AI Takes Its Toll, by Javier Molina

Javier Molina, Markets Analyst at etoro, stresses that AI can transform the economy while investment and financing absorb shareholder returns for years. However, he warns, before buying the dip it is worth looking at cash per share, the quality of demand and how much growth is already priced in.

To illustrate this trend, we bring you a summary and, in the attachment, the full report, with links to all the information available on eToro about indices such as the SPX500 or the Ibex-35 and assets such as Bitcoin. 

AI takes its toll

AI can transform the economy and, at the same time, turn into a disappointing investment for those who finance its development. That possibility is starting to weigh on Wall Street, where revenue growth is no longer enough to dispel doubts about how much it costs to sustain it and how much of the profits will ultimately reach shareholders.

Alphabet helps explain the shift. Google Cloud doubled its revenue in the third quarter, an expansion that at another time would have been enough to fuel enthusiasm. Now, investors are also looking at the investment needed to keep up that pace and the financing needs it generates. Big Tech companies, used to generating cash and buying back shares, are committing resources to data centers, chips and electricity whose profitability will depend on demand that is still hard to forecast.

For investors, this means revisiting some key points. A company can sell more and deserve a lower valuation if it needs to devote a growing share of its resources to defending its position. If it also turns to debt or issues new shares, growth may translate into a far less generous reward for existing shareholders, because return per share also depends on how much it costs to finance it.

It is also worth looking at who is behind the orders. Alphabet includes in its contracted backlog $16.8 billion from Crux AI, a company in which it holds a stake and to which it provides financial backing. It represents roughly 3% of the total, so it would be an exaggeration to use that figure to question all demand, although it forces us to ask how much growth comes from customers able to pay with their own revenue and how much depends on capital continuing to flow in.

From here, the favorable scenario would be for infrastructure utilization to rise enough to restore cash generation after investment. If margins hold up and the need for external financing declines, the drops could offer opportunities, although that improvement would have to show up consistently in the accounts.

There is another, less positive scenario for those who buy thinking any pullback is temporary. AI may deliver on much of its promise while investment and competition absorb returns for years. Solid businesses would then coexist with stocks unable to justify the price paid for them, because expectations would have run far ahead of the profits available to shareholders.

The most delicate scenario would arise if financing started to slow the expansion. More expensive credit could lead to project delays and order revisions, shifting the pressure from share prices to activity. That is why it is important to closely monitor financing conditions and the conversion of contracts into collections, which help distinguish a valuation correction from a deeper deterioration.

The US elections and employment could accelerate these moves through interest rates and spending expectations. An orderly cooling of the labor market would ease financial pressure, while a sharp deterioration would call customers’ budgets into question, even if it brought further rate cuts closer. 

Earnings from Apple and Palantir on Monday, AMD on Tuesday and Arm, Qualcomm, Uber and McDonald’s on Wednesday will make it possible to test AI monetization, margin trends and the strength of consumer spending.

Before buying the dip, I would look at the cash left after investment, the trend in share count and the ability to meet commitments without continually returning to the market. I would also check how much the portfolio depends on a single spending chain, even if it appears spread across different companies. 

The opportunity will lie where the price allows for prudent expectations and demand starts turning into cash per share, because a 20% drop only tells us how much a share price has fallen, not how much what we are buying is worth.

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