A new era or a new bubble: what to make of AI

How today's investments differ from the dot-com era

Today’s artificial intelligence (AI) investments aren’t like the frenzy stocks of the 1990s dot-com era. They focus more on real-world applications and profitability, centring on long-term infrastructures like advanced data centres.

Some think the AI boom might lead to the same kind of big, money-losing bust as before, but here’s why that’s unlikely.

Why this AI boom is different

• Profitability now more attainable

AI-related stocks have surged, much like those of the dot-com era, driven by eager investors. Unlike the dot-com period, which often lacked real business models, AI advancements today are based on real-world applications with clear profitability paths. The technology is already being used in healthcare to diagnose diseases and in finance to detect fraud and facilitate advanced trading

• Funding and cash flow

In the 1990s, many tech companies borrowed heavily to fuel rapid growth. Today’s AI leaders are on firmer financial ground. The $200 billion expected to be spent on AI this year may sound staggering, but it’s minor compared to the free cash flow tech giants generated last year. This solid financial standing decreases the risk of a liquidity crisis similar to the one during the dot-com crash

• Rapid adoption by users

AI technologies are being adopted much faster than internet services during the dot-com era. For example, ChatGPT amassed 100 million users in just a few months, demonstrating strong demand for AI. This rapid uptake signals more than just short-term excitement; it establishes a solid foundation for growth

Consumer adoption

• Investment focused on profits

During the dot-com boom, companies often followed the "build it and they will come" philosophy without solid revenue plans. Today, AI investments are more geared towards achieving tangible returns. Tech companies are investing in core infrastructures like advanced data centres, and investors now demand accountability in tech spending, focusing on enduring value rather than temporary trends.

AI stocks vs S&P 500 total return

Risks to consider

• AI-related stocks: excitement around AI leading to extremely high valuations, like Nvidia's stock which skyrocketed by 2600 times in the past five years. This could lead to volatility if AI's growth doesn't meet expectations. There’s a risk that stock prices could fall, despite companies showing real earnings growth
• The competitive landscape: AI lowers barriers to entry, potentially challenging current tech giants such as OpenAI, Perplexity, or Anthropic as well as Amazon and Microsoft which dominate cloud-based AI services. As smaller startups emerge with innovative solutions, the market could experience more volatility.

Investment opportunities in AI

When considering AI investments, it's essential to diversify beyond the major tech companies.

• Look into AI infrastructure: AI's growth depends on infrastructure. This creates investment opportunities beyond tech giants. Energy companies that power data centres or firms specialising in data centre cooling systems could benefit from rising demand. Companies like Amphenol, Caterpillar, and Quanta Services are examples of firms supporting AI infrastructure
• Focus on semiconductors: semiconductor companies are crucial to the AI ecosystem due to AI's reliance on powerful computing. Companies like Nvidia and Advanced Micro Devices (AMD) design the chips for high-performance AI models, while Taiwan Semiconductor Manufacturing Company (TSMC) manufactures these crucial components
• Balance growth with stability: AI stocks can be volatile due to high valuations. Balancing these with investments in stable sectors like industrials and utilities can provide a buffer against market fluctuations. These sectors may not offer rapid growth but can stabilise your portfolio during tech-driven downturns
• Stay informed on regulations: as AI evolves, so do regulations around data privacy and ethics. Monitoring these changes and understanding their impact on company profitability can guide smarter investment decisions. AI stocks have significant potential, but it’s important to stay grounded
• Don't just follow the hype: consider the broader ecosystem. Diversifying into related sectors, like semiconductors and infrastructure, can help you capitalise on the AI boom while managing risks effectively.