IS THE HYPE OVER AI JUSTIFIED?

Investment Experts at FAS provide an insight into how AI is affecting portfolio valuations

Global stock markets have performed well over recent months, and a major driver of the returns achieved has been the growing enthusiasm for the potential that artificial intelligence can bring and how companies can take advantage of the rapidly evolving technology.

What is AI?

AI is technology that enables computer systems to simulate human intelligence, with the aim of solving problems that would otherwise require human intervention. Although the concept of can be traced back to the s significant advancement in AI capability has been seen very recently.

Unlike traditional AI applications, which are typically used for data classification and prediction, Generative AI models learn from large datasets, and have the ability to learn and then create new content, from realistic images to speech and writing.

The investment case for AI

Businesses that adopt AI are discovering ways to harness the new technology to streamline operations introduce greater efficiency and boost profitability. or e ample in healthcare AI can help speed up drug research and provide more accurate diagnosis. Another common example is the use of automated customer services, which can learn from responses to increase efficiency.

Manufacturers can harness AI technology to streamline inventory management and insurers and banks are increasingly turning to AI to help detect fraud. Over coming years, e suspect more businesses from finance to vehicle manufacturers will find ways to boost profitability through technology however those companies who have adopted AI at an early stage may gain a competitive advantage.

Whilst many companies can see efficiencies from the use of AI, businesses that provide the infrastructure that enables AI have been amongst the biggest gainers over recent months. The company that may have been able to capitalise on the boom in generative AI more than any other is Nvidia.

As the need for processing power increases, the graphics processing units developed by Nvidia are in high demand, which has helped propel the market capitalisation of Nvidia to close to $3tn. Microchip manufacturers, such as ai an Semiconductor have also benefitted from the increased demand for AI solutions.

Other mega-cap tech companies have benefitted from the advancement of technology. Google and Microsoft have integrated AI technology into search assistants and the use of cloud computing in AI applications has boosted revenue received from cloud based servers. Recently, Apple have announced the integration of OpenAI into their Apple Intelligence system which will be available on Apple devices.

An overheated market?

Investors may recall the end of the last century as being a time when market interest in technology companies reached fever pitch. Known as the “Dot Com bubble”, the value of many technology stocks was driven to unrealistic levels based on the prospects for rapid growth in web-based applications. Whilst a select few companies justified their lofty valuations, many did not, and as investor risk appetite waned, sharp falls in value were seen across much of the sector.

Despite the strong returns achieved by a number of stocks involved in AI over recent months, it is possible to draw a distinction between the pure speculation that was apparent in 2000 when the tech bubble burst, and the returns that have been fuelled by the growth in AI.

Firstly, positive earnings reports from tech giants such as Nvidia and Microsoft continue to offer support at current valuation levels, and if quarterly earnings continue to beat estimates convincingly, valuations become less demanding however expect stock valuations to be punished if future earnings fail to deliver.

The second clear distinction between the current tech rally and 1999 is the breadth of businesses that are benefitting from the growth in AI. Whilst it is quite easy to identify the companies at the forefront of AI technology, it is likely that a wide range of companies across different sectors will be able to achieve efficiencies and cost savings through .

Finally, mega-tech giants such as Apple and Alphabet are highly cash generative and profitable. his is in contrast to many companies that were swept up in the bubble of 1999, who were many years away from profitability and often carried high levels of debt.

AI stocks are certainly not cheap on a valuation basis, and investors need to be aware that valuations are exposed should future earnings not meet expectations. That being said, the trend towards AI is showing no signs of slowing at present.

Investors should never look to formulate an investment strategy that focuses on a narrow trend such as AI, and any exposure should be part of a wider portfolio that invests in a range of sectors across the economy to spread risk. You should consult an independent adviser to ensure that your pension or investment portfolio is adequately diversified and doesn't carry excess investment risk.

The content of this article is for information only and does not constitute financial advice. It is for general information only and should not be relied upon when making any financial planning decisions. You should always obtain professional independent advice based on your circumstances. Financial Advice & Services Limited, Independent Financial Advisers, authorised and regulated by the Financial Conduct Authority.