musk have recently voiced their concerns about artificial intelligence being the greatest threat to humanity – far more sinister than robots just stealing our jobs.

How seriously should we heed the call of these warnings and is there anything we can or should do about them? Will they prove to be unwarranted, just like all the doomsday warnings about the millennium bug (AKA Y2K) at the turn of the century?

The threat of mass unemployment

A common argument against the threat of widespread unemployment due to robots and automation is that the process of displacing workers will take place over many years, buying us time to react and adapt before most humans lose their jobs. Another retort is that this era of automation will spawn new industries that we cannot even imagine today and that these new industries will create millions of human jobs to offset the ones lost to automation. For example, how many young students in the 1980s were advised to pursue careers in website development or search engine algorithms or even social media? There was no way of foreseeing these roles a decade before they emerged.

But even the most optimistic scenario concedes that many jobs, even those of skilled professionals, will eventually be automated and replaced by robots in a similar way to the many manual jobs that were displaced as a consequence of the industrial revolution some 250 years ago. In fact, James Watt’s steam engine and the subsequent industrial revolution was the single most significant event in human history in terms of its impact on the global population and social development. Nothing that occurred prior to this event comes anywhere close. This is because for the first time, it allowed humans to utilise mechanical power many times that of our own limited muscle strength, giving us an exponential rise in productivity.

Just as the industrial revolution replaced manual workers with more productive machines, today’s revolution is replacing human brains with computer programmes. Our limited brain power will slowly lose out to unlimited computer processing power. This will impact the global population and social development far more than the industrial revolution ever did. Its impact on jobs will be far-reaching, but will there be new human jobs available to replace those lost?

To answer this question, let’s take a look at two relatively new companies that have emerged over the past decade or so: Google and Facebook. Undeniably they have become global behemoths in the blink of an eye on a corporate timescale and they have indeed created new jobs that didn’t exist only a generation ago. But how many employees do these companies have? Google is reported to have a staff of around 60,000 and Facebook around 12,500. These are impressive numbers until you consider the market capitalisation of these companies – Google’s is $490 billion and Facebook’s is $300 billion (give or take market fluctuations). If we take the ratio of market capitalisation to headcount as a crude measure of productivity, we find that Google’s is approximately $8.2 million per employee and Facebook’s is $24 million per employee. For privately held companies such as Snapchat and Uber, this ratio is even higher.

When we calculate this ratio for more traditional companies such as McDonald’s, it is only around $63,000 per employee, and for Walmart it is $93,000 per employee. These are orders of magnitude less than the modern tech giants. Even an old tech giant like IBM has a ratio of approximately $347,000 per employee, still only a fraction of Google and Facebook’s.

Although by no means conclusive, it would be reasonable to infer that new tech companies being born out of the computer revolution tend to be staff ‘light’ and don’t require as many employees to deliver high profits to shareholders when compared to the more traditional ones. Unfortunately, it is these traditional companies that are probably going to be among the first to replace their staff with robots and automation. McDonald’s employs 1.7 million people and Walmart employs 2.2 million!

This comparison between the new and the old corporation is an indicator of what is and will continue to happen across all sectors over the coming decades, which clearly does not bode well for society as a whole. Already, the rich-poor divide has never been greater in human history with the richest 2% of the population having as much wealth as the poorest 55%. Worse still, the richest 85 people are wealthier than the poorest three billion. This income inequality will be further amplified as more robots and computers enter the work force. Poverty ultimately leads to social instability, even in the developed world, so everyone will be affected, even the rich. What can be done to avert a future breakdown in society where mass unemployment abounds?

Is there a solution?

Of all the economic models, a capitalist-derived system based on private ownership, production and profit has been the most effective at building national wealth and improving the quality of life of citizens. But what happens as we approach an era in which production is automated? The owners of production (the rich) will reap all the profits, leaving everyone else out of the loop, and the rich-poor gap will continue to widen until some rift or breaking point in society occurs. Adopting a wait-and-see approach is probably not the wisest course of action, although policymakers often react like deer staring at the headlights of an oncoming vehicle when faced with global dilemmas, with climate change being a good example. So what can be done to avert this scenario?

In a post-work era, our current economic system would need an overhaul. Without human workers, governments would suffer huge revenue shortfalls as money collected from payroll tax, income tax and VAT diminishes over time. To offset against this, governments could impose a tax on companies that use robots based on how many units they have or how productive they are. Countries could compete for companies to establish production facilities in a similar way that they do today with corporation tax rates.

But even if governments were able to introduce such new taxes to offset against those previously collected, what should they do about the mass of unemployed and poverty-stricken workers?

One radical idea is to introduce a guaranteed monthly income to all citizens. This would at least ensure that each person is able to afford food and basic accommodation regardless of their plight. Obviously the existing welfare system would need major reform as part of this change. People would then be free to pursue any career or higher learning ambitions they may have. Any income earned through employment, investment or business enterprise would be retained by the individual and taxed at the appropriate rates.

Proponents of this approach believe that it would encourage entrepreneurial activity and innovation as people tend to take more business risk, safe in the knowledge of having a guaranteed basic income.

How today’s jobs will change in the future

As more people find themselves replaced by machines in the coming decades, it may be possible for agile, skilled human workers to adapt their roles, working alongside robots. For example, let’s take the role of a surgeon: as the number of types of procedures performed by robots increases, the surgeon’s role would require less cutting and more supervising and troubleshooting, ensuring that everything is working smoothly with his team of surgical robots. Over time, a surgeon’s role will continue to migrate up the difficulty scale, performing the more unusual procedures that robots are still not capable or certified to do.

Take also the role of drivers. It is estimated that 10% of today’s jobs in the US are driving-related. It is likely that this percentage is similar in the UK. Although over the next couple of decades these jobs will be replaced by driverless vehicles, new job roles in this sector will almost certainly emerge. It is hard to envisage today what these roles might be, but they may involve working in a centralised network monitoring centre to troubleshoot traffic accidents or vehicle malfunctions – a sort of hybrid between a call centre and an air traffic control centre. There may also be remote human override centres run by vehicle manufacturers to handle anomalies that are beyond the capability of the vehicle’s decision-making algorithm.

Of course, given a long enough time horizon, pretty much all of today’s jobs will be automated or performed by robots, but as a consequence of this, new jobs will emerge that do not exist in any form today. Luckily, the transition to a totally automated world will take many decades, giving us time to adjust and adapt to some of these changes.

Threat to humanity

How seriously should we take the perceived threat of artificial intelligence to humanity in which a “Terminator” movie-style apocalypse wages war on us humans? The key to whether this could become a reality hinges on whether computers will be able to develop self-awareness, or consciousness, at some point in the future. Given that we still can’t define scientifically what self-awareness actually is, it would be rather challenging to write an algorithm for it. However, the human brain comprises 86 billion neurons each with hundreds of thousands of synapses. As large as these numbers are, they are finite and eventually with enough computer processing power, it will be possible to replicate the human brain in some form. However, I don’t believe we will reach this milestone until at least mid-century. By that time, we humans will likely be augmented with certain types of organic-based brain implants or ‘upgrades’, such as the ability to speak different languages, or the ability to excel at certain sports or disciplines.

So for the next 35 years or so, we only have to worry about robots stealing our jobs rather than taking over the world. And by the time computers develop self-awareness, I’d like to think that we will have achieved it in a manner that is compatible with humanity coexisting alongside.

The investment opportunities

The use of automation to replace human workers is an irreversible trend and no one can future-proof their job. For those well into their working lives, the chances are that you will manage to get to retirement before you are replaced by robots. For those starting out in the work place, be aware of the coming changes and try to find a way to adapt your role to still be relevant. At the same time it would be wise to include in your investment portfolio some equity in companies that are leading the charge in the robot revolution. Given how fast this industry is moving, it would not be surprising if some of the big players in automation in 10 years’ time have not even been incorporated yet. However, we can invest in today’s industry leaders as they will likely remain in a strong position in the coming years.

The current macro-economic uncertainty does not serve as an ideal backdrop for investing in equities, so it may be wise to build positions in these companies gradually to smooth out any market volatility say, over a four- to six-month time period. I’m going to suggest a number of companies, all very well-established and each specialising in a certain area of automation, such as industrial, medical and military. These companies have large R&D budgets to further their technology, as well as the cash to acquire other companies that may develop superior or complementary technology to their own.

First up is Fanuc Corporation (TYO:6954), listed on the Tokyo Stock Exchange. This is a solid company that is well-positioned to capitalise on the growing trend in factory automation. It has taken a beating in the recent market wobbles and is now around 25% cheaper than it was a year ago. With a dividend yield of 4.5% and a PE ratio of 18, this is a must have stock in any robotics portfolio.

In the medical field, there is NASDAQ-listed Intuitive Surgical (NASDAQ:ISRG), the maker of the market-leading da Vinci Surgical System, a high-precision surgical apparatus that provides minimally invasive surgical procedures. The system comprises a number of mechanical probes controlled by a surgeon through a console with a high definition screen. Intuitive Surgical was the first company to be granted FDA approval for general laparoscopic surgery back in 2000. Today it is in use across 64 countries, with the US being its largest market covering all 50 states. The company is currently on its fourth generation system called the da Vinci Xi, offering surgeons more precision and control.

With a $20 billion market capitalisation and an extensive track record in minimally invasive surgery, Intuitive is ideally positioned to transition towards becoming a maker of automated surgical systems within the next decade. Its access to capital will also allow Intuitive to make strategic acquisitions should it spot a technology that could boost its own system’s capability.

The US military spends $600 billion on defence annually and the top three beneficiaries of this enormous government spending in 2015 were Lockheed Martin (NYSE:LMT), Boeing (NYSE:BA) and BAE Systems (LON:BA.). Big US government contracts provide solid revenue and involve development in leading edge technologies, which often have lucrative private sector applications across a number of areas from space exploration to drones to augmented reality.

NASDAQ-listed iRobot Corporation (NASDAQ:IRBT) has a range of products for the home and the workplace. Its leading product, the Roomba (a robotic vacuum cleaner) has sold over 14 million units worldwide. The company is generating steady top line growth and has been profitable for a number of years. It is currently trading in the $30 range, which is roughly in the middle of its five-year high and low range. The company recently announced its 2015 revenues, which were $616.8 million. Net income for the year was also up to $44.1 million. It is a mass-market play in relatively simple and affordable labour-saving robots, so in this respect the company should see steady growth provided that it continues to innovate and enhance its products. Its home robots account for 85% of its revenues, which is evenly split between domestic (US) and international sales.

Finally, it would be remiss of me not to mention Alphabet (NASDAQ:GOOG), formerly Google. With so many fingers in so many pies, it could already be considered a diversified robotics and automation portfolio in itself, with other businesses thrown in. It is already a leader in driverless cars, artificial intelligence (Deep Mind acquisition) and robots (Boston Dynamics acquisition). Alphabet is well-positioned for the present and the future.

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