his year, we’ve seen technology companies implement a huge ramp-up in spending on artificial intelligence (AI). However, we have yet to see a product that generates significant revenue and returns from all this investment.

Other than this one…

For example, cloud computing companies have been buying graphics processing units (GPUs), the hardware needed to train AI models, in huge quantities. This is why Nvidia (NVDA) saw its year-over-year revenue double in its most recent quarter. But so far, it seems to be the only company where there has been meaningful revenue uplift from AI.

For everyone else, AI seems to just be a big drag on their return on equity (ROE).

According to FactSet, between December 2021 and June 2023, Alphabet’s (GOOGL) ROE has fallen 8.7 percentage points, to 23.3%; Meta’s (META) ROE is down 13.7 percentage points, to 17.3%; and Microsoft’s (MSFT) ROE is down 10.2 percentage points, to 38.8%.

Where’s the AI Revenue?

Per Investors’ Chronicle: “Microsoft may be the company closest to receiving a meaningful revenue uplift from AI. It is charging $30…per user per month to use its AI-enabled Office 365 ‘Copilot’. This is in addition to the $36 per month customers currently pay for the regular Office 365, equivalent to an 83 per cent price increase.”

Nevertheless, even Microsoft is being very careful when it comes to the hard numbers surrounding AI. In its July earnings call, it forecast that meaningful revenue growth from AI will only start appearing in the second half of 2024. That’s why the market tapped the brakes with regard to Microsoft stock, which is down 7% over the past three months. It is pausing to see if the AI story everyone has already bought into will now actually start producing real cash flows.

AI revenues look even further away for other technology firms.

At Adobe (ADBE), the AI product on offer is just a marketing gimmick. In September, the company launched its text-to-image generative AI product Firefly, which it offers for free via a web app. Adobe’s hope is that if lots of people start using the free product, some of them will eventually upgrade to a paid-for subscription in the future.

Firefly is an expensive gimmick for Adobe. AI models are expensive to build and expensive to run. Every time someone uses Adobe Firefly to generate an image, there are computing costs, and so far Firefly has created more than two billion images. To pay for this, Adobe has had to boost profitability (raise prices) elsewhere in its business.

Salesforce (CRM) is similarly far away from generating any revenue from AI. The company has just released an AI product called Einstein Copilot. However, there is unlikely to be any revenue uplift from it until late 2024 or 2025. In light of this, Salesforce has managed to maintain its profit margins by getting rid of about 10% of its workforce. The longer it takes for AI to start producing a revenue uplift at Salesforce, the more jobs may be lost.

So, is any company making money from AI at the moment? As I said earlier: yes, Nvidia.

But is it too expensive to buy at its current price? Maybe not…

Nvidia: Cheap?

Innovative companies that achieve high growth cannot be measured on traditional valuation multiples. Companies like Microsoft and Nvidia have track records of introducing sizable new businesses that were not expected by the market.

The price/earnings growth (PEG) ratio, a metric that assesses growth, may offer a more precise picture of how pricey (or not) tech stocks are at the moment. This valuation metric takes the price/earnings (P/E) ratio and divides it by the growth rate over a certain time period.

FactSet employs a common way to calculate the PEG ratio, taking the forward PE and divides it by the consensus medium-term annual growth rate. The higher the number, the more expensive the stock. As a rule, a number of 1.0 is considered fair value. For reference, the S&P 500 is currently trading with a PEG ratio of 1.33.

If we take a look at some of the tech giants and their PEG ratios, the results are surprising.

Apple (AAPL) stands out, but not for being cheap. Instead, it is particularly highly valued. Wall Street analysts are expecting very little revenue growth in the coming year. That translates to the iPhone maker trading on a forward PEG of around 3, as high as it has been at any time in the past four years.

Microsoft saw its stock driven up earlier this year by the hype surrounding AI. It is trading on a forward PEG ratio of 2. That is higher than at any point since mid-2021.

But what about the king of AI hype, Nvidia? It is not expensive if you look at the PEG ratio.

Fortunately for Nvidia, it is one of the only companies that has real AI revenues. The AI chip designer has doubled its revenue in the past year and is expected to keep growing at a healthy rate. The gap between demand for AI chips and the number Nvidia can make is growing and sets the stage for further gains. That’s why Nvidia’s forward PEG ratio remains at a relatively bargain basement-level of 0.75!

The company’ stock is down about 15% from its peak at $502.66 a share. Take advantage of the current weakness and buy NVDA anywhere under $425.

— Tony Daltorio

Start Collecting Daily Dividend Checks [sponsor]
After researching income stocks for over 30 years, I've come up with a one of a kind dividend portfolio. With the right 20-30 stocks, you can collect a dividend check every single day the market is open. That's over 260 dividend checks per year. Click here for the names of these 20+ stocks.

Source: Investors Alley