A corner store in a great location can be a great business, but only if the price is right.
Consider a store that generates $100,000 in profits per year on $1 million in invested capital. That's a 10% return, and it's probably worth buying if it's priced under $1.2 million. After all, even if you paid $1.2 million, you're still getting an 8.3% cash return each year.
If you paid $10 million for that same store, you'd only make 1% profit — a terrible investment.
A teenage girl inflates a giant bubble gum balloon, 1950. (Photo by FPG/Hulton Archive/Getty Images)
That's why Warren Buffett always says, “The best investment is a great business at the right price.” It's not just a great business, nor is it just any good price.
The AI revolution has undoubtedly brought about a major shift in the way we do business and spawned a whole new set of incredible businesses, many of which are already hugely profitable and have great potential for future growth. But just like with the dot-com bubble, the market is getting ahead of itself. Way ahead of itself.
A new AI bubble has been created with money desperately rushing to avoid FOMO. This film will end in tears, just like its predecessor. Like the dot-com bubble, the technology will prove important and enduring, and many companies will become hugely successful, but the stock prices of many companies will first have to crash before their true value can be reset to reality.
Take the darling of the AI world, Nvidia (NVDA). The company's lightning-fast chips form the superhighway of the artificial intelligence grid. Other semiconductor companies have fallen behind in the race, giving NVDA a quasi-monopoly. And NVDA's stock price matches the price: NVDA trades at 77 times earnings and 66 times book value, the same level as the NASDAQ was in 1999. It's one of the three most valuable companies in the world, along with Apple and Microsoft. An undisputed superstar, the company's current stock price still bodes well for future valuations.
It's easy to forget that Amazon (AMZN), the clear winner of the dot-com bubble, had to fall 95% — yes, 95% — from its 1999 peak before bouncing back to the phenomenal success it is today, and it took years to recover.
There are some companies that have benefited from the AI eatup and trade at reasonable multiples. For example, Alphabet (GOOGL) trades at 29 times earnings and 8 times book value. It's also expensive, but its 21% return on invested capital and its leading position in generative AI tool Gemini make it very justified. There are also a number of reasonably priced companies that will benefit from the AI revolution, such as Oracle (ORCL) and Applied Materials (AMAT), which are included in the Schwab Large Cap Value ETF (SCHV).
Schwab US Large Cap Value ETF
The lessons of past market cycles should have great relevance for the current tech bubble: To use an analogy with an old-fashioned game that predates dot-coms and AI, you don't want to be the person without a chair when the music stops.
James Berman owns GOOGL, AMAT, ORCL, and SCHV for himself and his clients.
