As was the case with internet stocks in the late 1990s and the housing market circa 2006, the AI industry is an epicenter of bubble talk.
Predictably, that chatter is relevant to investors engaging with AI stocks and ETFs heavily allocated to those names. Those include the Invesco QQQ Trust (QQQ) and the Invesco NASDAQ 100 ETF (QQQM). A byproduct of bubble talk is market participants wondering if this time will be different. It’s appropriate to wonder about that. But there may be some good news for apprehensive investors.
Time will tell if the current state of AI is conducive to a bubble. But there encouraging signs for QQQ/QQQM investors. Those include sturdy profitability among some of the most AI-intensive companies.
“There are clear echoes of the late-1990s dot-com bubble—both in investor sentiment and speculative positioning. But while market cycles often rhyme, they rarely repeat in the same way. One key difference: today’s AI rally is underpinned by real earnings growth, unlike the profitless exuberance of the dot-com era,” noted Mark Hackett of Nationwide.
Consider the Cash Flow
One of the marquee differences between QQQ today and its holdings at the height of the internet bubble isn’t just that today’s members firms are highly profitable. They’re also prodigious generators of free cash flow. That’s a trait that could provide a buffer if the AI trade experiences a material correction.
“While profitability comparisons to the dot-com era are common, they often overlook a key metric: free cash flow (FCF) margin,” added Hackett. “Today, the S&P 500 technology sector boasts an FCF margin of approximately [20%. That’s more] than double the levels seen in the late 1990s and early 2000s. Although pockets of froth [remain … the]data suggests that hyperscalers are the true engines of the current rally. These firms are backed by fortress balance sheets, strong margins, and consistent revenue and earnings growth.”
Those FCF-generating capabilities and strong balance sheets are all the more important at a time when some investors are concerned about concentration in widely followed equity indexes. Those include the S&P 500 and the Nasdaq-100 (NDX). The latter is the gauge followed by QQQ and QQQM.
Indeed, concentration risk is an issue. But it’s arguably one investors don’t need to lose sleep over because the concentration is in quality companies.
The Magnificent Seven “have delivered year-over-year earnings growth of 27% in Q1 and 26% in Q2, with Q3 estimates pointing to another 14% gain. That is just 5% growth for the remaining 493 companies in the Index. Unlike many dot-com darlings, these firms are not only profitable—they’re driving the market’s earnings engine,” concluded Hackett.
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