Valuations in the artificial intelligence sector are approaching dotcom-era levels, UBS has warned, with US technology stocks trading at an economic price-to-earnings multiple above 35 times.
The bank noted that excitement around AI has driven unprecedented investment, with combined capex from Meta (NASDAQ:META), Alphabet (NASDAQ:GOOG), Amazon.com (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) this year expected to exceed that of the entire listed energy and utilities sectors in the US and Europe.
Apple, Nvidia and Broadcom (NASDAQ:AVGO) also spent more on R&D together in 2024 than all listed European equities combined.
While US tech giants generate 37% of the country’s total economic profit, UBS said future cash flows remain uncertain.
"Whereas dotcom multiples were often bid up due to low earnings among internet plays, the dilemma with AI plays today is over cash flow resilience/growth from high levels."
Valuations "flashing red" leave "little room for cash flow disappointments", UBS said, against a background where "multiple unknowns" could still weigh on the medium-term cash flow return on investment and growth trajectories of AI players.
Risks include unclear returns on investment (one big uncertainty is that the use cases of AI are yet to be fully understood), power supply constraints for data centres, and rising R&D spending in China.
UBS said: “For all the buzz around AI, however, many of the use cases are premised on future, rather than current revenue opportunities and even prominent AI figures like Sam Altman, the CEO of OpenAI, acknowledge that the sector may be in a bubble."
The bank advised investors to diversify, highlighting opportunities in global growth stocks such as Visa Inc (NYSE:V, ETR:3V64), Iberdrola, BYD Co (HKG:1211, LSE:0HKY, OTCQX:BYDDY), Imperial Brands PLC (LSE:IMB), 3i Group PLC (LSE:III) and Airtel Africa PLC (LSE:AAF) as it highlighted less tech-correlated sectors including energy, utilities and consumer staples.