Investing in AI: Another bubble or early days for world-changing technology?

SPONSORED BY TRADING 212The Independent Money channel is brought to you by Trading 212.Some people are keen to label every investment trend that has seen great success as a bubble that will have to burst.The reality is much more nuanced that that.

While comparisons between artificial intelligence (AI) and the dotcom internet stocks bubble of 1995-2000 are often made, this is misleading for a few reasons.Here, The Independent takes a look at what makes for a concerning bubble in the stock markets, and how that translates to the AI boom we’re witnessing.What is a stock market bubble?

A stock market bubble does not have a single, exact definition that is widely agreed on, but there is a consensus on the main factors that can create one. First and foremost, share prices will have risen very quickly over a sustained period.Share prices are supposed to go up over time, so that in itself does not mean a bubble is in play.

The people running companies are specifically tasked with getting the share price to climb as the business develops new products or services, and earns more money.Where the question of a bubble arises is when the price rises do not appear to have an adequate link to the development of goods or services by companies, or the earnings they are generating versus their spending.A bubble can be described as a scenario where prices are being driven largely by speculation about what the future may hold, and something called reflexivity.

This is where people buy stocks simply because they have seen them go up. The more stock prices go up, the more people want to buy them, and a feedback loop is formed. It can also be referred to as market euphoria or FOMO (fear of missing out).

The big fear around this is that eventually, investors lose confidence in the companies’ ability to live up to the hopes, and large numbers of people panic-sell at once, causing a market crash.Get a free fractional share worth up to £100.Capital at risk.

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Terms and conditions apply.Go to websiteADVERTISEMENTWho are the top AI companies?One helpful way to think about the AI investment landscape is to split it into the companies developing AI models or services, and those which design and manufacture the computing components needed.

In terms of the companies at the forefront of AI model development which are currently publicly listed on the stock market, we are mainly talking about Google (Alphabet), xAI (SpaceX), Microsoft and Meta Platforms.The two firms leading AI model development alongside Google and xAI are OpenAI and Anthropic.open image in galleryGemini is Google’s AI, with OpenAI owning Chat GPT and Anthropic having Claude (AFP/Getty)They are both unlisted, privately owned companies - for now.

The pair are expected to float shares on the stock market through an initial public offering (IPO) in the coming months, in a similar way to SpaceX. On the components and infrastructure side, the leading names include GPU chipmakers Nvidia and AMD. More recently, Intel has emerged as a major player due to the other main kind of chip, CPUs, becoming a bigger factor in AI.

The dotcom bubbleIt is widely accepted that the early years of internet adoption, in the late 1990s, saw a stock market bubble develop. Known as the dotcom bubble due to the website URL format used as the company name by so many businesses then, it saw prices of hundreds of newly launched internet firms with low or non-existent earnings rocket to high levels.The rises in value were often based purely on speculation that the internet would be ‘the future,’ and these companies would make a lot of money one day.

Indeed, the internet did turn out to be the future of the global economy, but most of the companies trying to tap into it failed to do so successfully to deliver on investors’ hopes. open image in galleryPets.com burned through hundreds of millions in advertising while bringing in low sales figures.

When the stock market cash dried up, it went broke - just months after its IPO, losing investors more than 99% of their money (Getty)The Nasdaq index containing many of these internet-based companies hit a peak in March 2000. As people lost faith and realised most of them would never make money, the index fell close to 80 per cent in the ensuing panic.Is AI in a stock market bubble too?

This is a hotly contested question. While the rise of AI industry stocks bears some similarities to the dotcom boom, there are very important differences. There is clearly some degree of speculative, momentum-driven buying, but the share price rises are coinciding with huge revenues being raked in by the likes of Nvidia.

Other tech giants at the cutting edge such as Google, Microsoft and Meta Platforms are large, long-established companies with many different sources of revenue, and billions of dollars of cash on their balance sheets.AI is also already being put to work to generate m