AI companies may be expensive, but there’s no doubting their strength. They have kept delivering on earnings and profitability. This quarter was no exception, with Nvidia the most recent group to deliver a bumper set of earnings. This has kept the flame alive for investors, but can they rely on this strength continuing?
AI keeps beating expectations
Nvidia has been the poster-child for another bumper earnings season for the technology giants. It reported second-quarter revenue of $96.22 billion, more than double the previous year. It also said its revenues for next year would be 70% higher, outpacing market estimates*. In a market that has become increasingly hard to impress, investors were cheered by the result.
It wasn’t the only success story; Amazon and Alphabet delivered huge earnings growth, even if the market was nervous about the cash burn on AI spending. It was a similar picture in Asia, with the memory and semiconductor names all delivering chunky revenue improvements. With some rare exceptions, the picture was one of buoyant demand and ongoing strength. In theory, investors could sit easy, knowing that the boom could continue.
However, this neglects some of the other messages to emerge from this quarter’s earnings season. Mark Peden, manager of the Aegon Global Equity Income fund, points out that the AI theme is broadening out and boosting earnings in adjacent sectors: “Industrials is a case in point, as companies with exposure to data centre build out through activities such as power management, construction equipment manufacture or rental and electricity grid installation are all seeing their earnings boosted by the AI race.”
Equally, it wasn’t just the AI trade where earnings were strong. Craig Rippe, fund manager at Keyridge Asset Management, says: “Upgrades are not just a narrow ‘Mag Seven’ story. Banks, cyclicals and parts of Europe are beginning to contribute. If Q2 results confirm that profits are broadening while inflation pressure is contained, equities could continue to grind higher despite geopolitical noise.”
Financials in particular are in rude health, says Peden, buoyed by higher interest rates, “This has ensured a positive backdrop for bank earnings, which have been further boosted by surging investment banking profits. Times are good and banks are extremely well capitalised, which has made for strong distributions to shareholders.”
The same is true in Asia, where the undoubted strength of the semiconductor and memory cycle has crowded out other areas. Abbas Barkhordar, manager of the Schroder Asian Alpha Plus fund, says: “Crowded trades can become expensive as capital concentrates in a small number of well-understood names. Areas that suffer investor neglect, by contrast, can often be where the most compelling long-term opportunities are found.”
He says that technology remains a vital part of Asian growth, and a significant part of the Schroder portfolio, but Asia’s growth story is considerably broader. “Companies such as Midea, HD Hyundai Marine Solution and MakeMyTrip show where else that growth can be found. Technology has driven much of the region’s recent returns, but history and logic both suggest this will not always be the case.”
Keeping a foot in both camps
The approach for many fund managers has been to keep a foot in both camps. Rippe, for example, is still exposed to semiconductor companies, but also some of the second-order beneficiaries: industrials linked to electrification and power, selected infrastructure, and miners and metals connected to energy transition and grid build-out. He is also broadening out into European banks and infrastructure companies**.
Can AI justify the investment?
Investors also can’t ignore the risks associated with AI no matter how good the earnings. Peden says there are still questions over monetisation. “Will companies be able to generate the revenues necessary to derive an acceptable return on investment from the huge capital outlays they are making on AI?”
Equally, he says, there is a danger that AI models become commoditised, meaning there will be little competitive advantage to be gained for one model developer over another. “This would certainly challenge the economics of the tech space. For now, these are fairly long-dated questions and look more like tail risks than immediate challenges to the huge positive momentum behind the AI buildout.”
For the time being, the latest set of earnings suggest all is well in the world of AI, but investors need to be alert to the longer-term risks. Equally, they shouldn’t neglect the opportunities elsewhere. The AI build-out is creating winners beyond the technology giants, while areas such as financials are also showing strength.
