Big Tech's AI Investment Payoffs Are Facing an Earnings Test

The 'Magnificent 7'—a group of tech giants have been pivotal in driving the stock market's gains this year due to their hefty investments in artificial intelligence. Yet this season, analysts caution that merely exceeding quarterly expectations might not suffice to spark Wall Street's enthusiasm. Investors are seeking strong future performance guidance, the lack of which could potentially depress stock values.

Mark Malek, Siebert's chief investment officer, emphasized the heightened expectations, stating, "Investors are particularly eager to see how these firms are leveraging AI for profit and whether the substantial capital deployed is yielding worthwhile returns. Simply exceeding estimates may not suffice; the market is anticipating exceptional outcomes from this sector."

Sequoia Capital has voiced concerns about whether Big Tech can generate adequate returns on their massive AI investments to justify the spending, calling this dilemma 'AI's $600B Question'. Their analysis, building on their September 2023 study, points to a daunting revenue target of $600B needed from Nvidia's $150B annual data center run rate by the fourth quarter, assuming a 50% software margin for CSPs and a 50% operating cost from GPUs.

Concerns about the extensive funds directed toward AI projects have begun to give investors pause. This apprehension spurred some investors to secure profits from mega-tech stocks and shift their capital to smaller-cap companies, seen as having more growth potential especially as the Federal Reserve eases interest rates. As a result, tech stocks have lost some momentum.

John Belton of Gabelli Funds noted, "There's a growing weariness with the AI narrative, as evidenced by the underperformance of semiconductors and many AI-related stocks this quarter."

Solita Marcelli, Chief Investment Officer for the Americas at UBS Global Wealth Management, mentioned in a recent note that third-quarter outcomes could act as a catalyst for advances, as investors zero in on the fundamentals of technology and the potential of AI.

"We continue to favor the semiconductor space and megacaps for AI exposure," she wrote, noting that she expects tech and AI companies to beat results for the September quarter and raise their outlooks.