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A lot of investors are taking the view that the best shares to buy right now have something to do with artificial intelligence (AI). Unfortunately, I think that’s also true of some of the worst ones.
Investors are justifiably focused on what AI might be able to do for companies. But in several cases, I think they also need to be wary of what it could do in terms of strengthening competitors.
AI
Online retailer Etsy (NASDAQ:ETSY) is a good example. The stock jumped 16% on Monday (29 September) on news of a deal to allow customers to buy its products directly through ChatGPT.
There are obvious benefits to this in terms of potential higher sales, but the news isn’t all good. And the stock came back down to earth as investors started to realise this.
For one thing, customers buying directly through ChatGPT are likely to spend less time on Etsy’s website. As a result, they don’t have the same experience with the company.
On top of this, there’s more competition. The app is likely to return search results for potential buyers from across the web, putting the firm next to cheaper alternatives.
In other words, while a ChatGPT deal might well expand Etsy’s reach, it’s also set to do the same thing for its competitors. And it’s easy to overlook this point.
It’s easy for investors to focus on what looks like an attractive opportunity and miss potential threats. And with Etsy, I think this shows up in other areas as well.
Cash flows
Etsy shares look extremely cheap right now. The company has a market value of $7.35bn and generates $671m a year in free cash, which implies a potential return of over 9%.
That’s a low valuation for a growth stock. And the firm has been looking to take advantage of this by returning around $1.1bn to investors via share buybacks since the start of 2023.
The trouble is, however, that all this spending hasn’t actually made any difference to the company’s share count. In fact, the number of shares outstanding has actually gone from 127m to 132m.
The reason is relatively straightforward. During this time, Etsy has been issuing shares as part of its employee compensation packages. And the buybacks have mostly been offsetting this.
This is something investors need to factor into their view of how cheap the stock is. It’s not enough to just look at the free cash flows and the market value and take a view based on that.
Adjusting for stock-based compensation, Etsy’s annual free cash flows are currently around 5.5% of its market value. That’s still not exactly expensive, but it’s not as cheap as it first seems.
A stock to avoid?
I’m not saying Etsy is the worst stock on the market right now. Its unique focus on handmade products gives it a point of differentiation in an otherwise crowded space.
That might prove to be important over the long term. But investors need to think carefully about what the rise of AI means for the business – and this isn’t the only example.
The worst companies to invest in right now are ones whose competitive positions are under threat. And in some cases, they might be ones that initially look like AI beneficiaries.
