Artificial Intelligence Stocks Propel Stock Market to New Heights
Since the beginning of this year, the Dow Jones Industrial Average, benchmark S&P 500, and Nasdaq Composite have all rebounded from the 2022 bear market and reached record highs. One of the primary driving forces behind this surge is the investment trend in artificial intelligence (AI), which has witnessed remarkable growth across various sectors.
AI refers to the use of software and systems to execute tasks instead of humans. The key ingredient to AI is machine learning, enabling software and systems to continually learn and improve their efficiency or acquire new skills over time.
The widespread emergence of AI can be attributed to its applicability in almost every industry and sector. Analysts at PwC estimate that AI has the potential to contribute a staggering $15.7 trillion to global gross domestic product (GDP) by 2030.
Nvidia Leads AI Revolution with Unprecedented Growth
No other company has reaped greater rewards from the AI revolution than Nvidia (NVDA), with shares of its stock skyrocketing. Nvidia, known for its dominance in graphics processing units (GPUs) used in gaming and cryptocurrency mining, has steadily capitalized on its competitive advantages in AI. Since the beginning of 2023, the company’s market capitalization has ballooned from $360 billion to a staggering $2.13 trillion, making it a serious contender to become the largest publicly traded company, surpassing even Apple and Microsoft.
One of the main factors driving Nvidia’s growth is its role as the infrastructure backbone for high-compute data centers. The company’s A100 and H100 GPUs are expected to make up a significant portion of GPUs deployed in AI-accelerated data centers operated by enterprises this year. The immense demand for Nvidia’s GPUs has given the company exceptional pricing power, despite its relatively limited supply. While anticipated production increases might alleviate the supply shortage, Nvidia’s data center sales growth has predominantly been driven by higher prices for its cutting-edge A100 and H100 GPUs.
However, it is essential to approach Nvidia’s success with caution, as history indicates that previous next-big-thing investments have eventually succumbed to market downturns. Over the past three decades, numerous investment trends witnessed initial soaring stock prices, only to come crashing down later.
History Reveals the Pitfalls of Next-Big-Thing Bubbles
Throughout history, aspiring investors have been lured by the prospects of next-big-thing investments. However, these investments have often failed to live up to their expectations. The dot-com bubble burst in the early 2000s, as e-commerce and business-to-business commerce failed to meet investors’ lofty predictions. Genome decoding, housing, China stocks, 3D printing, cannabis stocks, electric vehicles, and blockchain technology also experienced similar bursts after initial exuberance.
Considering the recurring patterns, it would be unwise to assume that the ongoing AI trend will be an exception. Many businesses are still in the early stages of developing concrete plans for utilizing AI effectively. This lack of clarity and uncertainty upends the notion of sustained AI adoption leading to exceptional investment returns.
Challenges Breaking Through the AI Infrastructure
Besides historical precedents, Nvidia faces a host of challenges that could pose significant obstacles to its continued success in the AI market. While an uptick in production may seem advantageous, the increased manufacturing of A100 and H100 GPUs may ultimately impact Nvidia’s gross margin. Surpassing last year’s gross margin was partly reliant on GPU scarcity, which will be cannibalized as production escalates.
Moreover, Nvidia will be confronted by fierce competition, not only from traditional rivals like Advanced Micro Devices and Intel but also from the very companies previously driving Nvidia’s sales. From Microsoft to Meta Platforms, Amazon, and Alphabet, Nvidia’s four largest customers, together accounting for 40% of its revenue, are all independently investing in the development of their own AI chips. This increased competition from within might dissuade their reliance on Nvidia’s A100 and H100 offerings.
Compounding matters, U.S. regulators have imposed restrictions on the export of high-compute AI chips to China, preventing Nvidia from shipping its superior AI-GPUs to the world’s second-largest economy. This restriction may lead to significant revenue losses for Nvidia each quarter.
Finally, the company’s valuation may not be as justified as presumed by some investors. Although the price-to-earnings-growth ratio suggests reasonable pricing, Nvidia is currently valued at 38 times its trailing-12-month sales. Except for Amazon and Cisco Systems at the peak of the dot-com bubble, which lasted only briefly and touched around the same valuation levels, no market leader has ever been valued at such a substantial premium to sales.
When scrutinizing these factors collectively, it becomes possible to question the sustainability and stability of Nvidia’s remarkable growth.
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