NYU Professor: "AI Stocks Begin Sifting the Wheat from the Chaff"...Warning of Impact on Small and Mid-Cap Stocks

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A warning has been issued that the artificial intelligence (AI) investment craze may enter a phase of sifting the wheat from the chaff. The impact is expected to first concentrate on small and medium-sized AI companies with weaker financial resources than ultra-large tech stocks.

According to crypto media outlet BeInCrypto on August 4 (local time), Aswath Damodaran, a professor at NYU Stern School of Business, stated that when restructuring in the AI industry begins in the future, attention should be paid to smaller companies. Damodaran, known as a valuation scholar on Wall Street, said, “When the sifting of wheat from the chaff begins in the AI sector, we should watch smaller companies rather than the Magnificent Seven.”

The Magnificent Seven consists of Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Meta (META), Apple (AAPL), and Tesla (TSLA). These companies have invested tens of billions of dollars in AI infrastructure. Damodaran assessed that robust cash flow and debt financing capabilities enhance the shock absorption capacity of large tech stocks. In contrast, he pointed out that smaller AI companies do not possess the same level of defense.

Damodaran cited the collapse of the hedge fund Situational Awareness as an example of how quickly AI investment sentiment can change. He explained that if market expectations falter, companies with weaker fundraising capabilities may face pressure first. Even large tech stocks could not avoid the warning that they must prove the performance of their AI investments.

The indicator Damodaran focused on is the marginal return on invested capital (ROIC). This figure shows how much profit is generated by each dollar of new capital expenditure. Meta, Alphabet, and Microsoft continued to increase AI-related spending, but their marginal ROIC sharply declined. Damodaran assessed that the decline in profitability was notable given the business scale of these three companies.

Tom Lee interpreted concerns surrounding AI capital expenditure as a bullish signal. He argued that increased market skepticism about AI investment means the upward cycle has not ended. Damodaran warned that if the profits of ultra-large cloud companies fail to keep pace with increased spending, a new form of big tech could emerge, characterized by increased capital input and lower profitability.

[Article Key Summary]

-Aswath Damodaran, a professor at NYU Stern School of Business, warned that small and medium-sized companies could suffer the biggest impact when the sifting of wheat from the chaff begins in the AI industry.

-He assessed that the Magnificent Seven are likely to withstand the shock of restructuring due to their strong cash flow and debt financing capabilities.

-Meta, Alphabet, and Microsoft expanded AI investments, but their marginal return on invested capital sharply declined.

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