AI Shakeouts: Damodaran Warns Lesser Companies

Our next guest is the so-called dean evaluation osw motor and NYU Stern School of Business professor of finance. Welcome back. It's nice to see you. >> Thank you for having me. >> You have multiple headline comments that I that I want to get to, but I want to I want to start with because the hyperscalers are having such a nice bump today on the on the back of their earnings. Uh the big question is how much the correction will continue. My bet is that we hit peak AI a few months ago and that there will be more consolidation and correction in the months ahead. You're talking about this space. Yeah. >> Yes. And I'm including the smaller players as well. The Mac 7 in many ways are the most protected part of the space. They've invested tens of billions of dollars, but they have the cash flows and the capacity to carry debt. So they're not in financial trouble. So I think when you see a shake out of the AI space, it's not so much the Mac 7 we should be watching but the lesser companies and I think that you know the recent the the stories about situational awareness in particular point to what can happen very quickly in the rest of the AI space as the correction and the cleaning up now continues. It's pretty amazing, wouldn't you say? Or or maybe not. You put it in your own words, the fact that where we are today relative to where we felt like we might be going on the situational awareness day and the recovery that's happened on the back of these earnings. I mean, how how would you put that all into perspective given the many markets that you've seen over the years, including some pretty notable blowups? I think the facile reason it tells you how much investors want to be in this space. So there are portfolio managers who are convinced that they're underinvest in AI. They're looking for any chance to jump in. So every time there's a correction rather than the correction continuing you're seeing funds flowing in to companies where finally people say hey now I have a chance to have an AI company in the space. So it's you know I wouldn't put it deeper than that. It's not like people are rethinking the fundamentals and coming back to investing. they just don't want to be left out of this party. >> But I mean in some respects we are maybe feeling better about the fundamentals right going into these prints we were thinking about return on investment. We were worried perhaps that the spending was going to at least you know peak uh if not you know get get pulled back. And neither one of those events happened which probably explains why we've seen the activity after earnings. >> The second one hasn't happened. companies are continuing to invest in capex like they're go like it's going out of style. The first one is still a concern. I was just looking even at the MAG five with the you know outside of Tesla and Nvidia and I was looking at the marginal return you're making on investment capital the change in operating income over the change in invested capital and you look at Meta you look at Alphabet you look at Microsoft the drop off in returns on capital is pretty amazing given how big these companies are. So unless they start delivering earnings commensurate with the tens of billions of investment capex you're you're going to see a very different kind of company emerging from the mix more capital intensive lower return invested capital company nothing wrong with that but I think investors in these companies are not used to what the risks are of investing in a more capital intensive company >> how do you judge a micron for example as as we say the you know the dean of valuation I mean so what we showed the forward valuation And it's like five or it's like six times earnings. And we had somebody that I was speaking with earlier before we got to the segment suggesting that it it actually is different this time that the earnings momentum that a micron for example has is so extraordinary that you can't judge these kinds of chips chip names as you would have throughout history thinking thinking that it's so cyclical that it it's different. H how would you assess that? I mean, I think it's been that battle between history and the the the AI shift that's gone on for the last few years. History in in chips has always been that earnings go up and earnings go down that you got to price it on some normalized version of earnings. The the optimists on Micron say, you know, that's not true anymore because this demand is not a cyclical demand. It's a secular shift in demand. So I think if somebody makes a bullish case for Micron I'm willing to listen. I think it's still a richly priced stock but I in terms of you know if you think about normalized earnings but if you think purely in terms of a shift in the demand coming from AI then I think there can be a case made that you should be investing a micron in spite of your worries about cycles and earnings.