I am increasingly sceptical about valuations in a number of the tech plays we have seen doing well over the past couple of years. I’m not a full-blown AI bear at all, and as a dividend investor I do hold a lot of companies that are exposed to the theme, either through more reasonably priced AI enablers or through companies that are benefitting, for example from growing industrial automation.
But I think increasingly the opportunities lie in companies that successfully use AI to improve their businesses, rather than just the pure picks and shovel names.
As an income investor, I’m used to focusing on total shareholder returns backed by dividends and buybacks. The big hyperscalers were previously companies that were returning huge quantities of cash to shareholders. Now they are spending most of their cash flow on capital expenditure (capex) for a return which is as yet unclear. Just as importantly, previously they were all swimming in their own lanes. That is no longer the case: they are now competing with each other and not everyone can win.
There’s a similar way of looking at the memory chip players in a couple of the markets I currently watch most closely. I’ve held some of these companies for a long time, but, for example, SK Hynix, Samsung, and Micron together next year are expected to generate around US$600 billion in net income.
That is higher than Microsoft, Apple, Meta, and Alphabet combined. While the memory supply-demand balance remains tight for the foreseeable future, the profit pool for these cyclical businesses looks unsustainable in the long run. This, combined with increasing retail investor participation in these stocks, makes me more sceptical about them in the medium term.
That is all worth bearing in mind when we look at the volatility of the past few months. There has been an equities market sell-off, but more than that: the recovery has been quite tightly about AI names, and many of them look richly priced given medium-term assumptions and the recognition that this is a cyclical industry.
In many ways that’s a reflection of my investment experience more generally over the last couple of years: my aim is to keep pace in rising markets, but to do so with a lower level of volatility and drawdowns; to achieve that outcome at a time of such volatility in the overall market, and such (over)concentration, takes a lot of nimble, hard work and a lot of good investment ideas.
Increasingly I find more and more of these in sectors that investors have neglected. Examples include healthcare, property, and selective names in the consumer space. That direction, along with what happens in the AI trade, may help shape the rest of the year.
