Tech companies overcome obstacles without fear of heights

Investors were anxiously awaiting Nvidia’s quarterly results this week. The leading designer of graphics cards used for artificial intelligence (AI) applications has become the benchmark for gauging the health of technology companies and, by extension, the entire stock market. On Wednesday – in the afternoon in the United States and early in the morning in Europe – the long-awaited figures were made public. Record sales and profits, even slightly better than the market expected. However, the outlook for future earnings was slightly worse than expected, which was enough for Nvidia shares to fall by more than 6%. A correction not so strong considering that its shares have appreciated by 150% in the year. The rest of the technology companies have held their own during the week. The lesson to be learned? The technology sector continues to ride the wave of artificial intelligence and, apart from a few momentary setbacks, there are no solid arguments to think that it could fall off in the short term.

The corrections that took place at the beginning of August, when the Nasdaq technology index lost almost 3.4% in a single session, highlighted the fear that the markets had of overheating in this sector, but a few weeks later almost all companies have recovered the lost ground.

Nvidia, based in Santa Clara, California, has seen its revenues soar by 122% compared to the second quarter of last year, reaching $30.04 billion (about 27 billion euros). Its profits, meanwhile, have grown by 168% to $16.599 billion, which is also a new record. The problem with such exceptional results is that Nvidia is trading at astronomical prices. Its shares are trading at $125, whereas just five years ago they were worth just $4. The most widely used metric to see how expensive or cheap a share is is the PER, which establishes a comparison between its price and the company’s net profit, that is, the number of times the profit is contained in the price of one of its shares. In the case of Nvidia, it is 75 times, three times that of other US stocks. For this level to be maintained, artificial intelligence must end up being as profitable as promised.

If Nvidia has quickly become a benchmark on Wall Street, it is because of the central role it plays in the hottest topic. Julián Pascual, fund manager and president of the firm Buy & Hold, explains that “Nvidia’s clients are what we call hyperscalers, companies like Amazon, Meta, Twitter or Google, which are creating gigantic computing centres to develop their artificial intelligence proposals.” If Nvidia sells many microprocessors, it is because its clients believe that they will be able to take full advantage of this new technology. Hence the connection.

Just as Nvidia’s evolution is a thermometer for the technology sector, this industry has become the thermometer for how the US Stock Market will perform. This dependence became evident in 2023, when the expression of the Magnificent Seven was coined to refer to the giants of the sector: Apple, Microsoft, Meta (parent company of Facebook and Whatsapp), Alphabet (parent company of Google and YouTube), Amazon (with more and more revenue from cloud storage), Tesla and Nvidia itself. That year, we saw how the evolution of the S&P 500 index was totally conditioned by these seven companies. Never before had so few companies marked the future of an entire market. Today, the dependence has not been reduced. The only relevant change is that Tesla has dropped out and Nvidia has increased its prominence to challenge Apple for the crown of the world’s largest listed company, both with more than 3 trillion dollars of value on the stock market.

Although the valuations of these magnificent seven are high, “the fundamentals of the technology companies remain very solid, with a slight respite in revenues in the second quarter, but still with average growth of between 20% and 25% year-on-year,” explains the Swiss bank UBS in a report for clients. “It also seems clear that spending on artificial intelligence will continue to be very strong.”

The truth is that the valuations of the tech giants are very challenging. If Nvidia is listed at a PER of 75 times, Tesla’s is over 100 times, and Meta, Amazon, Apple or Microsoft are between 25 and 40 times. Before the emergence of the tech giants, the PER of the US Stock Exchange was in the range between 10 and 20 times. Marta Diaz-Bajo, strategy director at Atl Capital, acknowledges that the prices of these shares are dizzying. “There are many clients who ask us if they are not excessive, if there is not a bubble, but we must remember that the historical valuations of technology companies have always been this high and that, for now, all these giants have fulfilled their promises and have managed to increase their results in line with what the market expected.”

Despite the excessive prices, the rise of artificial intelligence does not seem to be slowing down. The three most valuable technology companies in the world, Apple, Microsoft and Nvidia, are considering participating in the next round of financing for OpenAI, the AI ​​developer behind the popular ChatGPT. Microsoft’s entry into OpenAI’s shareholding, with an investment of 10 billion dollars at the beginning of 2023, was the starting signal for the frenzy over a type of technology that many compare to the industrial revolution or the emergence of the internet in the 1990s.

Danny Fish is the head of technology investment at the American asset manager Janus Henderson. After 30 years working in Silicon Valley (the cradle of the great innovations of the last decades), he explains that he had never seen a breakthrough like that of artificial intelligence. “It will end up impacting each and every sector of activity, and improving productivity,” he explains. In his opinion, there may be a certain overestimation of the short-term impact of these advances on the stock market, “but I think the transformative potential in the medium and long term will be much greater than we expect.”

Each of the tech giants is playing the AI ​​card in its own way. Microsoft, with its strategic agreement with OpenAI and the development of the Azure platform, can bring these advances to hundreds of millions of computers around the world in a matter of months. Apple has just incorporated new AI functionalities into its new range of iPhone mobile phones. Alphabet, Meta and Amazon have been developing powerful cloud computing and storage services for years, and have huge customer bases to sell AI applications to. And even Tesla, the leader in electric cars, is going to take advantage of AI with its huge databases collected to advance autonomous driving. At the center of all of them, Nvidia and the chip and semiconductor manufacturing industry, essential to continue increasing computing and calculation capacity.

On August 5, the technology sector received a warning signal with a major stock market correction, aggravated by low trading volumes during the summer. More than one analyst pointed to the date as the beginning of the end of the artificial intelligence bubble. But the truth is that the Magnificent Seven took the blow very well and there are already several of them trading above the valuations at the end of July (Apple, Nvidia, Meta…).

The main thesis of the major analyst firms has not changed. The technology sector is making a lot of money and will continue to make more in the coming quarters. A good example is the monitoring of Nvidia shares. Of the 73 experts who have a forecast for the evolution of this company’s shares, 65 recommend increasing exposure to it (despite its high price) and eight are in favour of maintaining the investment, according to data collected by Bloomberg. Not a single one believes that the time has come to sell. In fact, the average potential for revaluation in 12 months given by the analysts is 25%.

In the other members of the Magnificent Seven, buy recommendations also outnumber sell recommendations. For Alphabet, 85% of experts are betting on increasing the share and none on selling. In Amazon, this percentage reaches 96% (and again, without any sell advice). In the case of Apple, only two analysts recommend getting rid of shares, compared to 40 who recommend increasing exposure. And in Meta, four have a negative view, compared to 88% of experts who continue to recommend overweighting this company.

“We may not see such strong increases in technology companies as we have seen in the last two years,” explains Marta-Díaz Bajo. However, the expert points out that “the weight of this sector within the world stock markets is already almost 20%, so it would not make much sense for a client to suddenly decide to leave this type of company, no matter how expensive they are.”

While we wait for the impact of artificial intelligence on the productivity of countries and the profit and loss accounts of companies to be confirmed, it is increasingly clear that this is not a passing fad, as was the rise of the metaverse three years ago or the emergence of blockchain technology five years ago. blockchainand digital assets. The AI ​​wave continues to advance at full speed and the technology sector is the best prepared to continue surfing it.

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