The potential of AI is being touted as a game changer, primed to revamp our ways of doing business and drastically increase productivity, revenue, and profits. Yet, when it comes to solid advice for investors, the conversation is still relatively muted. Perhaps this is because AI is a greenfield sector, and predicting its trajectory is akin to weather forecasting in its infancy.

My inaugural encounter with AI investment research hails back to a 2018 Morgan Stanley recommendation. Their lineup included tech heavyweights Alphabet (Google), Microsoft, Nvidia, Amazon, Alibaba, and Baidu.  Quite a prescient list, and while the two China companies have lost 30-50% of their value, the rest have thrived, with Nvidia stealing the spotlight boasting an impressive gain of almost 700% (65% annualised). 

If you invested in all six stocks equally, you would have made 169%, a figure that certainly isn’t insignificant. However an investment in the reliable Nasdaq ETF would have yielded a slightly less, yet still substantial, 125% return.

What if instead you had invested into the handful of the larger AI ETFs available over the last five years? They all underperformed the Nasdaq index:

BOTZ +35%

ROBO +48%

IRBO +46%

NXTG +59%

AIQ +91%

Except AIQ, they all even underperformed the S&P500 ETF, which gained 78% in the same period.  If one was looking to invest specifically in the AI domain, existing ETFs may not be the golden ticket, at least not based on the previous half-decade.  Many of the AI beneficiaries happen to be the largest technology companies that are part of the S&P500, like Apple, Microsoft, Alphabet, Amazon, Tesla, and Nvidia. 

What lessons can be gleaned from this current AI investment landscape? A look back at the dawn of the internet era and the subsequent dot-com bust is instructive. 

Back then, Cisco stock was touted as the ‘must own’ company to benefit from the internet. You could ‘buy and forget’ it, letting the company compound its earnings at double-digits forever. Two decades later, we can see that the internet’s forecasted growth has been met, or even exceeded. I still remember the days of faxing 30 page presentations that came out in fuzzy black and white and could hardly be read. Now we can send 30 page pdf presentations in full colour instantly and for free to hundreds of people at the click of a button.

And yet, two decades later Cisco stock still trades -30% below its peak at the start of the millennium. At the peak the stock had a lofty valuation of 29x sales, and a P/E of 201.  While Cisco’s edge was not that significant, in that many other companies started making internet connectivity equipment, which did not require particularly advanced technology.  Cisco’s historical example can be a warning for fans of Nvidia. While Nvidia’s AI chips are much more advanced and difficult to replicate as compared to Cisco’s equipment, there is the possibility that future technological advances will reduce the cost of such equipment, and even come up with alternatives. Two decades ago Intel’s dominance of the CPU market looked unassailable. And yet Intel has been another casualty of technological advances, with its stock -50% below its peak in year 2000. Meanwhile Advanced Micro Devices (AMD), Intel’s perennial second-place competitor, has left Intel in the dust, with a gain of 4300% in 8 years. In the same period Intel gained a meagre 1%.  

Current valuations of Nvidia are assuming that it will maintain its market leading position. History shows that companies are rarely able to do so.

Another takeaway is that many internet success stories were still in their infancy during the dot-com boom. A parallel can be drawn with today’s AI investment landscape. Apart from OpenAI, valued at an impressive $29 billion, most other AI-centric private entities have far more modest valuations in the $1-5 billion bracket. 

Investors should bear in mind that while pioneering technology companies can often falter, the next big player in the AI space could be among these nascent entities. In the realm of AI investments, it might be prudent to consider opportunities beyond just publicly listed companies.