- Last week’s software-led tech rout reminded investors that the AI hype isn’t lifting all boats.
- Investors should place heightened emphasis on stock picking as winners and losers emerge.
- Futurum Group CEO and chief analyst Daniel Newman shared what he’s looking for in winning AI stocks.
The tech stock sell-off that rattled Wall Street last week served as a reminder to investors that AI hype works both ways, and endless enthusiasm is no longer lifting all boats.
The dramatic downturn hit software stocks hardest, but it also spilled into the broader tech sector. Major indexes have broadly recovered from last week’s sell-off, but investors are still on edge about what could be the next shoe to drop.
According to Futurum Group CEO and chief analyst Daniel Newman, the sell-off was a “healthy, overdue rotation and a market demanding receipts.”
“Ignore hype and look at growth and constraints,” he told Business Insider. The analyst also shared some tips for picking AI stocks.
Here is the framework Newman says he’s using to spot winners and losers as the AI trade evolves.
Look for AI spending that’s actually translating to revenue
Not all companies spending on AI are seeing it pay off. While many on Wall Street chalk this up to the early innings of the emerging tech, companies that are seeing AI drive revenue are ones to look for.
“Companies need to show that the $470+ billion the hyperscalers are spending this year is generating returns. Those that do will be rewarded,” Newman said.
He highlights Amazon and Microsoft as examples of AI spending fueling revenue real growth, through the tech giant” respective cloud businesses, AWS and Azure.
Companies building their own chips have an advantage
Companies creating their own silicon chips are better positioned to compete. Capacity constraints control the AI race, with chip demand outpacing supply.
Amazon, Alphabet, and Microsoft are all working on their own custom AI chips.
Newman highlighted that companies with in-house chips benefit from capacity advantages and vertical integration, which set them up for better margins.
Enterprise monetization dominates
Companies that have been successful in seeing a return on their AI spending have been largely focused on enterprise offerings. These include the cloud hyper scalers, Alphabet, Microsoft, and Amazon, as well as Palantir, a favorite among retail traders.
Some software companies are seeing enterprise monetization, despite the worries that sparked this week’s sell-off. Newman highlights ServiceNow and IBM as “companies driving agentic AI workflows and token consumption.”
Physical AI is expected to be the next frontier
Elon Musk told Tesla investors on the company’s most recent earnings call that its humanoid robot, Optimus, could generate up to $10 trillion in long-term revenue.
Newman said that physical AI is the next multi-trillion-dollar market outside of data centers. He called out Amazon and Tesla as companies bringing AI to the physical world.
Avoid seat-based software plays that aren’t evolving with AI
The market zeroed in on the software space for good reason, Newman said. “I don’t believe the AI will eat all software, but AI will eat some software,” he told Business Insider.
The analyst explained that software companies with data running core business applications can survive in an AI era, but they will have to adapt to meet the needs of enterprise customers who want AI insights to fuel productivity gains.
Some software companies partnering with AI factories include Salesforce and ServiceNow.
Steer clear of AI spending with “no clear ROI narrative” or funded by debt
As AI-disruption concerns continue to fuel market skittishness, investors should be wary of companies without a clear narrative for how capex will deliver tangible results.
Another sign that an AI stock is risky may be that a company is using debt to finance AI infrastructure buildouts. Newman clarified that while debt isn’t always a bad thing and can be a way to invest in critical growth, it can make a stock more of a risk-on play.
In a risk-off environment, Newman told Business Insider that there are a couple of things investors should be watching for.
“Look at the companies that can really afford to keep investing, for businesses that are going to basically create the cash flow that do it with the least risk.”
