"AI Will Change the World"

Sean Cawley, CFP®

June 06, 2023

Here is a sequence of events everyone is familiar with:

Develop an investment thesis (the internet will change the world)
Buy stock in the companies that will benefit from your investment thesis (Amazon/Microsoft)
Make lots of money

That sequence is nice and intuitive. It makes sense to everybody. Like 2+2=4. We’ll call that the Intuitive Sequence.

Here is another sequence. It is not quite as intuitive:

Develop an investment thesis (the internet will change the world)
Buy stock in the companies that will benefit from your investment thesis (Amazon/Microsoft)
Lose lots of money

Wait. That’s not how it’s supposed to work? That feels like 2+2 = Fish. We’ll call that the Counterintuitive Sequence.

There was a popular investment thesis in 1999. You remember 1999. If you wanted to communicate with someone you picked up a home/office phone (on a cord) and called them. Need to find a good restaurant in a new city? Ask the concierge at your hotel or a friend of yours that lives there (better hope he’s at home by his phone when you call). Making coq au vin? Dig out grandma’s handwritten recipe book. Booking a flight? Call an airline directly to make a reservation and pick up your boarding pass at the airport. I actually had to google “how did people book flights before the internet” to learn that. You can probably guess a popular investment thesis in 1999:

The internet will change the world.

A few decades later, we all agree that was on the nose. Probably more so than its proponents believed at the time. I mean, who could have comprehended the way internet would change everything back in 1999? Before smartphones and social media and everything else. If you were an investor blessed with an opportunity in 1999 to ask a genie about this thesis, the conversation may have gone something like this:

Investor: “Mr. Genie, what industries will be disrupted by the internet over the next two decades?”

Genie: “Hmm that is a bit difficult to answer, perhaps a better question is what industries won’t be disrupted by the internet over the next two decades.”

Investor: “Ok, which ones won’t be disrupted?”

Genie (with a knowing smirk): “None.”

Investor: “You’re kidding.”

Genie: “Buckle up, kid.”

Would it have been possible to overstate the power of the internet to change everything back in 1999? I doubt it. The wise investor, capitalizing on his good fortune having access to a genie before making stock picks, would want another question answered:

Investor: “Thanks for the tip. But I wasn’t born yesterday, I’m sure many of these new internet companies won’t make it. What companies will be the biggest beneficiaries of the internet changing the world?”

Genie: “The ones owned by Bill Gates and Jeff Bezos.”

Investor: “Which are those?”

Genie: “In a few years, you won’t need me to answer that, you’ll just Google it with the box you carry around in your pocket.”

Investor: “???”

So you run a (painstakingly slow) internet search on Ask Jeeves and discover the companies the genie recommended as the beneficiaries of the internet-changing-the-world phenomenon are Microsoft and Amazon. You call your stockbroker, and he informs you Amazon and Microsoft are up over 4,000% and over 200%, respectively, over the last five years.[i]Has this genie been dispensing similar advice to other investors?! No time to waste. You instruct your broker to buy bunches of Amazon and Microsoft stock as you prepare to get rich. It’s nice to have a genie confirm parts (a) (investment thesis) and (b) (companies that benefit) of the Intuitive Sequence for you.

Both companies’ stock prices hit all-time highs in December of 1999.[ii] Then the tech bubble burst. The drawdown in the market was brutal. By 2001, the NASDAQ dropped 72%. Microsoft fell 65%. Amazon plummeted 94%.[iii]

Booms and busts are normal. It’s only two years later. You remember that friendly genie. He said Microsoft and Amazon would be the great beneficiaries of the internet changing the world.

So you wait. And wait.

Amazon would surpass its 1999 high in… 2009.[iv] A decade is a long time to wait.

Microsoft would surpass its 1999 high in… 2016.[v] 17 years of waiting. Seventeen! Can you imagine sitting on a losing position for 17 years even if you had a genie telling you it would be a winner? What about without a genie?

This is the Counterintuitive Sequence we talked about earlier:

Develop an investment thesis (the internet will change the world)
Buy stock in the companies that will benefit from your thesis (Microsoft & Amazon)
Lose lots of money (Microsoft down 65%/takes 17 years to recover; Amazon down 94%/takes 10 years to recover)

You had the benefit of a genie and you still got crushed. To be clear, if you held those positions until 2023, you would have been blessed with the Intuitive Sequence - the one that ends in making lots of money. From their highs in 1999 to the end of May 2023, here are the returns of those two stocks:

Amazon: +2,240%[vi]

Microsoft: +791%[vii]

So the genie was right. He just didn’t mention the part about sitting on losing positions for over a decade even with the right investment thesis and the right companies. There are not many people willing to do that. Especially without a genie. I would like to meet one person other than Jeff Bezos who owned Amazon in 1999, rode their position down 90+%, and still held on for over two decades. Just one. I suspect that person doesn’t exist.

A popular investment thesis in 2023 sounds like 1999’s:

Artificial intelligence will change the world.

In the first quarter of this year, investors were tracking how many times “AI” and “artificial intelligence” were referenced on earnings calls.[viii] It’s the incantation du jour that purportedly boosts stock prices. If your CFO isn’t finagling a way to mention “AI” at least 20 times on earnings calls, he isn’t worth keeping around.

So I see a lot of people foaming at the mouth about the Intuitive Sequence:

Develop an investment thesis (AI will change the world)
Buy stock in the companies that will benefit from your investment thesis (Nvidia)
Make lots of money

I’ve singled out Nvidia because that seems to be the stock with the most AI buzz presently. We are at the beginning phase where investors are guessing who will be the beneficiaries of the AI revolution. I suspect a wave of AI IPOs promising untold riches is around the corner.

For now, Nvidia enjoys the bulk of the AI hype. They own the computer chip market for the highly advanced graphic processing units (GPUs) required for AI systems. Recent reports indicate they possess a 95% market share. Nvidia’s chips are so powerful, the US government as placed export controls on their most advanced chips for national security reasons.[ix] Uncle Sam does not want Nvidia’s cutting edge tech to make its way to China. Analysts are coming up with clever phrases like “there’s an AI war, and Nvidia is the only arms dealer”[x] and Nvidia is selling “picks and shovels”[xi] in the “AI gold rush.” Cute.

So, plenty of people are buying Nvidia stock preparing to make a killing. And this year they have! NVDA is up 175% YTD through May while the S&P is up 10%.[xii]

When MSFT peaked in 1999, their price to earnings ratio was 78.89.[xiii] That is, you paid $78.89 for every dollar of MSFT’s earnings. Today, MSFT’s P/E ratio is has dropped to 35.75.[xiv] So you’re paying less than half today for each dollar of MSFT’s earnings compared to what you paid in 1999 despite earnings per share being up 1,250%.[xv]

Note: P/E ratio is one of the more well-known stock valuation metrics. It is certainly not the only variable worth considering, but it does help provide a framework for how expensive a stock is. To give you a sense of scale, the P/E ratio of the S&P 500 is presently 21.64.[xvi]

Nvidia’s P/E ratio is 197.27.[xvii] You must shell out nearly $200 for each $1 of NVDA earnings. That is… uhh… rather expensive. Does that mean NVDA will underperform going forward? I don’t know! I’m trying to step out of the “AI will change the world” and “NVDA is up 175%” manias for a moment and add a bit of context and history.

People forget Nvidia was around during the tech bubble at the turn of the century too. NVDA stock hit an all-time high on June 7, 2001.[xviii] Its P/E ratio at the time jumped to 166.87.[xix] NVDA’s stock price then declined 93% over the next 16 months.[xx] It briefly made a new high (barely) in 2009 before suffering another precipitous decline before finally breaking through its 2001 high for good at the end of 2015.[xxi] Similar to Microsoft and Amazon, Nvidia was a big winner of the internet changing the world, it just took 15 years to make money on a position taken when the investment thesis was popular.

The AI will change the world so buy AI stocks now frenzy is reminiscent of the tech mania of ~20 years ago fueled by the belief the internet would change the world. Back then, the Intuitive Sequence (making lots of money) transformed into the Counterintuitive Sequence (losing lots of money) quickly, and it took 10+ years to really see a significant ROI on investments in the companies that most benefitted from the investment thesis proving accurate.

Will the story be different for those investing on the AI thesis?

I don’t know, but I’m not making any bets.

Sean Cawley, CFP®

*Do not read this post as commentary on NVDA. We don’t have an opinion! We are bearish on investing ideas expecting quick and easy fortunes and anything that can be considered a mania (remember crypto in 2021?).

Neither asset allocation nor diversification guarantee against investment loss. All investments and investment strategies involve risk, including loss of principal.

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This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time with

[i] YCharts, MSFT & AMZN Total Return Fundamental Chart, 12/01/1994 – 12/01/1999