Some observers point out that today’s valuations are not comparable to those of the year 2000, which suggests that we are not in the same situation as during the technology bubble. That is true. In my opinion, however, the issue is that certain companies, particularly semiconductor manufacturers and those supplying data centers for AI, are reporting profit margins that are significantly higher than in the past. What would happen if these margins were to revert to their historical average over the coming years?
I have often written about the phenomenon of mean reversion. If there is one area where mean reversion applies, it is corporate profit margins. In a competitive economy, companies with abnormally high margins eventually attract competition, which tends to bring them back to more normal levels. The reverse is also true: abnormally low profit margins tend to return to more attractive and sustainable levels, as less profitable companies eventually disappear, allowing survivors to achieve better margins.
One of the lessons I learned during the pandemic is to be cautious about profit margins that increase due to exceptional conditions.
Today, in my view, we are experiencing an exceptional situation in the AI market, with companies, particularly hyperscalers, investing vast amounts in data centers dedicated to AI computing. Demand is unusually high for everything required in these data centers, especially chips and semiconductors.
As a result, several companies in the technology sector are currently reporting net profit margins that are significantly higher than before. Here are some examples:
| Company | Adjusted profit margin most recent quarter | Adjusted profit margin trailing 12 months |
|---|---|---|
| NVIDIA | 58,1 % | 54,2 % |
| Broadcom** | 53,9 % | 52,8 % |
| Advanced Micro Devices*** | 22,1 % | 20,1 % |
| Micron**** | 58,8 % | 44,4 % |
** History excludes 2016, which was a loss year
*** History excludes 2026, which was a loss year
**** History excludes two loss years, 2016 and 2023
The profit margins achieved by these companies are clearly higher than their historical averages. This likely reflects the unprecedented demand for chips and semiconductors used in data centers. It is possible that part of the gap between recent margins and those of the past is structural. However, it seems to me that a potential reversion toward historical averages is likely.
Indeed, exceptionally high margins inevitably attract competition. For example, companies such as Apple, Amazon, Alphabet, Microsoft, and Alibaba have announced plans to produce their own semiconductors.
When an industry goes through an exceptionally favorable period, investors must resist the temptation to extrapolate margins observed at the peak of the cycle.
Philippe Le Blanc, CFA, MBA
Chief Investment Officer at COTE 100
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