AI revolution: outrageously high valuations, a new tech stock bubble?

The artificial intelligence, or “AI,” revolution is upon us. The financial media and headlines are abuzz with stories of generative “AI” and the subsequent “industrial revolution.”

Not surprisingly, attention has turned to AI with the launch of ChatGPT. The benefits are already apparent with the incorporation of AI into search engines. Even TikTok videos on ” making a million” using AI suggest why stocks associated with AI surged in recent months.
The Industrial Revolution is often considered a continuous event from the 1800s to the present. However, it is better understood as a series of paradigm shifts. The fourth paradigm shift is occurring now. That revolution encompasses the advent of exponential technologies, from artificial intelligence and intelligent machines to robotics, blockchain, and virtual reality. Those technologies have already impacted how we live for over a decade.
These booms provided great opportunities as the innovations offered great investment opportunities to capitalize on the advances. Each phase led to stellar market returns that lasted a decade or more as investors chased emerging opportunities. (We will come back to those blue-shaded areas momentarily.)

We are experiencing another of these speculative “booms” as “Generative AI” grips investors’ imaginations. The chart below compares the 1999 “Dot.com/Internet Revolution” in the Nasdaq composite versus the 2023 “Generative AI” revolution.

If that analogy holds, it suggests the opportunity to capitalize on the impact of “AI” from an investment perspective remains.
But what about those blue-shaded boxes?

Those Blue Shaded Boxes
While the allure of “AI” certainly has investors salivating at the potential return profile, the valuation problem remains. As shown, despite the technological advances made from space exploration, the internet, or even “AI,” over-valuation can lead to long periods of stagnation.

Yes, many of these companies will benefit from adopting “AI.” However, it is hard to justify, even under optimistic assumptions, that revenue growth will support the multiples paid today.

The companies that advanced regardless of actual revenue, earnings, or valuations were on the cutting edge of the internet revolution. As such, many thought “trees could grow to the sky.” Endless possibilities existed of how the internet would change our lives, the workplace, and futures. While the internet did indeed change our world, the reality of valuations and earnings growth eventually “mean reverted.”
It is crucial to remember that while valuations are essential to the eventual outcome of speculative market phases, it is a terrible market timing indicator. Price measures the current “psychology” of the “herd” and is the most precise representation of the behavioral dynamics of the living organism we call “the market.”