I get a lot of questions these days along the lines of “is this an AI bubble?” or “is the AI Bubble Popping?” And those are good questions because bubbles do eventually burst, and you don’t want to be left holding the bag when they do.

First, let me show you what a bubble looks like.

 

There is talk of this feeling like 1999 when any company with “dot com” in their name attracted investors. Many of these companies never had profits. Some never even had sales. But they had good stories and that was all investors thought was necessary to strike it rich. And some did indeed do well.

This is a chart of some tech leaders from 1998-99, and they did post big gains. 

The S&P 500 (red line) was up 51% in those two years, which is very respectable.  

However, Qualcom (in yellow) posted gains of 2700% during that same period.  Amazon gained 14X – most of it in ’98 as you can see by Amazon (in light blue) chopping sideways in 1999. 

We can compare the “Dot Com” leaders to today’s “Magnificent 7” stocks that lead the current AI boom. The 7 are Alphabet (Google parent), Amazon, Apple, Meta (formerly Facebook), Microsoft, Nvidia, and Tesla. 

Specialized AIs had been in development for many years. Think Netflix movie recommendations or Google’s auto fill search prompts. Those are all AI driven. But the Artificial Intelligence boom in stocks really started about 2 years ago with the release of ChatGPT which allowed the average computer user access to AI’s power, like clicking on icons simplified web browsing in the 1990s. It freed you from having to be a programmer to use the technology. 

Two years ago, the term “AI” became the “mating call” for companies trying to attract investor dollars, much like “Dot Com” did 25 years ago.  

Venture capital firm MMC Ventures recently studied 2,830 AI startups. In 40% of cases, they found no evidence that AI was an important part of their businesses. Those are the story stocks of today. 

Could there be a crash following this AI frenzy? It is possible, certainly. Here is what a crash and the financial hangover from it look like. 

The Nasdaq 100 Index posted an 82% loss between 2000 and 2003, and that is with dividends reinvested. That should make investors nervous considering how long it took to recover.

The Nasdaq took until Nov 15, 2016 to recover. The March 24, 2000 highs were not seen again for 16.5 years! Tell a buy and hold investor he may have to wait 16 years to break even and see what he says. This is why we believe so strongly in proactively stepping aside during down markets.

However, let’s take a look at today’s market, because I believe there are big differences between “dot com” stocks and “AI” stocks. 

You can see the similarities with the Dot Com period in this one-year chart of 5 big tech stocks. The S&P 500 (red line) is up 19.32% over this period, while NVIDIA (yellow line) is up 139%. 

The real difference is that current tech leaders have more than stories. They have a LOT of money, unlike the “dot com” leaders.  

On August 28th NVIDIA posted better than expected earnings results for the quarter ending July 28, 2024.  Revenue was $30.04 billion, a 122% increase year-over-year. Net income for the same period was up 168%.   

NVIDIA board of directors authorized adding $50 billion to their share repurchase program, telling the world that they think the shares are still undervalued. 

Despite reports like that of MMC Ventures, the difference in the AI wave and the Dot Com Bubble is that many of the leading AI companies of today are, in fact, profitable.

This chart is the result of screening all 9,589 stocks in the Finviz database for companies that were profitable and valued over $10 billion. This screen left 746 large, profitable companies to consider.

Return on assets, a measure of investment efficiency, of the five AI stocks listed is several times higher than the average large, profitable company. 

Profit margins show how much money a company makes on each sale. Large margins mean that company can stave off competition by lowering prices when needed. Again, profit margins in the five AI stocks is several times higher than the average successful company. 

In addition, the “Cash on Hand” would allow these companies to invest in new technology and if needed, to outright buy any but the very largest of competing companies. Talk about staying power! 

Will every AI company prosper? Absolutely not. It has been said that AI is the fastest depreciating asset ever. Companies that have sunk billions and billions of dollars into AI projects are at risk of having their product overshadowed by something newer. I expect to see a lot of weak companies struggle over the next few years as AI targets are missed.  Those with good ideas will get snapped up by the AI leaders at bargain sale prices. 

How should an investor protect themselves from owning a company that might fail? Follow the money! Look for how much revenue the company produces with AI. Look for companies with deep pockets so if their AI dreams get derailed, they have the stamina and resources needed to bounce back. And look for companies making healthy profits. As competition heats up, the companies with the largest profit margins can cut prices to fight off competition and survive. 

The stock market correction in July had many investors looking to rush into some previously under-performing segment of the market looking for value there when there is a perfectly good megatrend, right in its moneymaking sweet spot, staring us in the face. 

Don’t skip the rest of the AI boom because you are scared that it can’t last. I believe it can last. Instead of running scared, I focus on the AI companies that are making money as a key element of managing risk.  

Some things really do change the world! Railroads, automobiles and computers did. I believe that we are in the early innings of the “AI boom” that will put AI on that list of technologies that changed the world. 

As a Shadowridge portfolio manager, I focus on companies that are already profitable, avoid heavy debt and are in a technological sweet spot.  

Disclosure: Certain Shadowridge clients hold NVIDIA, Apple, Tesla and Microsoft shares. We currently have no holdings of Google, Meta or Amazon.