What is the best way to invest in the AI trend, in your opinion?
The short answer is: with caution.
The stock market in general, and the technology space in particular, are notorious for boom-bust cycles. When a hot sector takes over the collective imagination, stock prices rocket higher, pushing valuations to unsustainable levels. Eventually, common sense prevails and prices return to more reasonable levels.
We’ve seen this movie before with the dot-com madness of the late 1990s, the U.S. housing mania of the mid 2000s, the bitcoin bubble and, more recently, the COVID-19-related surge in tech companies that benefited from the shift to working, shopping and exercising at home. The market was assuming these trends would last forever, which presumably justified the inflated price-to-earnings multiples assigned to many of these pandemic stocks.
But, as interest rates rose and COVID-19 restrictions eased, the pandemic darlings got crushed. Zoom Video Communications Inc. ZM-Q, for instance, plummeted about 90 per cent from peak to trough. Exercise bike maker Peloton Interactive Inc. PTON-Q plunged about 96 per cent. As reality set in, tech giants including Microsoft Corp. MSFT-Q, Amazon.com Inc. AMZN-Q, Alphabet Inc. GOOG-Q and Meta Platforms Inc. META-Q collectively laid off more than 50,000 employees.
Now, the artificial intelligence boom has picked up where the pandemic rally left off. Perhaps no stock illustrates this better than Nvidia Corp. NVDA-Q, which supplies the powerful graphics processing units used by ChatGPT and other AI applications. Shares of Nvidia – which recently reported a blowout quarter – have nearly tripled since the start of the year, closing Friday at US$422.09 a share. That implies a P/E multiple of about 54 times estimated earnings per share for Nvidia’s current fiscal year ending in Jan. 31, 2024, and 41 times estimates for fiscal 2025, indicating that investors are pricing in tremendous growth for Nvidia over the next few years.
A high P/E ratio isn’t a problem as long as a company meets or exceeds earnings expectations. But if it stumbles, even a little, watch out. It’s not just Nvidia. Many other tech stocks have also surged recently, including the aforementioned companies that were handing out thousands of pink slips just a few months ago. Even companies with the most tenuous connections to AI have been playing up the technology, because they know it’s the investing flavour du jour.
Just to be clear, I’m not trying to scare you away from investing in tech. It’s a hugely important part of the economy, and its importance will only continue to grow. AI is already changing how we live, work and play. However, I believe it would be a mistake to load up on AI companies in the hope of riding the boom to big riches. As we’ve seen countless times before, the stock market has a way of humbling investors who try to catch the latest wave.
A more prudent approach, in my opinion, is to invest a portion of your portfolio in an exchange-traded fund that holds a diversified basket of technology stocks – not just those focused on AI. For example, several Canadian ETF providers offer funds that track the tech-dominated Nasdaq 100 Index, such as the BMO Nasdaq 100 Equity Index ETF (ZNQ). BMO and iShares also offer currency-hedged Nasdaq 100 ETFs, trading under the symbols ZQQ and XQQ, respectively. All three of these funds trade in Canadian dollars, which saves you from converting your loonies into U.S. dollars and paying stiff currency-conversion costs.
What many investors may not realize, however, is that they don’t need to buy a Nasdaq 100 ETF to get plenty of technology exposure. The much broader S&P 500 Index currently has a 28 per cent weighting in information technology stocks, with Apple Inc. (AAPL), Microsoft, Amazon.com, Nvidia, Alphabet and Meta representing the top five spots and accounting for more than one-quarter of the market capitalization of S&P 500 ETFs. So, if you invest in one, you may be getting all the tech exposure you need, with the benefit of additional diversification from sectors such as health care, financials, industrials and consumer stocks that have relatively low weightings in the Nasdaq 100.
The other nice thing about S&P 500 ETFs is that they are dirt cheap to own. The iShares Core S&P 500 Index ETF (XUS) and Horizons S&P 500 Index ETF (HXS), for instance, each have a management expense ratio of 0.1 per cent, while the BMO S&P 500 Index ETF (ZSP) charges just 0.09 per cent. That compares with 0.39 per cent for the three Nasdaq 100 ETFs mentioned above.
Whatever you decide, I would look at your investment in technology as a long-term commitment, not as a way to play the hottest trend. The AI story is everywhere, and stock prices are already pricing in substantial growth. By spreading your bets across the technology sector and holding through the inevitable up and down cycles to come, you’ll be sure to participate in the gains that AI and other tech innovations generate, while controlling your risk.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.