The AI conundrum that every investor needs to know about

DeepSeek seems like a long time ago now. It has only been a year since the introduction of China’s AI champion was being talked about as a potential ‘Sputnik Moment’ when the US feared it had lost its technological edge to a communist state. 

More important was the impact on the stock market, wiping $1trn off the Nasdaq in a matter of days. Nvidia alone fell by close to 40% between 23 January and 4 April¹, with the ‘Liberation Day’ tariff announcements giving it another kick while it was down. The view at the time was that DeepSeek, which was developed at a much lower cost than its US competitors, would kill investment in AI. 

We felt this was the wrong way of looking at it and we have been proved right. Since then, expected AI capex for 2028 has increased from $250bn to $500bn. We think it will be closer to $1trn. Since bottoming out on 4 April, Nvidia is up by more than 100%².

Big tech exceeds expectations

Exceeding expectations has been a common theme since we first invested in Nvidia in 2023. This is one of the reasons why we are sceptical about claims of another Dotcom Bubble. There are many others. 

If you look at them individually, every one of the Magnificent Seven has a set of characteristics that make them attractive to investors. They have consistently delivered some of the highest earnings growth in the market. They have dominant positions in the areas in which they operate. And for all the talk of excessive valuations, they have average free cashflow yields of 16%³. 

Last quarter was a strong one for the tech giants, with many of them beating expectations. Yet rather than surge on the good news, some of them actually fell, making them cheaper as they grew faster. This is not what ‘irrational exuberance’ looks like.

No ‘traditional’ bubble in AI

Yet here we would sound a note of caution. We do not think the US market has entered a bubble of the type that peaked around the turn of the millennium. Instead, we think the bubble – if there is one – will take a different form. 

Last quarter was a strong one for the tech giants, with many of them beating expectations. Yet rather than surge on the good news, some of them actually fell, making them cheaper as they grew faster.

AI presents an existential threat as well as an opportunity to the business models of the tech giants. Whereas most of these currently operate in effective monopolies, AI means every category in which they compete is now up for grabs, whether that be e-commerce transactions, human software interactions, digital ad sales or even social media posts.

Greater competition will bring down prices for customers, while the cost of delivering these services will rise as the providers are forced to spend more on AI accelerators.

As a result, if there is any sort of bubble among the tech giants, we think it will be in the cashflows they generate: these will eventually fall back from their elevated levels towards the market average, with valuations potentially going the same way. 

How to make money from the AI boom

Once you have taken this on board, you can begin to think about how to make money from the AI boom – because there is still plenty to be made. 

Inevitably, there will be winners and losers among the tech giants, but we don’t yet know who they will be. We want to retain an open mind so that when the evidence presents itself, we can act accordingly.

One thing we are fairly certain about, however, is that the billions of dollars already allocated to AI is going to be spent, and then some. 

The heads of the hyperscalers (the providers of massive cloud computing services) are terrified of being left behind, and one of the main determinants of who wins and loses will be who has secured enough chips. 

Therefore, that old cliché about the ‘picks and shovels’ approach to making money from a bubble first leads us to Nvidia – the world is going to need every chip it can produce for at least the next three years.

AI’s reliance on energy 

Another potential bottleneck for these businesses is securing enough energy for their data centres. While they appear to be pinning their hopes on nuclear power, this won’t be the answer for at least the next five years. Instead, it will likely be a mixture of natural gas, solar and fuel cells – our investment in Bloom Energy in early 2025 has proved to be a shrewd one.

The heads of the hyperscalers are terrified of being left behind, and one of the main determinants of who wins and loses will be who has secured enough chips.

But the beneficiaries go all the way down to boring old regulated utilities. We are used to these growing at a fairly unexciting 5% a year, but they have now raised their forecasts to 9%⁴– a figure that is pretty much nailed on following negotiations with the utility commission.

AI’s boost for blue-collar workers 

Another consideration with the data centres is the small issue of who is actually going to build them. Somebody has to flatten the land, lay the concrete, connect the power and air conditioning and supply all the necessary equipment. The supply of skilled labour could be as much of a bottleneck as the supply of energy or microchips – if you have gone to the great expense of building a data centre, you don’t want it sitting there doing nothing for a month because you haven’t connected the power. 

We recently met the chief financial officer of one of our holdings that is benefiting from the build-out of AI centres. Previously, the fortunes of his business had been closely tied to economic growth, so even in the good times a downturn was never too far away. Decades of this experience do not typically produce a chief financial officer prone to hyperbole. Therefore, we were struck by his observation that – because of the expected size of the AI build-out and the contracts for other industries that were getting squeezed out but would have to be built in the future – he did not expect a blue-collar recession in his lifetime.

There is plenty of excitement around AI and its potential to transform and disrupt even the most advanced industries. But this time around, taking a ‘picks and shovels’ approach to a stock market boom could well mean investing in the people that actually use picks and shovels.