In the two years since ChatGPT was launched, artificial intelligence (AI) has piqued the interest of investors more than any other tech innovation in the past two decades. Major tech firms are channeling tens of billions of dollars every quarter to bolster the computing power required for the development and execution of AI systems.

For its most passionate advocates, the potential repercussions are astounding: AI is poised to replace a multitude of workers, assist researchers in identifying life-saving treatments, help businesses penetrate new markets, and unveil notable efficiencies that will enhance corporate profits for years to come. As a result, AI-related stocks have played a significant role in the bull market that began in October 2022.

While AI shows immense potential, it has yet to yield substantial revenue due to its associated costs. A recent Gallup poll reveals that only 4% of U.S. workers utilize AI on a daily basis, while more than two-thirds indicated they never interact with it. Daron Acemoglu, a Nobel Prize-winning economist from the Massachusetts Institute of Technology, argues that expectations surrounding AI advancements are overly optimistic. “The models we have currently are indeed impressive in certain respects,” he notes. “Yet, they remain largely impractical on a widespread scale.”

Some investors are reminiscing about the excitement of the 1990s when the nascent internet evoked a similar buzz. That technological transition took longer than projected, resulting in a significant disconnection between stock prices and actual fundamentals, which ultimately led to a substantial market crash. Many Big Tech stocks are once again trading at valuations that exceed historical earnings norms.

Today, whether they intend to or not, the majority of investors are inherently betting on AI.

Are you an owner of an S&P 500 index fund? If so, a third of your investment is concentrated in eight companies, including Nvidia, Microsoft, and Apple, all of which are banking on the future prospects of AI. This does not include related sectors, such as utilities, which are also reaping benefits from AI’s energy-intensive data centers.

Read/listen: We are being swept along inexorably by the AI boom

For both advocates and critics of AI, examining the related risks and opportunities is crucial. Start by distinguishing between companies that create AI services, like Microsoft Corp and Alphabet Inc, and those that provide the necessary infrastructure—like chips, servers, and energy—that supports computing.

The leading tech corporations are highly profitable and make up the majority of AI investment. In Q3 2024, Alphabet, Amazon.com, Apple, Meta Platforms, and Microsoft combined spent $62 billion on capital expenditures, setting a record and reflecting over a 50% increase from the same period last year. For the first time since 2018, this group allocated more to capex than stock repurchases—by $5 billion, to be precise. These companies have the financial capability for such expenditures, having generated $76 billion in free cash flow. Investors tend to back the capital investments of Big Tech due to the sector’s past successes.

Dave Mazza, CEO of Roundhill Financial Inc, an investment firm in New York, believes that AI will eventually produce considerable revenue. However, he cautions that investors may run out of patience. “If companies announce substantial spending commitments without a clear timeline for returns, investors are likely to withdraw their support,” he states. “At some point, reality will set in, and time is of the essence.”

Read: Megacap tech stocks have gotten too big for Nasdaq 100 again

Arvind Narayanan, co-author of AI Snake Oil: What Artificial Intelligence Can Do, What It Can’t, and How to Tell the Difference, emphasizes that achieving significant AI returns will take more than just a year or two. “Embracing new technology demands modifications in workflows, organizational structures, and legal frameworks,” explains Narayanan, a computer science professor at Princeton University. “These changes do not happen as quickly as technological advancements. Consequently, we should expect it will take a decade or longer for companies to fully harness the benefits of even today’s generative AI.”

Currently, tech giants experience the most pronounced AI-driven revenue from their cloud computing divisions, such as Amazon Web Services and Google Cloud. However, Microsoft—an early benefactor of AI success through its collaboration with OpenAI—is already under pressure. By the end of November, Microsoft’s stock had underperformed the S&P 500 for four consecutive months. In October, the company faced its largest stock drop in two years as its revenue growth forecast for the Azure cloud computing service failed to meet expectations. Nevertheless, Microsoft intends to invest $62 billion in capital expenditures this fiscal year, more than double its spending from two years earlier. Alphabet, Amazon, and Meta have also announced plans to ramp up their investments.

This investment commitment has instilled confidence in those following a well-known AI investment strategy: the pick-and-shovel approach, which refers to vendors who profited by supplying tools to prospectors during the California gold rush of the 19th century. Nvidia Corp exemplifies this trend, leading the market for computer chips designed for managing AI-related computations. Its stock has soared over 700% since ChatGPT’s launch in November 2022. Nvidia’s surging profits and revenue have cemented its status as one of the world’s most valuable companies, boasting a market capitalization of $3.4 trillion at the end of November, rivaling Apple Inc for the top position.

Read: Microsoft unveils zero-water data centers to reduce AI climate impact

The typically stable stocks of utility companies are also witnessing a rise. Vistra Corp and Constellation Energy Corp rank among the top performers in the S&P 500 for 2024, positioning utility stocks for their strongest year since 2019.

With major tech companies committing to ongoing spending, even skeptics like Jim Covello see no reason to abandon the pick-and-shovel strategy while capital continues to flow. Covello, the head of equity research at Goldman Sachs Group Inc, argues that AI cannot deliver on many of its supporters’ lofty expectations. “Most technological transitions throughout history, particularly transformative ones, have involved replacing very expensive solutions with cheaper alternatives,” he stated in July. “Thus far, AI—and its associated high costs—stands in stark contrast.” He suggests that when this realization becomes widespread, tech giants will reassess their extensive spending, resulting in a downturn for infrastructure stocks.

This scenario would pose challenges for Big Tech firms, dampening their growth prospects. Nevertheless, it’s unlikely to erase their long-term appeal, as growth from their core businesses is expected to remain steady.

Take Meta Platforms in 2022, for instance, when the parent company of Facebook invested heavily in its metaverse initiative. When revenue growth faltered, the stock tumbled. However, Meta managed to rebound and is now trading at record highs following a series of acknowledgments from CEO Mark Zuckerberg and a strategic shift.

Read: A very ChatGPT Christmas

Identifying the long-term winners in this landscape may prove challenging, according to Michael O’Rourke, chief market strategist at Jonestrading in Chicago. In 2000, hardware manufacturers such as Cisco Systems Inc and Sun Microsystems—the pick-and-shovel suppliers of the dot-com era—were among the top-performing stocks. Ultimately, however, companies like Amazon and Google emerged, carving out substantial businesses around the technology.

“Typically, it is others who refine these concepts and come to dominate the market,” O’Rourke explains. “We are still in the early phases of understanding how the environment will evolve. I hesitate to declare this too early to discern; that might imply that those investing now should do so. The late ’90s was early in the internet age, and it was not the appropriate time to invest.”

© 2024 Bloomberg

Follow Moneyweb’s comprehensive finance and business news on WhatsApp here.