In the J.R.R. Tolkien story, The Lord of the Rings, there is one all-powerful ring that binds and rules the other rings of power. When I saw the following slide depicting the interconnectedness of the major players in the AI buildout, it made me think of that storyline, and a slight sense of unease came over me.
In our world of investing, that all-powerful ring is Nvidia, the company responsible for the production of the graphics-processing units on the chips used for accelerated computing, the backbone of AI. The performance of the shares of the companies in this family of AI creators, also known as the Mag7, has been the topic of a lot of chatter around the water cooler and braais over recent years, and the prevailing sentiment is that they have become too expensive. We have seen a subsequent fall in the prices of most of these shares with Nvidia down 12% from its all-time highs, Amazon down 13%, Meta down 25% and Tesla down 17%. The index representing these shares, i.e. the Nasdaq100, is down 5.66% from its all-time highs in October, but still up 10.5% year to date.
As an investor in equities, you always have to ask yourself one question, “Do I still have a firm conviction that the price I pay for the company I am investing in today, will be higher five years from now?” If your answer is yes, then you will not mind the noise created by the media and negative sentiment following short-term price volatility. If you get spooked by these short-term trends, then you should either call yourself a trader, or not be invested in equities at all. It is always unsettling to see a share, or in this case a group of shares, go up so much so fast, as we have seen the Mag7 do over the last three years, and that is why you have to take stock of the reasons behind the performance. If we take the godfather of AI and the most valuable company in the world today, Nvidia, and we analyze it, we see the following:
- The share is up 1142% over the last three years
- It is trading at a forward P/E of 30, which is higher than the average 22.6 of the S&P500 index
- In the Q3 results published on the 19 November, the earnings per share are up 60% year over year (astounding!) and the sales are up 63% yoy (astounding!)
As we have mentioned before, if the earnings of a company can support the price of its share, and there is an expectation that those earnings will keep on growing, then you can be a high-conviction owner of that share, and the only reason to sell will be to rebalance your portfolio for healthy risk management, or to top up your cash requirements. With the inter-connectedness of companies participating in the technology buildout worldwide, is has to be said that not all of them will succeed and their failure will contaminate some of the other participants. We will see periods of volatility where the winners will have to recalibrate and your investment return expectations will have to be moderated.
The area of more concern currently, is the performance of commodities like gold and silver. We have discussed the reasons behind the recent spectacular growth in the price of these metals, and especially in the prices of the mining companies, but we have to remember that commodities are cyclical and although there are some strong tailwinds that can see them performing well for some time to come, the downturn is inevitable. The dark horse with no fundamentals or method of valuation, remains the crypto market. We have seen a sharp decline in Bitcoin and all other crypto instruments over the last week or so. This is not uncommon for this asset class and most supporters of crypto will laugh at a 30% decline in the price. If you are a believer in crypto you have only one anchor to hold on to and that is worldwide adoption. Crypto has made fools of all the fundamentalist investors for a very long time, but you cannot commit money to crypto if you cannot afford to wait a long time for whatever the ultimate outcome will be. It is, however, very clear that crypto will play an important role in our lives in the years to come.