AI Stocks Swing Down On Doubts About Sustainability and Payout Prospects

It is fair to say that the AI haircut is more of a trim than a shave. But the shock to the market is that there is any tangible expression of doubt about the wisdom of tech leadership's AI hype and the spending it continues to spawn. Witness Palantir CEO Karp's meltdown last week over investors' nerve in selling his company's stock. 

The reality is that the the proverbial path to profitability in AI does not yet exist. And 'trust us,' is no longer working for those who are doing the math. Questions of valuation and sustainability (of the financial, not environmental kind) invariably creep in when the numbers get too out of whack as expectations of reversion to the mean loom. There have been too many 'this time is different' episodes which didn't pan out for savvy investors to ignore. JL

Asa Fitch and Dan Gallagher report in the Wall Street Journal:

Even AI companies posting strong financial results haven’t avoided investors’ wrath. There are real reasons to worry about the sustainability of the boom. Chief among them, that there is far more AI spending than there is AI revenue, a gulf that is widening. OpenAI lacks a clear business model to reach the hundreds of billions it needs within the next few years to keep spending growth going. AI-related companies issued $139 billion of corporate bonds this year, a 23% jump over last year. Meta fell 17% since its third-quarter report two weeks ago. Palantir, whichhad soared to an absurd price-to-forward-earnings ratio above 250, is down 8% since Monday. There are fundamental factors driving the AI story, notably the spending of the biggest companies in tech. After three years of investment and no financial model for profitable AI, fear and fatigue among investors are inevitable.

increase; green up pwhich had soared to an absurd price-to-forward-earnings ratio above 250, is down nearly 8%.decrease; red down pointing triahas shed nearly 17% since its solid third-quarter report two weeks ago that included another plan for blowout capital spending. Palantir PLTR 1.09%increase; green up pointihe AI software company that had soared to an absurd price-to-forward-earnings ratio above 250, is down nearly 8% since its respectable earnings last Monday.

Perfect isn’t good enough, and any sign of weakness is a disaster: Justified or not, that’s the current mood in the markets about the AI boom.

Recent history suggests that the gloom won’t last. But the shake-up serves as a strong reminder that the early years of AI pose a challenge for investors accustomed to measuring returns on a 12-month time horizon.

Generative artificial-intelligence services require massive data centers and state-of-the-art chips and server racks that don’t come together quickly. The companies at the heart of AI now are talking about years—plural—of major investments still ahead.

 

The latest episode of fragility started last week, when shares of some of the sector’s leading lights lost ground. After a broad-based recovery Monday on news of a possible end to the government shutdown, AI-exposed stocks fell again on Tuesday. Nvidia NVDA 1.77%

increase; green up pointing triangle lost 7% last week and slipped another 3% on Tuesday—leaving it well shy of its $5 trillion market-cap milestone last month.

Even companies posting strong financial results haven’t avoided investors’ wrath lately. Meta Platforms META -0.07%decrease; red down pointing triangle has shed nearly 17% since its solid third-quarter report two weeks ago that included another plan for blowout capital spending. Palantir PLTR 1.09%increase; green up pointing triangle, the AI software company that had soared to an absurd price-to-forward-earnings ratio above 250, is down nearly 8% since its respectable earnings last Monday.

There are, of course, real reasons to worry about the sustainability of the boom. Chief among them is that there is far more AI computing infrastructure spending than there is AI revenue, a gulf that is widening by the day. 

OpenAI says it is planning to spend $1.4 trillion in the next eight years. But it is pulling in only around $20 billion of annual revenue today, and it lacks a clear business model to reach the hundreds of billions it needs within the next few years to keep spending growth going.

OpenAI is already projecting that losses will swell to $74 billion in 2028. So skittish has the mood become that Chief Executive Sam Altman felt the need last week to defend the company on X, saying the spending was “understandably” causing concern. He pointed to his plans to boost revenue with new consumer devices, robotics efforts and an AI cloud-computing service, none of which currently exist.

 

Another source of concern lies in the huge amount of leverage needed to finance the outsize ambitions of AI’s biggest players. Oracle ORCL 2.43%

increase; green up pointing triangle reached a $300 billion deal with OpenAI in September to supply it with AI computing power, and it raised $18 billion through a bond sale the same month. That is a foretaste of what analysts say will be a growing pool of debt tied to data centers. 

AI-related companies had issued $139 billion of corporate bonds this year as of last month, according to a Goldman Sachs report—about 9% of all investor-grade issuance and a 23% jump over last year. Meta Platforms organized a $27.3 billion financing for a Louisiana data-center complex last month alone in what was the largest-ever private-debt deal.

 

Then there are the inevitable hiccups from shortages of power and other supply-chain bottlenecks. CoreWeave CRWV -1.25%

decrease; red down pointing triangle, an AI cloud player backed by Nvidia, reported strong earnings on Monday but noted a delay in data-center construction that would dent revenue in the current quarter. Its shares slid 16% on Tuesday and have lost a third of their value since the beginning of last week, as the highly leveraged company is considered one of the riskier stocks in the AI space.  

So far, though, there is little sign that the underlying spending boom is stagnating. The big tech companies’ capital spending on AI is on the rise, with more than $400 billion planned this year. Nvidia, Advanced Micro Devices AMD -0.46%decrease; red down pointing triangle, Arm ARM -0.38%decrease; red down pointing triangle, Supermicro SMCI 3.79%increase; green up pointing triangle and other suppliers to the boom haven’t moderated their tone at all—if anything, they appear increasingly bullish. Nvidia has already projected revenue growing 56% year over year for the fiscal third quarter that it plans to report next week.

 

On Tuesday, AMD Chief Executive Lisa Su said some customers last year thought their investments in AI would level off but now say they are accelerating. “If you have the chance, if you have the balance sheet, if you have the capability to put on more compute, you’re going to do it, because it’s going to give you incremental advantage versus your competition,” she said.

Overall, tech valuations don’t look outrageous, especially with companies like Nvidia minting profits. The average forward price-to-earnings ratio for the tech-heavy Nasdaq Composite Index is about 29—a high number, to be sure, but nothing astronomical for a basket of growing companies. That figure reached above 32 in 2021, the year before the AI boom.

Investors are twitchy about any sign of weakness in the AI trade and have been for some time. The emergence of DeepSeek, a sophisticated Chinese model created with relatively few AI chips, caused a scare earlier this year. Other smaller moments of panic have also come up since; Nvidia’s stock alone has seen worse weekly drops four times this year compared with last week’s decline.

As was the case then and still is now, there are fundamental factors driving the AI story, most notably the very real spending intentions of the biggest companies in tech. But after three years of booming investment and no clear financial model for profitable AI, breakouts of fear and fatigue among investors are inevitable.