Champagne corks are popping at OpenAI.
It’s the company Sam Altman, Elon Musk, and a bunch of big-brain computer scientists founded in 2015 to build “safe and beneficial” artificial intelligence (“AI”).
Last November, it shot to prominence with the release of its groundbreaking generative AI assistant, ChatGPT.
The company is still in private hands. So, it relies on money from venture capitalists (“VCs”) to fund its operations.
And it hasn’t had trouble bringing in big bucks.
In April, it sold shares to VCs that valued the company at $28 billion.
But according to a report in The Wall Street Journal last week, it’s now in discussions with VCs to sell shares at a valuation closer to $90 billion.
That’s a 221% increase in value over just five months.
And it makes it the most expensive pure AI software company in the world.
OpenAI generates about $1 billion in sales a year. So, a $90 billion valuation would make it worth 90x sales.
That’s even more than AI chipmaker and recent market darling Nvidia (NVDA) with its price/sales (P/S) of 34x.
And a lot of folks in the mainstream media claim it shows that AI is in a bubble.
For instance, earlier this month CNBC’s Mad Money host Jim Cramer warned viewers that AI was reaching its peak.
But as you’ll see today, traditional ways of valuing stocks will make you miss out on the biggest gains from bleeding-edge technologies.
And anyone beating the drum that AI is in a bubble is going to end up with egg on their face.
There Is No Magic Number
These calls are mainly coming from two distinct groups – traditional value investors and the technologically uninformed.
Let’s look first at the traditional value investors.
You know the type. These folks love to throw around terms you probably first encountered in a Finance 101 class such as the price-to-earnings (P/E) ratio, book value, and the price-to-sales (P/S) ratio.
Now, don’t get me wrong. These metrics have their place. They tell you something about how much you’re paying to own a stock.
But if becoming wealthy was as easy as following these ratios, we’d all be rich by now.
We’d all just wait for the P/E ratio to hit some magic number… buy stocks… then sell when it hits another magic number.
But these ratios are rudimentary tools at best.
Listening to folks who tell you to sidestep an investment because its "P/E is too high" can put you on a fast track to missing out on the next big thing.
Just consider how often over the past decade we’ve heard that Tesla, Amazon, and other super successful companies were “overvalued.”
If I had a dollar for every time a pundit claimed these stocks were overvalued, I’d be as rich as Jeff Bezos and Elon Musk by now.
Let me show you what I mean…
Value Investors Were Wrong About Tesla
It may seem crazy… But one of the best times to buy Tesla was when it was trading at its peak P/E ratio of 2,301 in June 2020.
That means its shares were trading at 2,301 times its earnings at the time.
That made Tesla the world’s most expensive car maker. And mainstream pundits were screaming about how it was overpriced and destined to crash.
Shares were trading for a split-adjusted $62.
If you’d held until today, you’d have 4x your money with a 263% profit.
Tesla wasn’t alone.
Amazon set its highest P/E ratio of 350 in March 2018. It’s up 61% since then.
Meta hit its peak P/E ratio in March 2017. It’s up 114% since then.
Remember, these are returns from the peak of the P/E ratio. And they’ve still outperformed the S&P 500.
If you were strategic about when to buy these companies, your returns would’ve been much higher.
Now, imagine if you’d steered clear of those because some talking head told you the P/E was too high.
You’d have missed these market-beating returns.
But couldn’t OpenAI’s rich valuation still be a sign that AI is in a bubble?
I get why people think that. It is a very rich valuation.
But let’s not jump the gun here. It’s crucial to dig deeper and apply more nuanced metrics to truly understand the dynamics at play.
Ignore This Old-School Thinking
In 2022, OpenAI generated $28 million in revenue for the entire year.
Fast forward to today, and the company is pulling $1 billion a year. That’s a 3,471% jump.
And OpenAI isn’t just another player in the AI industry. It’s the leader in a transformative new technology – a technology that’s on par, in terms of its significance, with the steam engine, electricity, and the computer.
Traditional valuation metrics couldn’t predict the rise of Tesla and Amazon shares. And it doesn’t work here, either.
Remember, OpenAI’s ChatGPT was the fastest-growing consumer app in history. It reached 100 million users in just two months.
That’s faster than Snapchat, Instagram, and Facebook which all took years to reach 100 million users.
This kind of explosive growth – and the market leadership position that comes with it – can’t be captured by P/E and P/S ratios.
Those numbers were designed for stable, mature industries, not paradigm-shifting technological revolutions.
The whole thing makes my blood boil.
Judging the future of a sector as transformative and dynamic as AI based on outdated financial metrics isn’t just naive… It’s financially reckless. The technological landscape is evolving, and the metrics for assessing value need to evolve along with it.
If you’re investing in AI, you’re not investing in a company’s present financials. You’re investing in a paradigm-shifting future. And that future is only just getting started.
So, the next time someone tells you AI is in a bubble, take a long, hard look at where that advice is coming from.
If it smells like old-school thinking, it’s probably best to keep your eye on the horizon and your finger far from the sell button.
Regards,
Colin Tedards
Editor, The Bleeding Edge