Darius recently hosted our friend Beth Kindig on 42 Macro’s Pro to Pro, where they discussed the outlook for the Tech and Communication sectors, how companies will benefit from AI, the scale of AI as an investment opportunity, and more.
If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio:
1. Are The Tech and Communication Services Sectors Overvalued?
Our research shows that the valuations of the Tech and Communication Services sectors, when combined, are comparable to levels seen during the dot-com bubble.
At 42 Macro, we monitor metrics such as the trailing 12-month price-to-earnings (P/E) ratio, price-to-sales ratio, and the combined market cap of these sectors as a share of total S&P 500 market cap.
While the current earnings and cash flow generation of these companies make a return to the extreme P/E levels of the dot-com bubble unlikely in the medium term, we have already exceeded the peak price-to-sales ratio and their share of the overall S&P 500 index from that period. This suggests that while earnings may provide some cushion, valuation pressures remain elevated compared to historical benchmarks.
2. How Will Firms Become More Profitable Through The Implementation of AI?
Estimates from McKinsey and Gartner indicate that AI will generate $4.4 trillion in global profits. But where will these profits come from?
One example, highlighted by Beth Kindig, is Klarna, the buy-now-pay-later unicorn valued at around $7 billion. Klarna recently announced plans to eliminate Salesforce and Workday from their tech stack by developing custom large language models tailored to their needs.
Beth estimates the custom models might cost them between $3 to $7 million, compared to the tens of millions they would spend on Salesforce and Workday subscriptions. By integrating custom AI solutions and cutting out those expensive software products, Klarna will likely become more profitable.
3. Is AI A Better Investment Opportunity Than The Internet?
The internet is open-source and highly democratized, allowing anyone to create a website easily.
AI, however, is the opposite. It is proprietary, with companies owning their large language models. The barrier to entry for AI is extremely high, unlike the internet, where it is nearly nonexistent.
Training an LLM is costly, and the scarcity of GPUs makes success in AI challenging. This creates a winner-takes-all environment where early movers gain a significant competitive edge. Investing in AI today presents a rare opportunity to benefit from a high-barrier-to-entry industry with massive growth potential and the power to shape entire sectors for years to come.
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