Picks and Shovels

The 1848 discovery of gold at Sutter’s Mill in Coloma, California resulted in several hundred thousand prospectors rushing to strike it rich during the California Gold Rush. For most, the dream of riches remained just that, as most prospectors had little to show for their efforts. However, you did not have to mine for gold to get rich in the gold rush. Those that supplied the prospectors with tools, clothes and everything else they needed to prospect, flourished. The greatest wealth creation came not from gold, but from supplying the picks and shovels required to mine for gold. Indeed, the gold rush was the start of a little company called Levi Strauss that made the toughest outerwear for the miners.

The Great Artificial Intelligence (AI) Rush has recently begun and the primary players have already skyrocketed to extreme valuations. And while they seem destined to succeed in the AI world, the market appears to have already discounted a fair portion of that success. David Trainer CEO of research company, New Constructs, discussed NVIDIA‘s valuation in late May, saying that if an investor desired a 10% annual return, NVIDIA would need to increase its after tax operating profit margin from 27% to 45% AND grow revenue at 20 % per year for the next 20 years! That’s a long time and you’d have be very sure that some other company wouldn’t overtake NVIDIA in market prominence.

We know that seems improbable today, but no less improbable than Intel fumbling away their lead in semiconductor development over the last 10 years. We note that it is rarely the first to market that ends up dominating a market. Remember when Yahoo! was the king of search? Or when Facebook was an also ran to Myspace?

In the heat of the moment and at the height of FOMO (Fear Of Missing Out), it is always wise to step back, take a deep breath, and rationally assess valuations. We recall the white-hot Snowflake (SNOW) IPO in the summer of 2020. Unless you were one of the privileged few to get an allocation at the IPO price of $120, you had to buy shares after they opened at $245. SNOW is fine company and likely destined to be very successful, but you can buy the shares today, almost 3 years later, for about $180.

The lesson is that FOMO can make us do unreasonable things. The financial media harp all day long on the poor investors that missed this AI bubble in the first half of this year. Now is not the time to make that assessment. Let’s see how the AI situation develops over the next several years. We suggest that investors are much more likely to garner that 10% return by investing in more reasonably valued companies that will use AI to reduce costs and increase productivity and profits. There is more than one way to skin a cat.


What We’re Reading

Where’s the Recession We Were Promised?

Buttigieg warns of potential for flight delays as July 1 5G deadline looms

European business activity slows in June as higher interest rates begin to bite

The market continues to not believe the Fed

Flash PMI data for June signal cooler global prices amid mounting growth risks

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General News

By: Adam