Artificial Intelligence, Real Companies

In today’s rapidly evolving digital landscape, one term is getting more attention than any other: Artificial Intelligence (AI). From autonomous vehicles to conversations with ChatGPT, AI has the potential to transform industries and reshape the way we live and work. It also carries significant risks for specific professions and our broader social fabric, presenting challenges for policymakers and regulators. For investors, AI is already impacting valuations and stock market growth as companies begin to leverage this new technology. 

At its core, AI is a machine’s ability to perform the cognitive functions we associate with human minds, such as perceiving, reasoning, learning, interacting with an environment, problem solving, and even exercising creativity.[1] AI is already integrated into our daily lives – voice assistants like Siri and Alexa are founded on AI technology, as well as personalized movie recommendations from Netflix or Hulu. Additionally, AI has the ability to analyze vast amounts of data, identify patterns, and make predictions with increased accuracy and speed for medical imaging, marketing campaigns, and industrial design. With such transformative potential, AI has captured the attention of investors worldwide, and prices have skyrocketed, evoking memories of past bubbles driven by disruptive technologies. 

History provides plenty of cautionary tales, reminding us of past bubbles fueled by inflated expectations. From the Dutch tulip mania[2] in the 1600s to the dot-com bubble of the late 1990s and even the recent cryptocurrency boom and bust, history demonstrates that blind enthusiasm without a grounded understanding of the fundamentals can lead to unsustainable valuations and subsequent market corrections. 

Through the historical cycles of technology adoption and investment it’s possible to see recurring patterns. At first, speculation builds and a bubble inflates and deflates, after which enduring technologies tend to re-emerge as a driver of growth in the stock market. Secondary innovations arise, creating new companies and products, while other industries are disrupted by the innovations. While we are cautious about the current boom in AI company valuations, we believe that the technology will fuel growth in the broader market for many years to come. 

There are various differences between current AI-related excitement and the exuberance of the internet stock bubble in the late 90s. Most of today’s large tech companies have strong balance sheets, and importantly, they’re already very profitable and generate cash. In the previous tech bubble, many companies were relatively new, having IPO’ed within the prior three years, compared to the current slate of mature tech companies that have been publicly traded for many years. Notably, the seven largest companies in 2000 in terms of market capitalization – Microsoft, Cisco, Intel, Oracle, Sun Microsystems, Worldcom, and Dell – had a similar market share as today’s ‘Magnificent Seven’ of Apple, Meta, Alphabet, Microsoft, Tesla, NVIDIA, and Amazon. 

The P/E ratio on the tech-heavy Nasdaq 100 index, which compares a company’s stock price with its earnings-per-share, is currently 32.5x. At the peak of the dot-com boom, the index had a much higher ratio of 80.1x, suggesting stocks were significantly overvalued. This contrast highlights that while current tech leaders may decline in price, their valuations are less stretched, and they should be more resilient through any volatility prior to this new technology reaching a more sustainable phase.

From the comparison of the top companies above, only one managed to stay on the list: Microsoft. This highlights the dangers of investing in a rapidly evolving technology landscape – many companies go bust or fail to adapt quickly enough to maintain their market advantage. Even for Microsoft, investors who bought the stock in December 1999 had to wait 16 years before the price recovered to where they initially bought in.  For investors who purchased stock in Cisco or Intel in early 2000, the stock prices declined more than -60% and still haven’t recovered to those prior highs. This is one reason we prefer to invest in diversified funds that hold a broad array of companies. Attempting to pick the specific winners and losers carries significant risk, but benefiting from the overall tailwind of new technology can be done in a diversified portfolio. Through our allocation to the S&P 500, our clients maintain exposure to many companies that are directly benefiting from the current AI boom. 

Microsoft is the largest company in the S&P 500 and had the foresight to invest $1 billion in OpenAI (the maker of ChatGPT) in 2019. Since then, it has invested an additional $12 billion and is entitled to a share of its profit distributions. This has positioned Microsoft to benefit from the AI megatrend, and they are also aggressively integrating AI across their product lines including GitHub and Microsoft Office. 

Nvidia is the world’s most valuable semiconductor company, and the third largest company in the S&P 500. It produces the chips – specifically, graphics processing units (GPUs) – that power the development of AI applications. The company provides the hardware for this technological revolution, and its stock price grew nearly 240% in 2023 alone. Despite this lofty growth, the company recently beat earnings expectations and signaled that it sees more upside ahead as AI adoption continues to expand. 

In the medical field, Intuitive Surgical is another company in the S&P 500 benefiting from substantial investment in AI. This company is the established leader in robotic surgery systems. Adding AI to their already cutting-edge medical hardware and software has allowed for enhanced precision, shortened training times for new surgeons, more efficient operating room scheduling, and better review of surgery outcomes in order to improve future results.[3] 

AI is being incorporated by companies across the stock market, from Google’s inclusion of the technology in their search algorithms to Amazon’s use of AI to optimize their AWS tools to Accenture offering AI consulting for global companies. More than 36% of companies in the S&P 500 index specifically mentioned AI in their conference calls with investors during the fourth quarter of 2023.[4]  At North Berkeley, we take comfort in having diversified exposure, knowing that our clients will benefit from this technological tailwind without being overly exposed to any single company.

We’re still in the early days of this multi-decade computational transformation powered by AI. Economists from Goldman Sachs recently noted that they expect generative AI to boost global labor productivity by one percentage point per year over the next decade. Historically, these periods of rapid productivity growth have coincided with periods of significant economic expansion. Our portfolios are designed to participate in this growth, without taking on an excess amount of risk. 

We will continue to maintain diversified portfolios and rebalance along the way to systematically trim stocks at moments of overexcitement and buy stocks when short-term fears lead to discounted prices. As AI continues to permeate many aspects of the economy and our daily lives, it will create new risks as well as new opportunities. We partner with our clients to separate meaningful developments from the hype that often accompanies a technological leap forward.

Resources:

[1] What is AI? McKinsey 

[2] The Real Story Behind the 17th-Century ‘Tulip Mania’ Financial Crash History.com  

[3] Intuitive’s Tony Jarc on how AI is improving robotic surgery. MedTechDive

[4] AI mentions rise in S&P 500 earnings calls, Goldman says Reuters