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THE CIRCULAR NATURE OF AI RELATIONSHIPS

Upward earnings revisions are making U.S. stocks look cheaper on a price-to-earnings basis, but among the risks analysts and investors may be overlooking are the increasingly circular relationships surrounding artificial intelligence investments and big technology firms, according to a Rosenberg Research report.

"Big Tech" companies are investing in high-growth private AI companies, reporting gains as "other income," and also booking cloud-computing commitments from the same companies, write Mehmet Beceren and Zachary Young in the report this week.

Analysts continue to upgrade profit forecasts for the companies on the news, all of which is resulting in a situation where "AI earnings are starting to feed on themselves," they say.

For example, Alphabet GOOGL.O reported "staggering" profit growth in the latest earnings season, they write, adding that Alphabet booked $37.7 billion of "other income" for the first quarter, which they say accounted for more than half of its quarterly net income. They say that Amazon.com AMZN.O had $16 billion in other income, which they note was nearly half of Amazon's quarterly net income.

Together, Alphabet and Amazon generated $53 billion of other income in the quarter, while one sell-side analysis estimates that $49 billion of that amount was tied to equity stakes in private companies, they write.

"There is nothing inherently wrong with booking gains on private investments," they note. "But the issue become more interesting when those private companies are also among the largest customers of the investors booking the gains."

Both Google-owner Alphabet and Amazon, for example, are investing in AI company Anthropic, while Anthropic's big cloud-computing commitments include ones to Google and Amazon.

"That creates a circulatory problem," they say, where the companies' gains "feed into earnings forecasts, valuation multiples, and market sentiment in a circular fashion."

(Caroline Valetkevitch)

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