Roughly three decades ago, the advent of the internet changed the growth trajectory of corporate America forever. The ability to transact online revolutionized how companies can generate sales and profit.
Since the internet began going mainstream, numerous next-big-thing technologies, trends, and innovations have come along that promised substantive addressable markets. However, none of these prior game-changing trends offered an addressable market remotely close to what the internet provided businesses... that is until the arrival of artificial intelligence (AI).
Image source: Getty Images.
According to Sizing the Prize, a report issued by researchers at PwC, AI is forecast to contribute $15.7 trillion to the global economy by 2030. This boost is predicted to come from a combination of increased productivity ($6.6 trillion) and various consumption-side effects ($9.1 trillion).
Large addressable markets tend to draw in sizable investment crowds, which is why we've witnessed most AI stocks ascend to the heavens. Nvidia (NVDA -3.12%), at its peak, gained more than $3 trillion in market cap in less than 18 months riding the AI wave, while Broadcom completed into its first-ever stock split in July following a near-parabolic climb for the AI networking solutions leader.
While it would appear AI stocks are the clear place to invest right now, I've taken a hands-off approach. Although I do own stakes in a small number of companies that have benefited from the rise of AI, there are three reasons I'm not actively investing in the artificial intelligence revolution.
1. All next-big-thing technologies endure early stage bubbles
Let me preface this first point by stating that I'm a student of history. Even though history rarely repeats to a "t" on Wall Street, it does have a tendency to rhyme -- and history has been highly unkind to next-big-thing trends over the last 30 years. This means parabolic ascents, like that of Nvidia, won't be sustainable.
Since the proliferation of the internet in the mid-1990s, every single highly touted innovation, technology, and trend has endured an early stage bubble-bursting event. This includes the internet, business-to-business commerce, genome decoding, U.S. housing, China stocks, nanotechnology, 3D printing, cryptocurrency, blockchain technology, cannabis, and the metaverse.
All innovations, technologies, and trends need time to mature. Unfortunately, investors often become wide-eyed seeing large addressable market forecasts and unrealistically expect instant adoption and utility for these game-changing trends. When lofty expectations inevitably come up short, the euphoria fades and the bubble bursts.
The telltale that we're likely dealing with the next in what's been a long line of bubbles since the mid-1990s is the fact most businesses investing in AI data centers and solutions lack a concrete plan to grow their sales and profit from this technology.
I have little doubt that artificial intelligence can, over time (key phrase!), be a key contributor to the top- and bottom-line for most industry-leading businesses. But it's going to be a while before companies figure out how best to harness this technology. In the meantime, many of Wall Street's leading AI stocks are susceptible to lofty expectations not being met.
Image source: Getty Images.
2. Valuations are, generally, not appealing
The second reason I want nothing to do with the AI revolution is because the valuations of the companies involved are, for the most part, not that appealing.
On paper, optimists can make a valid argument that Nvidia is still a bargain, even following a 694% increase in the company's share price since the start of 2023 (as of the closing bell on Sept. 20, 2024). Shares of the company are valued at 29 times forward-year earnings per share (EPS), with EPS forecast to grow by an annualized average of 52.5% over the next five years.
However, Nvidia is also trading at a nosebleed 30 times trailing-12-month (TTM) sales and peaked at a price-to-sales (P/S) ratio of closer to 43 over the TTM. Historically speaking, we've only seen market-leading businesses touch a TTM P/S ratio of around 40 two other times -- Amazon and Cisco Systems -- and both occurred prior to the dot-com bubble bursting. Both companies eventually shed around 90% of their value on a peak-to-trough basis before finally rebounding.
NVDA PS Ratio data by YCharts.
Admittedly, Nvidia is in considerably better shape than Amazon was during the height of the dot-com bubble. Its other established operating segments, which include GPUs sold to the gaming and crypto industries, as well as its virtualization software, should assist Nvidia and keep it from suffering the same devastating wipeouts we've witnessed from other next-big-thing leaders. Nevertheless, its TTM P/S ratio points toward substantial downside to come.
Other high-flying AI stocks are bound to have investors doing double-takes, too. For instance, autonomous food delivery robot company Serve Robotics (SERV 8.08%), which Nvidia has invested in, sports an aggressive $317 million market cap while pacing only $1.7 million in sales for the current year. Worse yet, 64% of its recognized sales in the second quarter came from software service revenue and not its core food-delivery operations.
The AI arena is littered with highly speculative valuations. While there are a few historically cheap bargains, this is more the exception than the norm.
3. Warning signs are mounting for Wall Street (and AI stocks won't be spared)
The third reason I'm not actively investing in the AI revolution is because warnings are building that suggest the U.S. economy, and subsequently the stock market, may be pointing lower in the not-too-distant future.
More quick prefacing: There's no such thing as a foolproof metric, indicator, or forecasting model that can concretely predict directional moves in stocks. If there was, we'd all be using it. There are, however, certain metrics and events that have strongly correlated with moves higher or lower in stocks and/or the economy throughout history.
For example, the S&P 500's Shiller price-to-earnings (P/E) ratio, also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio), shows stocks are at one of their priciest valuations in 153 years.
S&P 500 Shiller CAPE Ratio data by YCharts.
The Shiller P/E, which is based on average inflation-adjusted earnings from the previous 10 years, ended Sept. 20 at 36.63, which is more than double its average reading of 17.16, when back-tested to January 1871. Including the present, there have been only six instances where stocks have been this pricey during a bull market rally, and the S&P 500 eventually went on to lose at least 20% of its value following the five prior occurrences.
In addition to stocks being historically pricey, the first notable decline in U.S. M2 money supply since the Great Depression, coupled with the longest yield-curve inversion in history, both point to the growing likelihood of a U.S. recession. Although stocks aren't tied at the hip to the U.S. economy, a weakened or shrinking economy would be expected to adversely impact corporate earnings. This, in turn, would be expected to weigh on equities.
Given the investor euphoria that's propelled AI stocks higher for much of the last two years, this group of companies would likely be hit hard if a recession took shape and/or a stock market correction arose.
To reiterate, I believe the long-term future for artificial intelligence is bright. But it's going to take a while for businesses to figure out how to utilize and optimize this game-changing technology. I'd rather sit back and wait for the boom-bust cycle to play out before wagering on AI to meaningfully change the long-term fortune of the companies I'm investing in.
