Investors are increasingly nervous the artificial intelligence “frenzy” is massively over-inflating tech company valuations, prompting fears of a bubble.
Taken together, the so-called “magnificent seven” big technology companies – Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla – are now worth more than £16trillion.
Microsoft’s shares are trading at 33 times forward earnings. Chipmaker Nvidia is now trading at 54 times its historic earnings. Most companies trade somewhere between six and 15 times earnings.
OpenAI, the engine behind ChatGPT, is now valued at over $500billion, making it the most valuable privately owned company in the world.
But opinion is divided, with some claiming frothy share prices are only a risk for smaller AI start-ups, which are pouring billions into scaling up loss-making businesses on the hope it will pay off.
What do the experts say?
Ben Seager-Scott, chief investment officer at advisory firm Forvis Mazars, said: “A bubble is generally considered a situation where the valuation applied to a company is in extreme excess of the company’s fundamentals – so earnings.
“As we saw in the dotcom bubble, the problem is usually the expectations of earnings growth in the future which simply didn’t materialise.
“That’s not the case with a lot of the AI story at the moment – prices have moved up but so have earnings in many cases.”
He pointed to chip make Nvidia, currently worth just under £4trillion.
“Over the past five years, its share price has gone up 14 times but earnings by the end of this year earnings will be about 20 times higher than five years ago,” he said.
“While it is expensive, it is actually cheaper than it was in 2020 – and will have made investors a lot of money over that time.”
Chris Beauchamp, chief market analyst at investing and trading platform IG, admitted the market “could be in a bit of a frenzy over AI”.
But he added: “Unlike the dotcom era, today’s leaders generate enormous cashflows.
“AI spending is driving genuine productivity, not just hype. Microsoft is already monetising AI through Azure and Copilot with measurable revenue streams, not speculative hopes.”
Microsoft earned over £70billion in net income last year, Apple more than £76billion.
“Both companies carry net cash positions and return hundreds of billions through buybacks and dividends – the opposite of bubble-era leverage,” said Beauchamp.
Warning signs are emerging though.
Seager-Scott said he is “watching the bottom end of the AI market closely”.
He said: “A lot of AI start-ups with no earnings at all, and no realistic earnings potential in the near term, are starting to attract very high valuations.
“At the top end, the circular investing we’re starting to see also has worrying echoes of the dotcom era.”
For example, OpenAI has struck several deals worth up to £76 trillion with other technology firms, including taking billions of investment from Microsoft and Nvidia.
Eyewatering amounts of money are needed to fund the huge infrastructure investments needed to support future AI growth, mainly data centres, cooling systems and power infrastructure.
This is making investors jittery. On Thursday 30 October, Facebook owner Meta saw its share price fall more than 12% after upping the amount it plans to spend developing its AI tools – in spite of posting strong results.
How much are the Magnificent Seven worth?
Alphabet – $3.3trillion
Amazon – $2.5trillion
Apple – $4trillion
Meta – $1.9trillion
Microsoft – $4trillion
Nvidia – $5trillion
Tesla – $1.5trillion
What should investors do?
Jason Hollands, managing director of investment platform Bestinvest, said: “AI looks certain to be game changing for society and economic productivity.
“However, so was the build out of the Victorian railway system and the emergence of the internet, yet investors suffered steep losses when the investment bubbles surrounding them burst.
“The lesson here is that you can believe in the tech, but that will not guarantee you can’t make losses.”
Camilla Esmund, senior manager at investment platform Interactive Investor, said investors who keep their nerve tend to be rewarded over time.
She added: “None of us have a crystal ball, but talk of a bubble is a timely reminder to review your investment strategy and check the level of risk you’re taking in your portfolio.
“It is wise to diversify your portfolio across sectors, regions, and asset classes, so no single shock derails your progress. It doesn’t always sound exciting but it is a strong defence against market uncertainty.”
Hollands agreed. “Many investors have become heavily exposed to US equities and the ‘Big Tech’ AI darlings over time, as US and US dominated global funds have become steadily more popular.
“UK funds – once the cornerstone of most ISAs and pensions – have become somewhat unloved. Ironically, the ‘boring’ UK FTSE 100 has delivered a total return of 21.8% so far this year, twice that of the 11% return of the US index S&P 500.”
Top five bubble bursts
Markets are notorious for going through repeated cycles of boom and bust as investors get wildly over-excited about some fad, only to see their money evaporate when reality strikes.
Dutch Tulip Mania in the 1630s
Demand for tulip bulbs suddenly rocketed, with prices soaring by 20 times between November 1936 and February 1637. Three months later they collapsed back by 99%.
South Sea Bubble in 1720
The South Sea Company was formed in 1711 on the back of an exclusive contract with the British government to deal with shipping for all trade with the Spanish colonies in South America. Investors assumed it would be another major success like the East India Company and shares ballooned from £125 in January 1720 to £950 in July. Within months they had collapsed, triggering an economic crash.
British railway bubble in the 1840s
Massive infrastructure investment was poured into the British railway system in the 1840s. Railway company shares surged on the assumption it would transform manufacturing transport at a time when the industrial revolution was at its height. Fuelled by low borrowing costs, it finally peaked in 1845 after the Bank of England hiked interest rates and investors realised that not all railway routes were proving profitable.
Japan’s lost decades in the 1980s
Japan’s economy exploded after the end of the Second World War, with the Nikkei 225 index of company shares reaching an all-time high in 1989. A flood of cheap capital fuelled investor mania pushing up company share prices and property values. According to newspaper The Economist, between 1985 to 1989, the Nikkei 225 tripled to around 39,000 and briefly accounted for more than one third of global stock market capitalisation.
In 1989 The Bank of Japan raised interest rates, bursting the bubble. The Nikkei halved within a year, before falling another 25% by 1992.
The dotcom bubble that spectacularly burst in 2000
The dotcom bubble ran for five years before bursting in the spring of 2000. Internet start-ups saw their companies nab multi-billion pound valuations despite being consistently loss-making. When it burst, the S&P 500 fell 47% from peak to trough and took until late 2007 to recover.
The NASDAQ Composite fell 77 per cent to its October 2002 nadir and took 15 years from regain its March 2000 peak.