BT issue 16 VF - Flipbook - Page 31
ISSUE 16
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HIGHLY VALUED
The internet has undoubtedly proven a game-changer
in many areas, but many of the most successful
companies that benefited from its widespread adoption
were already fairly, or highly, valued in the early 2000s.
Many companies that failed to benefit were also highly
valued. One way of viewing a stock’s valuation is to look
at its price/earnings (P/E) ratio. The P/E ratio simply
shows how many times last year’s earnings it will take
to match the current market valuation. For instance, a
stock worth US$100bn that earned US$10bn last year
would trade on a P/E ratio of 10.
Nvidia currently trades at a lofty 195x last year’s
earnings, an extremely high valuation historically
among companies worth anywhere near as much. This
is obviously a backward-looking measure, not taking
into account future growth, and the company did
recently revise its expected sales figure up by more than
50% to US$11bn for the three months to the end of July.
However, it still needs to go some to justify the current
market valuation.
A comparison can be made to Cisco Systems which
traded at a P/E above 200x in early 2000, after investors
priced-in a lot of good news on the growth potential of
the internet. The business has in fact been a success,
growing along the lines of expectations over the last 20+
years, but those buying the stock at its early peak would
have had to wait until 2018 just to get back to their entry
level. As of early June 2023, they would be sitting on a
total gain of just over 20%.
Nvidia is just one example, albeit arguably the most
extreme, of the market impact caused by the surging
interest in AI. Its chips power AI applications, including
ChatGPT, and have become key components to building
generative AI systems. There are several other ways to
gain exposure to the technology though and, as always,
there is undoubted benefit to retaining clear and critical
thinking when assessing a firm’s prospects.
Venture capitalists have speculated that the market
for generative AI applications could be as large as
US$1tn annually. But rather than take their word for
it, it is prudent to consider estimations behind these
projections. With over one billion knowledge workers
globally, and OpenAI charging US$42 a month for the
professional version of ChatGPT, you would need every
single one to sign up for two accounts to get close to that
valuation, as noted by Lloyd Walmsley, a UBS analyst, in
a recent note.
At Quilter Cheviot, we recognise the clear potential in
the AI space and are invested in - and actively searching
for further opportunities - companies exposed to the
theme, which we believe trade at sensible valuations.
The bursting of the ‘.com bubble’ showed us that while
you can be right on the technology, you can still suffer
large losses if you hold the wrong investment. We
welcome recent developments and share in some of the
excitement in the space, while remaining mindful of
the fact that euphoric levels of investor sentiment rarely
lead to outsized long-term returns. It also significantly
increases the probability of sharp near-term losses.
THERE HAS BEEN A SHARP
INCREASE IN AI MENTIONS
ON Q1 EARNINGS CALLS
3 1
Source: TS Lombard
31
