Jul 18 • General discussion
When it Comes to AI, it's Time to Buy the Shovels
Throughout history, revolutionary technologies have followed a predictable pattern: Initial discovery sparks excitement, leading to a frenzy of speculation and inflated valuations. However, as reality sets in, the hype cycle subsides, and the true winners emerge – often those providing the tools and services that enable the new technology. This phenomenon is playing out once again with the rise of artificial intelligence (AI), and savvy investors would be wise to "buy the shovels" this time around.
The Gold Rush Analogy: Levi Strauss and Beyond
The California Gold Rush of the mid-19th century serves as a perfect analogy. While a few lucky prospectors struck it rich by finding gold, the real fortunes were made by those who sold shovels, pickaxes, and other supplies to the miners. Levi Strauss capitalized on this opportunity by selling durable denim pants to prospectors, laying the foundation for what would become a global apparel empire. Similarly, companies like Studebaker and Wells Fargo flourished by providing transportation and banking services to the mining communities.
The Radio Corporation of America (RCA) Saga
Looking back further in Wall Street history, the rise and fall of the Radio Corporation of America (RCA) provides another cautionary tale. In the early 20th century, RCA was at the forefront of the radio revolution, and its stock soared as investors piled in to the radio revolution. However, the company's fortunes faded as it failed to keep pace with technological advancements, and its stock price languished for decades.
The Nifty Fifty: A Cautionary Tale from the 1970s
During the 1970s, a group of leading blue-chip stocks dubbed the "Nifty Fifty" (including Coca Cola, Walt Disney and John & Johnson) reached astronomical valuations as investors became convinced these companies were impervious to economic cycles. Caught up in intense optimism, traders bid up share prices to dizzying heights, pricing in perpetual growth that defied business realities. However, this unbridled exuberance proved unsustainable. One by one, the high-flying Nifty Fifty stocks came back down to earth with painful corrections as it became clear their once-revered business models were not immune to economic forces after all.
The Dotcom Bubble: A Cautionary Tale
Fast forward to the late 1990s and early 2000s, and we witnessed a similar pattern with the dotcom boom. Speculative frenzy drove tech stocks to stratospheric heights, only for the bubble to burst spectacularly – remember Pets.com? While many of the high-flying internet companies of that era went bust, the true winners were the companies that provided the infrastructure and services that powered the internet revolution – think companies like Cisco, Oracle, and Microsoft.
Online Betting and Cannabis Stocks: Recent Cautionary Tales
More recent examples of overhyped sectors include online betting and cannabis stocks. As online sports betting was legalized across various states, companies like DraftKings (DKNG) and Penn National Gaming (PENN) saw their valuations skyrocket, trading at exorbitant price-to-earnings ratios. As I watched that occur, I was wondering if anyone buying these shares realized just how challenging it was to set lines and be a bookie. I had some idea, and inherently knew those stocks were primed to be shorted, but that’s a story for another day. Similarly, the cannabis industry experienced a "green rush," with stocks like Canopy Growth (CGC) and Aurora Cannabis (ACB) trading ridiculously high (pun intended) before crashing and burning back down to earth.
The AI Revolution: Separating Hype from Reality
Now, the spotlight is on AI, with breathtaking advancements in natural language processing, computer vision, and machine learning capturing the world's imagination. Investors have piled into AI-related stocks, driving valuations to frothy levels. However, as with previous technological revolutions, the AI hype is likely to outpace the reality in the near term.
While AI will undoubtedly transform countless industries and create immense value, the companies at the forefront of this revolution may not be the ones reaping the biggest rewards – at least not yet. Instead, investors may be better served by focusing on the companies providing the tools, infrastructure, and services that enable AI development and deployment.
But this Time it’s Different
That’s what they always say, with “they” being the dumb money that Wall Street insiders have duped once again. Let’s face it, when shoeshine boys give stock advice, like right before the great depression, and hairdressers join together to buy a negative cash flow condo because it will be “worth more tomorrow”, like occurred before the Great Recession, then it’s time to be selling with both fists before the herd stampedes behind you.
Many Wall Street professionals mocked Warren Buffet for being behind the times as he warily viewed the Dotcom bubble with a jaundiced eye, only to be proved correct, yet again. Only once in my lifetime, has “this time” ever truly “been different” and that’s with Cryptocurrency, something I’m bullish on until we see any high level of government interference. Besides that, time and again, market forces have proven that a falling tide exposes those who are swimming naked (paraphrasing Warren Buffet).
The AI Shovels: Chip Makers, Cloud Providers, and More
So, the inevitable question is “what are the "shovels" in the AI gold rush?” Semiconductor companies like NVIDIA (NVDA) and AMD (AMD), whose powerful graphics processing units (GPUs) are essential for training AI models, are prime candidates. Frankly, I’m a bit nervous about how frothy their stock valuations have become as many people jump into that crowded trade. However, in the long run, they are the right companies in the right space at the right time. They will only continue to grow. Look to add positions in these stocks slowly, over time, catching the price dips.
I also love the Cloud computing giants like Amazon (AMZN), Microsoft (MSFT), and Google (GOOGL), which provide the computing power and data storage required for AI workloads Corning (GLW) is another great opportunity because demand for their optical connectivity products has been through the roof. All these companies are well-positioned to ride this AI wave.
Other potential "shovel sellers" include software companies that develop AI development tools and platforms, as well as consulting firms that help businesses integrate AI into their operations. Even companies that provide the vast troves of data used to train AI models could be considered part of this ecosystem. I’ll keep keeping an eye out for some of those small up and comers to share with you in the future.
Patience and Diversification are Key
As with any technological revolution, the AI boom will likely create immense wealth – but also substantial disappointment for those caught up in the hype. Investors would be wise to temper their expectations and focus on the companies providing the tools and services that enable AI, rather than betting the farm on the companies promising the moon.
Diversification and patience will be key, as the true winners of the AI revolution may not be immediately apparent. But by utilizing a "buying the shovels" mindset, investors can position themselves to profit from this transformative technology while mitigating the risks associated with overhyped and overvalued AI companies.
History has shown time and again that the surest path to riches lies not in chasing the latest craze but in providing the tools and services that enable it. As the AI revolution unfolds, savvy investors would do well to heed this age-old wisdom and invest in the "shovel sellers" of the AI gold rush.
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When it Comes to AI, it's Time to Buy the Shovels
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