What AI Spending Could Mean for Investors

In today's video, Focus Partners’ Kevin Grogan discusses the massive build-out in artificial intelligence infrastructure and why it poses both an opportunity and a risk for investors. 

Over the next five years, McKinsey estimates that cumulative artificial intelligence (AI) investment will reach a staggering $5.2 trillion. There's no doubt that that is a massive number, and it begs the question: What are these companies spending this money on?  

It's generally being spent on building data centers and manufacturing chips and servers. Technology firms of today are no longer purely software companies; they are now capital-intensive infrastructure firms. Kai Wu at Sparkline Capital looked at decades of data and found that firms with high capital expenditures, or those becoming more asset-heavy, generally underperformed their peers.  

There are a few different reasons for this: 

• Number one, building infrastructure means that you actually have to use that infrastructure to generate revenue. And if demand falls short, you can end up with excess capacity, lower margins, and weaker returns.
• Second, asset-heavy models are easier to replicate and more subject to competition, which can mean greater pricing pressure.
• Third, shifting from an asset-light model, which many tech firms have enjoyed historically, to an asset-heavy model tends to reduce returns on invested capital. 

So, what this means for the big technology firms and the Magnificent Seven companies is that they are generally transforming from asset-lite software companies to asset-heavy infrastructure companies.  

Now, importantly, this doesn't mean that these companies are doomed to underperform in the future; it just means that their risk profile is different today than what it was historically. Today, these firms are more like industrial firms than pure technology innovators. 

Implications for Investors 

In terms of implications for investors, there are two: 

• Number one is that I wouldn't assume that the biggest spenders will be the biggest winners. As you think back to the late 1990s and the telecom fiber optic build-out, there were a lot of companies that spent a lot of money building all of that out. They wound up not being the big winners from the internet revolution. It tended to be other companies, like Amazon, for example. 
• Second, while AI is no doubt exciting, it's always important for investors to remember that valuations matter. If you overpay for an investment, your returns will suffer no matter how great the technology winds up being. 

If you do have any questions on anything I've covered in today's video, please don't hesitate to reach out to your advisor. 

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