Is AI a fad?
If you spend enough time embedded in the world of equities and markets, you eventually see it all. Acknowledging the generations of investors before my generation, I am sure there is still more to see and experience. But from the 33-odd years I have been doing this, I like to think there’s a few things I am now able to recognise.
One of those things is when a high-quality company (yep, I think I can recognise and define those now too) hits a temporary speed hump that the market treats as permanent. You don’t need a 70-page report to understand that opportunity, in fact there often isn’t enough time to read a 70-page report before ethe opportunity is gone.
Figure 1. The dream
Figure 2. The reality
The second is when the combination of a company, its business, its product or service and the equity market conspire to produce a thesis and a price that reflect a fad.
Back on September 4, 2019, in a post entitled Beware the Fallout When the Cheap Money Tap Turns Off, I noted, “History shows that investment analysts have a bad habit of being too optimistic about the magnitude of a company’s future earnings, the speed with which those earnings will be delivered and the length of time the growth will last”, noting, the claim in Uber’s prospectus that its “total addressable market (TAM) was US$17 trillion. But given global total gross domestic product (GDP) is $75 trillion and Uber (NYSE:UBER) cannot operate in China, which is 15 per cent of the global economy, Uber’s claimed TAM is equivalent to 27 per cent of global GDP. It took four years for Uber’s share price to move above, and stay above, the price it traded at on its initial public offering (IPO).
On September 12, 2019 in a blog post entitled Why Peloton Interactive is Just the Latest Hula-Hoop, I wrote, “The issue arises because many of these ‘unicorns’ – companies with billion dollar plus valuations – have no clear or obvious path to increase revenue, or cut costs, enough to begin generating profits sufficient to justify their low-interest-rate-fuelled market values.” And concerning Peloton, I concluded, “Peloton’s products, apps and in-room cycling fad will fade just as surely as all the fitness crazes that came before it. And I can assure you Richard Simmons didn’t spend US$324 million to gain awareness like Peloton has in the last two years.” However, the warnings were either dismissed or ignored, and the share price promptly rallied 544 per cent to a high of US$163.00. But you can be sure plenty of losses were subsequently realised, with the share price crashing to US$5.48 today.
And I don’t even have time to write about WeWork’s IPO prospectus, which reported a “Community-based earnings before interest, taxes, depreciation and amortisation (EBITDA)” that not only removed the “ITDA” but also real estate- related expenses, which comprised the bulk of cost required to deliver its service.”
Fads are a function of the human condition. The belief that the technology transforming society will also transform investors’ wallets ignores the monumental losses collectively realised by investors in industries such as commercial air travel, car manufacturing and Television. These technologies were all transformative for humanity, but since their creation, they collectively lost some investors billions.
Consider commercial air travel. Over almost 80 years, since 1945, the total aggregate global profit of all international airlines is estimated at just US$20 billion. Saudi Aramco generates that in just one month, and Microsoft does it in just three months.
While the popularity of products can produce fads, so can investors’ fear of missing out. The latter produces share price fads. Sometimes, if not often now – thanks to social media and easy access to global investing, there can be a fad in the product or service and the share price simultaneously.
Is artificial intelligence (AI) a Fad?
I wonder to what extent there is an element of a fad in the share price and hype surrounding AI-powered large language models.
There is certainly an element of the technology that is transformative for humanity. Indeed, that’s a key ingredient, at least, for a share price fad. Market bubbles almost always build on a kernel of truth – from an entirely sensible, original and rational investment thesis. As the share price starts to go up, it reinforces the validity of the initial thesis. People point to the rising share price after their purchase as proof their thesis was ‘right’. But when the twenty millionth investor hops aboard after the share price has risen 1000 per cent – arguing the same dissertation, we have a fad and a bubble.
Another classic source of fad-like irrational pricing stems from the belief that all participants in a new transformative industry will win. Bottom up stock analysis produces valuations based on the company in question capturing some ‘share’ of the total addressable market. However, few bottom-up analysts step back to examine the consequences of their assumptions. They rarely if ever aggregate their assumptions. Often the resultant collective sales of all the participants is larger than Earth can possibly support.
I remember the claim in Uber’s prospectus back in 2019 that its TAM (total addressable market) was US$17 trillion. But given global total GDP at the time was $75 trillion and Uber could not operate in China, which represented 15 per cent of the global economy, Uber’s claimed TAM was equivalent to 27 per cent of global GDP. We can safely say that Uber does not have a total addressable market that is more than a quarter of the global economy.
Returning to AI-powered large language model’s (LLM), there might be some truth to the idea promoted by its inventors that LLM’s and even small language models (SLMs) can transform the way we live and work. But is there truth to the idea that all players (all seem to have galactic valuations) will win? Clearly not. So some will emerge victorious and most will lose market share or disappear through acquisition or through a lack of investor and consumer support.
And is there truth to the thesis that LLMs keep scaling towards achieving artificial general intelligence? I have read some of the musing by those close to AI’s development that there simply isn’t enough power on Earth to support the ‘scaling’ path to AGI. Without a clear, feasible path for the technology to leap from LLMs to bigger LLMs to AGI, one wonders whether Open AI’s US$150 billion valuation can be supported, especially when the leading commercial use case is currently companion bots – chatbots that keep people company.
It’s worth noting that ChatGPT-4’s ability improved substantially over GPT-3, but the step to 01 was far more modest. Meanwhile the optimists have Chat GPTs capability curve looking rather like the exponential vinyl disco record sales in Figure 1.
I believe OpenAI and its peers are genuine businesses and I don’t believe LLMs are fads. But I do believe, thanks to hype and the uneven distribution of information that sucks investors into a legitimate thesis late, their valuations reflect an investment fad. People paying today’s prices should expect a significant transformation of their investment along the journey, but perhaps not in a good way.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
