Is the AI boom just another gold rush?

Is it too late to invest in NVIDIA? And who will benefit from the AI boom? These are common questions for people looking to jump aboard the AI bandwagon. I turned to an industry expert for help.

In the current AI gold rush, NVIDIA is the one “selling the shovels,” said Eric Lynch, Managing Director of Scharf Investments, in a recent interview with Reuters. He compared the AI boom to the 19th-century Gold Rush in the US, where it was actually the shovel makers who made the most money.

I interviewed Lynch to learn some of the fundamentals about investing in AI.

Who benefited most from the California Gold Rush?

The California Gold Rush refers to a mid-19th century gold fever in western USA. Around 300,000 people from all over the country and beyond poured into the state, hoping to strike it rich.

Ironically, it wasn’t the miners who benefited most from the sudden gold fever. It’s said that Samuel Brannan, a reseller of supplies in the goldfields, was the wealthiest man in California at the beginning of the Gold Rush.

To put it simply, he sold shovels. Similar to what NVIDIA, at least according to Lynch, is doing now by producing chips – a scarce yet crucial resource for AI development.

“There is this feeling of fear of missing out (FOMO) across all sectors and capital providers. There's this gold rush mentality similar to the American Gold Rush, where obviously the suppliers made all the money,” Lynch added.

What’s happening with AI right now?

NVIDIA has recently joined the trillion-dollar club. Its stock has risen over 200% since last October, indicating investor confidence in the future of AI. Shareholders are also betting on companies like Palantir, C3.ai, and Microsoft, of course, among others.

According to Lynch, from a business standpoint, the use cases for generative AI are very credible. It’s not accurate to refer to it as mere hype.

“Whether it's in healthcare, business, or education, clearly this will be at least very evolutionary, if not revolutionary. That's not hype,” he said.

However, companies and anyone trying to monetize AI are hyping it, exaggerating the speed of its implementation and monetization.

“Just look at the consumption of Microsoft Bing search engine since they formalized the integration of ChatGPT. It's actually lost market share,” Lynch said.

According to Statcounter, Microsoft Bing’s market share was 8.85% in January. By May, months after the launch of Bing Chat, it had dropped to 6.81%.

Last tech hype ended with dot-com crash

While it is normal to get excited by new technology, the hype will cool down at some point. Historically, it takes years for major technological advances to start generating profits, Lynch said.

He drew a parallel to the internet, which brought us a “huge advancement” – distributed computing and immediate connectivity worldwide. But everyone got so psyched that a huge dot-com bubble formed in the late 1990s. It burst in the early 2000s, sinking everyone’s profits.

“Honestly, it probably took seven to nine years to really start seeing profitability in the IT sector,” Lynch said.

Many companies are jumping on the AI bandwagon, whether creating their own applications or investing in the hype. But, Lynch reckons, only a couple of them will surface victorious.

Here’s an interesting fact. S&P 500 grew by 56.2% from January to May 2023. If we excluded Apple, Microsoft, Alphabet, Amazon, and NVIDIA gains, the market would be up just 1.5% this year.

Creme de la creme of the tech world

Interestingly, we can’t be 100% sure about who’s going to win. As per Goldman Sachs, five companies in the year 2000 accounted for 18% of the S&P 500 index. They were: Microsoft, Cisco, Exxon Mobil, GE (General Electric), and Intel. Nokia, Kodak, IBM, and Xerox also used to enjoy their fair share of the spotlight.

But when did you last hear of Nokia or Kodak in a context other than decline and bankruptcy?

While it might seem safe to bet on companies like NVIDIA, Lynch believes that some tech giants might actually lose from the mainstream adoption of AI. Companies like Amazon and Google are more at risk since AI might change how users interact with the top tech platforms.

“They all have a lot of money. They're all developing their own kind of AI strategies and implementing them. They may very well come out stronger or better, but I wouldn’t take it as a given that they’re the ones that will win,” Lynch said.

Currently, the top five S&P 500 companies are all tech firms:

• Apple
• Microsoft
• Amazon
• NVIDIA
• Alphabet

Is it too late to invest in NVIDIA?

If your cab driver is talking about investing in NVIDIA, it’s too late. That’s how the saying goes, and Lynch finds it to be accurate. AI development depends on NVIDIA because the company provides the hardware – the shovels in this AI rush. So it’s only natural that investors have jumped on the opportunity. But is it still a viable plan for investments?

Take into consideration the price-to-sales ratio (P/S). This is calculated by taking a company’s market cap and dividing it by its revenue over the past 12 months. The lower the ratio, the better the opportunity to invest.

For example, Microsoft's P/S ratio in June currently stands at around 12.2, meaning the company’s stocks are valued over 12 times more than its revenue.

NVIDIA’s current P/S ratio is around 41. While its shares are valued at over $1 trillion, its revenue for the last 12 months was nearly $26 billion.

Once again, Lynch drew a parallel to the early 2000s, when technology stocks were “eating the world, eating the stock markets,” eventually forming a bubble. When it burst, those stocks didn’t recover for around ten years.

“But value stocks, non-US stocks, small-cap stocks, those actually made money in the next ten years because the valuations were so attractive. I think that that could happen again because you have again just around ten stocks that are driving almost all the returns,” he said.

Also, if you’re betting on AI, it doesn’t necessarily mean you need to invest in technology companies.

“If you believe in the bull case for AI, that is going to fundamentally reshape society and businesses, improve profits and productivity, then obviously all the profits are not going to accrue only to the AI technology providers,” Lynch said. Sectors like healthcare and others that will be revolutionized by AI could also become a potentially profitable investment.