AI Is Wildly Overvalued - Here's the Receipts

📆This Week’s Topic

In 2008, the real estate market crashed. It crashed because people over-leveraged mortgages and mortgage bonds tanking their quality. The fallout devastated household finances and the broader U.S. economy. If you are unfamiliar with the crash of 2008, picture this: the real estate market was booming because Lewis Ranieri had invented mortgage bonds about 40 years earlier and they were a true low risk high reward investment and made the banks billions of dollars. As time went on the quality of the mortgages got lower actual ratings and that caused the banks and the economy to lose billions of dollars. Sound familiar? We may be watching the same story unfold with AI: heavily invested, expensive to run, and not making much money. This is an issue because when investors realize that AI doesn’t make any money they’re going to sell their investments.

💳 The Issue

AI has begun to get a lot more popular in the last couple of years. Many people have invested in various AI companies like OpenAI and Anthropic through private investments. The issue with these companies is training and running these models is extraordinarily expensive. Just as the housing market propped up the stock market before the 2008 crash, AI is causing the stock market to boom. Yet these companies are receiving sky-high valuations that their revenues don’t come close to justifying. It is a bubble because the valuations are so much higher and people are unaware of what is going on behind the scenes and when people discover it and investors pull out the bubble pops. These companies need to start exploring ways to improve revenue or it could affect a lot of people.

📊 How Does This Affect My Wallet?

This will affect your wallet pretty significantly because if investors realize AI valuations are inflated those valuations could collapse quickly since they have no real revenue to fall back on. An AI market crash could drag down the broader stock market which has been riding AI’s momentum. We saw after the housing market came crashing down their were significant negative effects to everyone since many investors found their portfolios nearly wiped out overnight. As the gap widens between the revenue and valuations I would encourage investors holding a lot of individual AI stocks to review your diversification to be safe.

🔚 Outcome

Without a correction in valuations or a meaningful jump in revenue the market could face a sharp correction. The problem may be growing even more as AI company valuations have grown by an estimated $27 trillion according to Goldman Sachs while revenue only has grown by $175 billion. That’s a valuation-to-revenue ratio of almost 100 times where the common rule is only 2-4 times. This is especially alarming given AI companies are carrying enormous operating expenses creating and improving their AI models. AI companies are still trying to figure out how to make money with their products. Making matters worse, the IMF flagged the AI bubble as a significant threat to global financial stability. Meanwhile, large corporations continue pouring in money, which could increase the size of the AI bubble.

⏳ Final Summary

In summary, the AI industry is hyper-inflated with valuations almost 100x their actual revenue. The issue is that AI companies which are being valued very high don’t make much money because of their business model. People are starting to get worried because we’ve had a similar situation with mortgage bonds in 2008 that crashed the entire housing market and the economy. Back then, the value of these mortgage bonds were massively inflated and we’re watching the same dynamic in play with AI today. The question is whether AI companies can close the gap before the market forces their hand.

🙏Thank You & Important Information

Thank you so much for reading this edition of Friday Finance. If you have any suggestions or want us to write about something hit reply to any of our emails or send an email to [email protected]. Have a great week and I will see you in two weeks!

Best,

Jacob Gans

Friday Finance