In the two years since the launch of ChatGPT, artificial intelligence has emerged as the most fascinating technological evolution for investors, far surpassing any advancements of the past two decades. Leading technology firms are sinking tens of billions of dollars into improving the computing power essential for the creation and management of AI systems each quarter.
For its passionate advocates, the potential outcomes are astounding: AI is poised to replace a multitude of jobs, assist researchers in the quest for life-saving treatments, help businesses expand into new markets, and unveil remarkable efficiencies that may enhance corporate profits for years to come. As a result, AI-linked stocks have played a significant role in the bull market that commenced in October 2022.
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Despite the immense potential of AI, significant revenue generation is still lacking due to its associated costs. A recent Gallup survey revealed that merely 4% of U.S. workers utilize AI daily, with over two-thirds stating they never interact with it. Daron Acemoglu, a Nobel Prize-winning economist from the Massachusetts Institute of Technology, contends that the prevalent expectations for AI progression are overly optimistic. “The models we have right now are pretty impressive in some respects,” he remarks. “However, they remain largely impractical at a broad level.”
Some investors find themselves nostalgic for the 1990s, a period when the rise of the internet incited a similar fervor. That technological transformation took longer than expected, producing a significant gap between stock prices and actual performance, ultimately resulting in a notable market crash. Many Big Tech stocks are presently trading at earnings valuations that again exceed historical averages.
Today, whether intended or not, most investors are inherently betting on AI.
Do you hold an S&P 500 index fund? One-third of your investment is tied up in eight companies, including Nvidia, Microsoft, and Apple, all of which are banking on AI’s potential. This doesn’t even account for adjacent sectors, such as utilities, which similarly benefit from AI’s energy-intensive data centers.
Read/listen: We are being swept along inexorably by the AI boom
For both supporters and detractors of AI, it’s vital to assess the associated risks and rewards. Begin by distinguishing between companies providing AI services, like Microsoft Corp and Alphabet Inc, and those supplying the infrastructure—chips, servers, and energy—that underpins computing.
The leading tech giants are exceptionally profitable and account for a large portion of AI investments. In Q3 2024, Alphabet, Amazon.com, Apple, Meta Platforms, and Microsoft collectively spent a record-breaking $62 billion on capital expenses, reflecting over a 50% increase from the same period last year. This marks the first time since 2018 that this group dedicated more funds to capital expenditures than to stock buybacks—amounting to precisely $5 billion more. These firms undoubtedly possess the financial resources to sustain such spending habits, having produced $76 billion in free cash flow. Investors typically endorse the capital investments of Big Tech given the sector’s historical accomplishments.
According to Dave Mazza, CEO of Roundhill Financial Inc, a New York-based investment firm, AI will eventually yield significant revenue, but he cautions that investors may have a limited patience. “If companies announce substantial spending commitments without clarity on payback timelines, investors are likely to react negatively,” he warns. “At some point, reality will set in, and the clock is ticking.”
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Arvind Narayanan, co-author of AI Snake Oil: What Artificial Intelligence Can Do, What It Can’t, and How to Tell the Difference, states that realizing substantial AI returns will necessitate more than just a year or two. “Embracing new technology requires adjustments in workflows, organizational structures, and legal frameworks,” explains Narayanan, a computer science professor at Princeton University. “These adjustments do not occur at the speed of technological advancements. Hence, we should expect that it might take a decade or more for companies to fully harness the benefits of even today’s generative AI.”
Currently, the revenue generated from AI by tech giants is most evident within their cloud computing divisions, such as Amazon Web Services and Google Cloud. However, Microsoft—an early winner in AI thanks to its partnership with OpenAI, the parent company of ChatGPT—is already feeling strain. By the end of November, Microsoft’s stock had lagged behind the S&P 500 for four consecutive months. In October, the company faced its largest stock drop in two years when its revenue growth forecast for the Azure cloud service fell short of expectations. Nevertheless, Microsoft plans to spend $62 billion on capital projects this fiscal year, more than double what it spent two years ago. Alphabet, Amazon, and Meta have also disclosed plans to ramp up their investments.
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This commitment has instilled confidence in those adhering to a well-known investment strategy concerning AI: the pick-and-shovel approach, referring to vendors who profited by equipping miners during the 19th-century California gold rush. Nvidia Corp exemplifies this strategy, dominating the sector for computer chips crafted for AI-related computations. Its stock has surged over 700% since the advent of ChatGPT in November 2022. Nvidia’s skyrocketing profits and revenue have established it as one of the most valuable companies globally, boasting a market capitalization of $3.4 trillion by the end of November, competing closely with Apple Inc for the top position.
Read: Microsoft unveils zero-water data centers to reduce AI climate impact
The historically stable stocks of utility companies are also witnessing a rise. Vistra Corp and Constellation Energy Corp stand out as top performers in the S&P 500 in 2024, positioning utility stocks for their best performance since 2019.
With significant tech firms pledging continued spending, even skeptics like Jim Covello see no reason to abandon the pick-and-shovel strategy as capital continues to flow. Covello, the head of equity research at Goldman Sachs Group Inc, argues that AI may not meet the lofty expectations of its advocates. “Most technological transitions in history, especially transformational ones, have replaced very expensive solutions with cheaper alternatives,” he remarked in July. “So far, AI—and its associated hefty costs—contradict this principle.” He believes that once this awareness becomes prevalent, tech giants will reassess their extensive expenditures, leading to a downturn for infrastructure stocks.
This situation could challenge Big Tech firms, dampening their growth prospects. However, it is unlikely to significantly diminish their long-term attractiveness, as growth from their core businesses is expected to remain robust.
Consider Meta Platforms in 2022, when the parent company of Facebook heavily invested in the development of the so-called metaverse. When revenue started to slow, the stock saw a sharp decline. Nonetheless, Meta managed to recover and is now trading at record highs after multiple acknowledgments from CEO Mark Zuckerberg and a strategic pivot.
Read: A very ChatGPT Christmas
Identifying the potential long-term leaders in this space may prove challenging, according to Michael O’Rourke, chief market strategist at Jonestrading in Chicago. In 2000, hardware manufacturers such as Cisco Systems Inc and Sun Microsystems—the pick-and-shovel suppliers during the dot-com boom—were among the best-performing stocks of that era. However, it was companies like Amazon and Google that ultimately emerged, establishing substantial businesses around the technology.
“Typically, it is others who refine these concepts and come to dominate the market,” O’Rourke clarifies. “We remain at an early stage in understanding how the environment will evolve moving forward. I hesitate to say it’s too early to tell; that might imply that those investing now should proceed. The late 1990s was an early period for the internet, and that was not the ideal time for investment.”
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