Aswath Damodaran: Why AI Needs $10 Trillion in Revenue to Work

24:04You should never get over-invested in a particular a macro story, no matter how strongly you feel about it. Because it's not that you won't get a big payoff if you're right, but if you're wrong, it takes you down and it changes your lifestyle. Your kids might not be able to go to the college they were planning to go to because you screwed up. So avoiding those big screw ups is as part of designing an investment portfolio as it is finding the big winners. I would love to go back to, for a minute here, the AI compost. And this is wonderful advice. And Mindy, I'm going to call you out here. Your SpaceX and Tesla stock are in your retirement accounts.

24:43So you don't even have to worry about the tax hit that he's talking about here when you actually make those moves. I hope you guys act on it before, you know, that changes things for you. We're in the middle of a big move. Once we're finished moving, which should be the end of this week, then we have a lot of time to have conversations about. And I think especially getting more balance in, especially if it's in a pension, it's in your 401k or somewhere where it's tax protected, then I would park it for the moment into an index fund, even if you can't find something specific to invest in. If you don't like index funds, put them in.

25:15I go directly into the treasury. You can invest in treasury bills directly. Put it into a six-month bill. You're going to get close to 4%. And while you wait, start looking around because once it goes into cash, it gets sticky. It's very difficult to get it out of cash because it feels safe for staying there. So you want to kind of do your homework while it sits around. I'd love to go back to the AI complex for a minute here. And I'd love to talk about Alphabet specifically, because I think it's a wonderful illustration of what confuses me as an amateur relative to someone like yourself by a long shot.

25:52But when I look at Alphabet, I see revenue of$120 billion, price to earnings ratio of like 15. I think we had$90 billion, somewhere in that range, on their income statement, or$77 billion unrealized gain in the last quarter's income statement on what was likely Anthropic and SpaceX. Yeah, mark-to-market, which you shouldn't even count as part of earnings, but no. Perfect. We have that. We also have an enormous, I think it's$200 billion in deferred revenue, revenue that will be realized in the coming years, coming from Anthropic, I believe, right? And Microsoft has its parallel universe over there with OpenAI.

26:29And I think that's what I think troubles me most about the AI story, which is the companies that claim to be companies that want to make their money on AI product services. Let's take SpaceX, right? You know where XAI's primary revenues came from last year? XAI. No, I do not. It didn't come from selling subscriptions to Grok or usage of Grok. It came from taking data centers they built and leasing it back out to Anthropic. And the problem with that story is if you're telling me as a banker that SpaceX is worth a lot because the AI business is going to be big and Grok is going to be a key player in that business, the catch in that story is you're now leasing out the factory you built to your biggest competitor.

27:12And if you truly believed your story, that would never happen. So either you don't buy into your own story and you want to make your money by selling to other people who might buy into the story more or there's something I'm not seeing in here. So you're right. A lot of those deferred revenues come from renting out data centers. They've already invested into other people and collecting. There's nothing wrong with doing that. You're getting money while you do it. But it cuts in the way of your bigger story, why you're making the investment in the first place, which is you think there's money to be made from selling AI product and services.

27:46And if you believe that, so how come you're leasing your factory out to competitors who can do that? What is it that you hope to do? There is this component of there's a circularity here that comes from many of these companies reporting revenues, but they're basically leasing the factory space to each other. That's why I would keep my eye on the product and service part, because without that, all of the intra-company leasing is all going to fall apart because none of the data centers would be valuable if nobody buys product services that use them. You had said earlier they're building data centers for two, two and a half trillion dollars.

28:17And right now, Anthropik's biggest revenue is 250 billion. No, that's not just Anthropik. Anthropik is less than their annualized run rate is about 70 billion. Oh, that's not just Anthropik. That's everybody is 250 billion. Everybody, Palantir, Anthropik, OpenAI, the collective revenues from selling products and services. So no contamination from leasing. So that's not fair, right? because that's just the factory being leased across people building. This is the actual stuff being sold from the factory. There's only$250 billion collectively. That's the bad news. The good news is it could be huge.

28:53So now let's ask a question. How huge can it get? And that requires dealing with an existential question about AI. What is AI going to do? Let's take a business. Let's take McKinsey. Let's assume Anthropic comes up with Claude Consulting Agents, which will help McKinsey consultants. It's a tool that makes them more productive. It's a cost to McKinsey, right? McKinsey will pay for these tools. But because it's a cost on top of their existing consultant pay, it can't be huge, right? It can't be billions because, you know, if you're paying 800 million on your consultants, you can't pay another 800 million on tools because then where are your revenues going to do?

29:33So it's going to be, if it's a tool, it's a relatively small number. So already, if AI is just a tool, the potential revenues you're talking about is much smaller. I'll give you a sense of what that collective number, the maximum it can look like. Last year, across the globe, the collective amount paid to employees in salaries, wages, compensation, all the good stuff, collectively was$26 trillion. Every employee in this private and public companies across the world. So let's say AI's pipe dream is it can replace every employee at every company. I'll tell you in a minute why this is going to be a nightmare for the rest of the world, right?

30:08But potentially, revenues could be up to$26 trillion. They're probably going to be smaller because why would you replace an employee with an agent if it costs the same? Potentially up to$26 trillion. But here's why the story crashes and burns almost instantaneously. If your end story is AI will replace every employee, it's true, that's a lot of money. But then all these employees who are now displaced have lost their jobs and their incomes and their consumption power. So what are all these companies that have replaced their employees with agents? Who are they going to sell this stuff to? So that story kind of crashes and burns because the macroeconomics don't work out.

30:47So when people talk about total addressable markets,$26 trillion is the absolute limit, but it's got to be much lower than that because you have to have a sustaining economy where people really have jobs. That's why I think if you're talking about total addressable markets more than$10 trillion, you're already reaching the limits of what's plausible. Because you're talking about AI then displacing a fairly large percentage of the workforce. It can't be just a tool anymore. If it's a tool, it's a$2 trillion total addressable market. We can already start writing off big chunks of the factory. If it's potentially replacing a lot of white collar employees, it could be$8 billion, $9 billion,$10 billion.

31:24You could get to some of the AI architecture being justified, but$2 trillion is probably still going to be too rich a capex. The problem is$2 trillion is right now. And these companies are not done, right? They're continuing to build data centers. They're continuing to add to architecture. It could be$3 trillion very quickly. We're adding about $700 to$800 billion every year to this capex. So unless you stop, this is very quickly going to become a number that is$3 trillion,$4 trillion,$4.5 trillion without the products and services yet catching up. And this brings me back to the alphabet item here.

31:57So I'm going to use numbers from a quarter out of date because I wrote this last last quarter here, but their TTM operating free cashflow last quarter was about$174 billion. And they spent about$110 billion on CapEx, which gives them net free cashflow$64 billion. That was through about June of this year. This year, they're projected to do$193 billion in operating cashflow. And that's real business. That's their core business that they're, you know, the advertising, 93 % advertising revenue we talked about. They're going to spend$185 billion, give or take, that probably has moved a little bit since this update, which gives them net free cash flow of$8 billion this year.

32:33Their CFO said next year, CapEx is going to significantly increase. So you can put an order number on there. I put$215 billion against that number, a small, you know, about$20 billion increase over this year's projected CapEx. And that means that for the next two years, for 2026 and 2027, investors are expecting zero free cash flow from Alphabet in an aggregate sense. And that same thing is effectively true at Microsoft. It's effectively true at Amazon. It's effectively true at Meta. NVIDIA is generating real, enormous cash flows. NVIDIA is the beneficiary of all of this overreaching, right? So in many ways, NVIDIA wants this circus to continue.

33:13So you're thinking of this as musical chairs. NVIDIA doesn't want the music to stop. That actually explains why NVIDIA is doing a lot of the things they're doing to keep the musical chairs going, like financing the purchase of their own chips by companies that can't afford to pay for the chips themselves. That provide by investing in companies. So in many ways, NVIDIA wants to make this a fait accompli where people are already committed to investing more and more because they benefit. So that's why I would separate NVIDIA from the rest because in many ways, they're playing a different game than Alphabet and Meta.

33:46You're right. Alphabet and Meta are making big loaded bets on AI. There are two ways to look at this. One is that they know more than us. Maybe they're seeing things that we don't see. And that's why they're making these bets. That's the upbeat, optimistic view of these. These are not dumb people. The other is they're caught up in a different kind of race that's leading them to invest, not because it's the right thing to do, but because they don't want to be left out. Now, I have a book called The Corporate Life Cycle, where I talk about companies aging and how difficult it is for companies to age.

34:20Growth companies wants to stay growth companies, just like human beings don't want to get middle-aged. They want to be in their 20s for the rest of their lives. Growth companies want to be growth companies. And the more glorious your history, the more you want to hold on to what used to be true. It's always been the case. Let's face it, these MAG7 companies have had glorious histories in the market. They've had an amazing run as growth companies, and they can sense middle-age creeping up on them. Meta senses, you know, six years ago with the metaverse thing, which is a badly thought through, smaller version of what you're seeing with AI.

34:58But I think there are two ways to explain what's going on. One is these companies want to stay growth companies, and they think that this is a business where they can stay growth companies. This can be another disruption where they can succeed. And they're all driven by the same forces that brought them here, which is their managers have succeeded at what they did. So they say, we're going to succeed at this next great market. Let's assume the AI market turns out to be$5 trillion, half of what you need it to be to justify the$3 trillion. But it turns out to be a market where there are two big winners, which I think is going to be the case.

35:29And let's say it's your alphabet and you think you can be one of those winners. You know what? That explains$194 billion this year, the$220 billion, because if you're going to be one of the two winners, you can justify the CapEx up front. I call this the big market delusion. It happens every time there's a big market and you have overconfident businesses looking at that big market, collectively, they overinvest. It's a feature, not a buck. And I have a feeling right now, one thing that's happening is what's being driven at these companies is everybody is looking at the big market, making judgments based on it.

36:03Nobody's looking sideways at what other companies are doing. So how do we all collectively live in that big market? Because their overconfidence leads them to believe that they're going to be the winners and the other guys are the ones who are investing too much money. So psychologically, we can see what's going on. But as investors, it does mean that if you have all these companies in your portfolio, there might be one winner and three losers. And collectively, you might end up losing money, but it's the nature of how this will play out. That's exactly my conclusion with this. And I'm, again, as an amateur here, I put these all together and I say, I can make a case for Alphabet winning.

36:40I can make a case for Microsoft winning. It's actually quite easy and quite believable. The story is not very complicated in many of these areas. And the revenue is easy to flow through, right? I mean, like Microsoft has the bookings from OpenAI. It's going to collect those unless OpenAI can't pay it. But when you, again, when you boil it all together, that's where the trouble starts because so much of the factory that you described is circular, right? Alphabet has invested in Anthropic and then Anthropic is using those dollars or some portion of them to then buy lease, you know, data center back from Alphabet.

37:17And that's going on all over this. And that's where I have a lot of trouble building up that valuation of Alphabet and saying, what's real here in terms of external demand that is flowing into the factory and then going into Alphabet's share? And how's that going to be long-term? How do you do that when you evaluate the companies that you hold personally? The first is if you can make a judgment on a winner and you are right, it's going to be an insane payoff. Let's take the dot-com boom, right? Let's say you made the decision to invest in Amazon and five other dot-com companies. Even with the dot-com, the boom busting, you'd still be a winner in this space because Amazon would have carried you.

37:58So my suggestion to you is if you can get the winner in your portfolio, you're going to be okay. Your problem is if you pick five companies and you say, one of these is going to be the winner and you turn out to be wrong and none of them happens to be the winner, then you're in trouble because an outsider has come in and essentially stolen the big market away from you. And then you end up with a portfolio that will really feel the pain. So you have two choices here. One is to stay out of AI altogether, which is going to give you a portfolio composed of less tech, because almost every tech company is an AI component.

38:30Now you're going to end up with the less tech, which is, I think, perfectly okay. The other is that, look, I can find winners. And if I find a winner, this is that hundred bagger that I talked about that I can boast about for the rest of my life. But that comes with a whole set of consequences that you've got to be willing to live with, one of which might be that none of the companies you pick that you thought were players in the field end up being the winner. And you end up with a portfolio of companies that all get hurt. I mean, if you think there was an argument for index funds before all of this craziness, I think the argument just got stronger rather than weaker for index funds, because the more uncertain you feel about how processes play out and winners and losers, the better off you are letting your money ride with a bunch of all companies in the market, hoping that you catch some of them.

39:18The investors who've been most hurt over the last 20 years are old-time value investors who've never owned any of the Mag 7, ever, because they've always looked too expensive to them. There are too much uncertainty, too. They don't fit into their definition of a cheap company. I can't imagine an investor being able to beat the market over the last 20 years without having any of them, because the Mag 7 alone accounted for about 25 % of the increase in market cap of all publicly traded U.S. companies in the last decade. It's tough to pick a portfolio without those MAG-7 that actually matches or beats the index.

39:56So it actually makes the case stronger for passive investing, where rather than wrangle with these individual questions that you find overwhelming, you basically spread your bets and you move on to living the rest of your life. That's a very sage point there, and a practical takeaway is the index. And in that context, the question I think that I keep coming back to is, which index then? Why does it have to be one index? Pick a big mix of index. In fact, I don't invest in index funds, but all of my children's money, I've increasingly moved index funds because it's not fair to them for me to leave them with individual companies in their portfolio.

40:31Why not fair? Because it requires more day-to-day. They have lives to live. They shouldn't be checking. Should I be selling Apple? Should I be holding Adobe? So increasingly move them to index funds. but not a single one. I have the S &P 500, and it's going to be usually the largest of the holdings because in market cap terms, the S &P 500 is such a... But I also have a small cap index. I have an emerging market index. The advantage of index funds and ETFs is you can create as diversified a portfolio as you want to with no upfront flotation transaction costs. I can just use Vanguard. I mean, I'm not pushing Vanguard, but I can just use Vanguard's website to get a bunch of index funds that meet my requirements that give me coverage across the entire market.

41:15That would mean that the S &P 500 doesn't become 90 % of your portfolio. It'll become 30 % of your portfolio. And you have these added index funds that give you the spread. But you will have your moments of regrets where the S &P 500 will outperform the entire market by 6%. I wish I'd done that. You have to be okay with that. That's the nature of index fund investing is you're going to match whatever market you are aiming to match and not much more than that. Sounds great. Well, I thought I would wrap up here with showing you my research project inspired by your work. So this is my mega cap valuation workbook here.

41:52And what I've done here is I have said, let's aggregate the roster of mega cap tech companies. Alphabet, Apple, Microsoft, Amazon, Taiwan, Semiconductor Manufacturing Company, Broadcom, SpaceX, Meta, Tesla, and Oracle. I'm missing a few, and I will add Anthropic and OpenAI when they go public. I've also factored out, you know, TSMC and SpaceX are not in the S &P 500, right? And, you know, some people, some of these are debatable whether you should include or not. So you can change these. And what I've done is I said, here's a discount rate associated with these. That's the first thing you're going to poke a hole in here.

42:26I've just used 10 % as a plug. Probably closer to 8.5 to 9%, but that's okay. You can use 9 % here then. I've took a terminal growth rate and I have a very simple way to articulate what the cash flows need to do for this complex in order for that to justify their current valuation with this reverse discount. And you're looking at the collective cash flows or individual cash and company cash flows? This is the collective cash flow. So you're valuing them collectively as a group. If you model it based on Wall Street consensus, you get to some very crazy stuff. And then I have to defend each one of those.

42:57So I just said, what has to happen for this valuation to be justified at today's valuation as an aggregate? That was my question I was asking here. Aggregate together to about a$30 trillion market cap. And, you know, after net cash and debt, we get to about$29.9 trillion in enterprise value. And the free cash flow over the last 12 months is about$450 billion, giving us a 66 times enterprise value to free cash flow across the collective here, which contains the factory and, confusingly, the other income stream. So how am I doing so far as a student in your class? Good. Yeah. Great. From there, I see that if you started today, you'd need a 32.6 % per year growth rate on the free cash flow.

43:38One thing about free cash flow is it's one, a very badly defined word in practice. So people are going to take different. Are you talking about free cash flow equity? This is after debt payments. So it's a net income based free cash flow. Or is it a free cash flow to the entire firm? This is operating cash flow, adding back CapEx. That's actually a free cash flow equity and you have enterprise value. So it should be free cash for the firm. And even if you did free cash for the firm, it's a tough number for people to relate to, right? Even if they know the definition, because it's the end number.

44:08It's a number that comes from revenues, margins, earnings, CapEx, working capital, etc. So my break even I framed in terms of revenues because the big debate here is, is there enough revenue here to justify? Because the pushback you'd get is you're missing the fact that there's a big market out there and we can make a lot of money in the market. This captures the free cash flow today, which doesn't include the free cash flow you will get from AI. So it will just require a couple of tweaks. Your free cash flow is an end product that comes from your capex, your investing, and your margins, which give you your earnings.

44:42So if you can put those into your equation as kind of inputs, I can then estimate the revenues I would need. So I asked, what do you think your target margin is going to be in the AI business? Is it a high margin business, a low margin business? Because if you can give me that, then I can take your existing market cap and reverse engineer from it, not the free cash flow, which is the end product, but the revenues that would give me that free cash flow. Sounds like it's a play in words, but it creates a more healthy conversation. Because now when you chat to somebody in the AI space who has no idea what free cash flow is, they're a tech person.

45:19They can still talk about revenues. And when they talk about revenues, you can ask them, what's your vision of AI? It creates conversations across areas, which I think is healthier. Because finance people talk to finance people, we can't resolve this. We don't understand enough of the technology. AI people talk to AI people can't resolve this because they don't understand enough of the business of AI. We need to create more of a conversation between the people who look at the bottom line, the EBITDA, the free cash flow, all of that stuff. and the people who are asking the questions about AI, is it a tool or is it a replacement?

45:53What is it going to do? I need to be able to talk to somebody in a topic who talks about Claude Fable and be able to get him to relate to my judgments on revenues. And I think that part can be breached. So that's the one suggestion I would make is reframe this not in terms of free cash flow, but in terms of revenues. Because I think that's really what this big debate is. What will the revenues look like in this business? And are they large enough to justify what we're investing in, what we're building right now? And if the collective answer is no, then what do I do as an investor? Do I avoid all of these companies or do I start asking this for individual companies?

46:32I'll take one company that makes Apple. The breakeven revenues you need to justify the market cap today are not that much higher. It's like 5 % a year growth. Why? Because they've not had this big CapEx boom in AI. So there might be individual companies you might still choose to invest in, even though collectively the space is a mess. You might believe that it's overpriced. And that might be a way in which you can bridge the gaps between people who like individual companies and dislike the group, as well as people who like AI as a technology and people who think about it as a business. I mean, one reason I wrote that post on AI as a business is I think we have two camps here.

47:10You have the optimists on AI who talk about how big it can be and how powerful it is. And they write on both, but they talk about the size of the market, the revenues. At the other side, you have people who talk about the bottom line. Where are the earnings? Where are the cash flows? And they look at it and say, there's no way. And right now, there is no crossing across these groups. We're talking different languages. We need to find a way to make the language something that we can both talk about. I'm an AI novice. As I wrote, I don't own the pro version of ChatCPT. I don't think I've ever used ChatCPT on my own writing.

47:47I'm an extremely ill-positioned person to talk about AI as a technology. So I need to talk to people who develop Claude Fable to understand what it can do. And I need to keep that conversation open. And the only way to do this is to stay away from finance terminology. I'm not talking cost of capital. I'm not talking free cash flow. So I'm talking, what are you going to do? Where are the revenues? And I'll impose macro constraints. This is how much you can afford to spend if you're McKinsey on replacing employees. You can't get any higher than that. Tell me where else you're going. So just some reactions to this.

48:23I think you're completely right. I started with free cash flow because I can't build a reverse discount cash flow without the cash flow. So that was the point of the engine here. I built the model dynamically responds, for example, to the 9 % discount rate. And that implies that revenue needs to grow from$2.8 trillion for this collective to about$14 trillion. Is that keeping margins constant as all of this shifts? If you take current free cash flow, there's an existing margin, an existing reinvestment that gave you the free cash flow. But both those numbers are in motion, right? Because you're talking about these companies changing their business models.

48:58You don't have to change what you're doing. You're doing a reverse DCF, but a reverse DCF, even though it might be based on cash flows, those cash flows come from revenue. So what I'm doing for my reverse engineering is doing a DCF, but I'm rather than framing it in terms of the free cash flow, I'm making the revenue. It's an algebraic question. I can make any variable the unknown rather than making the free cash flow the unknown. I'm making the revenue the unknown. So I'm reversing the process to get to those revenues. So it stays within the DCF approach, but it kind of builds up to a number where more people can have a conversation about what that number is.

49:34What do you think? I assumed in my model that it starts at 15 % today for free cash flow margin, and it ramps to 25%. Again, I can't even relate to free cash flow margin because free cash flow is already after reinvestment. The margin is kind of meaningless. It mixes up two things, right? The profitability of your business model and the reinvestment you need. The reason a free cash flow margin is going to rise in any company as it matures is your reinvestment as a percentage of your revenues will decrease as your growth decreases. That's why the operating margin is a number I can relate to because it comes from business economics, unit economics, economies of scale.

50:09The more you can move this conversation away from financial statement numbers to business models and market size, the healthier the conversation becomes. Because the way you push back at somebody who's being overall optimistic on AI is not telling them that the free cash flows are negative right now are not there, is to show them that the revenues they claim they will have are just not there. That's a tough constraint to get over, that you can't get to the revenues you need to justify even your story. Forget about the margins, the reinvestment, all the rest of the stuff. You're just in the realm of fairy tales now, when you've created a revenue number that can't be reached.

50:49And what's fun about that is the revenue, it overlaps with some of these, right? Like Google, Apple. This is a collective revenue. So you can't count revenues you get from each other, right? It's got to be collective revenues. And that's why I think you need to go outside these companies and look at, hey, what do companies collectively spend on employees? I need a story about what AI is going to do. And it also lets you connect with that part of the story, the dystopian stories of AI is going to leave us in a society with much greater inequalities of wealth. And 70 % of people, either unemployed or underemployed, sitting at home doing what?

51:25even if you guaranteed them a universal basic income. Work is not just about generating a paycheck. It's about a sense of self. What are you going to do to... I mean, it's a strange scenario to unfold because 33 years ago, 35 years ago, the early 90s, we saw this unfold in a different part of the economy. The disruption there was Chinese manufacturing. The disrupted were factory workers and miners. They lost their jobs and they were told pretty casually, learn to code, which I I thought it was the most insulting thing you can tell a 55-year-old factory worker learned to code. To code what? But we kind of let that pass because the people who were making the decision sat in New York and London and Tokyo.

52:08And to them, this was an abstraction. A small percent of people lost their jobs, blue-collar workers. And it took a while for the economy to adjust even to that loss of work. And that was a small loss. Can you imagine how much it's going to take the economy to absorb loss of bankers and consult white-collar workers with large incomes? And now, strangely, the people who are most protected are the electricians, the plumbers, the blue-collar workers, because AI can't replace them. But I think, in a sense, we've got to think through this fully. So when I talk to optimists, I let them play it out. Give me their optimistic story.

52:44And then I say, okay, let's take your optimistic story and let's see what the rest of the world will look like if your story comes true. And it's a scary thought because their most optimistic stories are dystopian ones for the rest of the world. You know how the change in seasons hits and suddenly you just want to declutter the garage, clean out the closets, and get everything all organized? That same feeling hits me with my finances every spring. I used to have accounts scattered everywhere, making it hard to stay on track with my money goals. Let Monarch do your financial spring cleaning for you.

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55:05And I walked through there. And now you get to something like$10 ,000 per every affluent person on earth spending that on AI to some degree. That's how I framed it. It's worse than the way that you just articulated a fool of corporate profits. But I think then you have to either confront either that means that these companies as a collective have dominated the global economy to yet another, you know, almost a tenfold increase in scale compared to where they're at today. Or one company has done that and carried the rest of them in order to produce investment returns. And now you've made a political bet.

55:37Now you're making a bet that the world population or the American population will accept that still very large increase in concentration of power. There's a much higher top line, which is global GDP can't grow at more than 2 % or 3 % a year in real terms. There's a cap. So all of this stuff is happening under the surface. Collectively, revenues at all companies can't grow 20 % a year. There's not enough income for it. So it's going to go 2%, 3%. So if revenues are not growing, all of this stuff is happening in the expense part of collective businesses, right? So if AI is getting bigger, something else is getting smaller.

56:12It has to. You know, it can't be, you know, you can't have your cake and eat it too. the most obvious item getting smaller is what you're paying employees. But there's an unfortunate problem. That is now the income that is used to generate the revenues, seeing as the top line. That's the part of the cycle where I think you need to kind of bridge the gap because I don't see an easy way to tell a really big AI story that doesn't cause the kind of disruption that damages your top revenues. But you end up in a global depression because so many people have lost their jobs and income. So I think that with the AI Optimist, that's my pushback.

56:46Tell me what happens if your story comes true. Tell me what the rest of the world looks like. And you don't have the option of saying, that's not my problem. It will be a problem politically. It'll be a problem economically. It'll be a problem business-wise. Because if that happens, you're going to get a backlash that makes the backlash we've seen in the last 20 years look like the child's play. You're going to see entire systems get overthrown, businesses get shut down. So I think this is the problem. And you let 25 to 30-year-olds without adult supervision build trillion-dollar companies without somebody pushing back and saying, this makes no sense.

57:22I mean, AI has been horrifically, the people who are spokespeople for AI have been among the worst tellers of a story that I've ever seen. They've taken a story that started right after ChatGPT came out in 2022 as this positive story, nice tool, look at all the neat stuff, into a story where 60 % of not just Americans, of the global population is looking and said, that's terrifying. I don't want that to happen. They should talk to tobacco company CEOs as to what happens when you become a company in a space where people think you're evil. Everything you do becomes the equivalent of pulling teeth.

57:59Everything is 10 times harder than you thought it was going to be. And if AI doesn't get the storyline going, and one of the suggestions I made was, you know, maybe they should follow AT &T's path from the last century when AT &T, when it was a regulated monopoly and everybody complained about their phone service, invested in Bell Labs, you know, something where they made no money but generated social goodwill. And they did it because it allowed them this freedom to operate as a regular money-making company that maybe the AI companies collectively need to think of their own version of Bell Labs.

58:35Where I've got these stories about how AI can cure cancer and AI can, which are things that can give you the kind of good storyline you need. But the way they're going about it, they're going to make lives more difficult for themselves. So even if that$20 trillion market is potentially there, they might never get even a fraction of that. if governments and politics start, I mean, look at how difficult it is to build a data center relative to two years ago, five years ago. It's only going to get more difficult rather than less so. And that's going to play out in every single dimension of the AI architecture if they don't start to fix the storyline they've created for themselves.

59:12I think that's a wonderful place to end and note to end on is I think that's right. There's a political or storytelling problem in the bowl case for AI here. I have a question here. Is there any chance that I could take your feedback and your wonderful wisdom you shared on today's show and re-architect my model here and submit it to you for a grade? Sure. I'd be glad to. Could I get the rubric for your final exam or the project of this type that you provide to your class? Yeah, absolutely. Easy enough to do. Yeah, I'd love to do that. I have some tweaks I need to make based on this and some tweaks that I was hoping to make before today's show, but did not quite get to.

59:48But anyways, yes, I would love to do that. And thank you so much for sharing the wisdom here. Any parting thoughts on the AI story here? I mean, the only thing I said, don't be an absolutist where, you know, you're on one side or the other. You know, I'll never buy an AI company or buy every single AI company. There's room to learn here because there's so much we don't know about this space that I think we need to keep talking. We need to keep the conversations going because that's the only way we get to a healthier healthier place than we are right now. Love it. For what it's worth, I'll say, I think AI is a great opportunity for those pursuing financial independence.

1:00:20It's going to bring the cost of executing a lot of ideas out there way down for you at a very small cost. As long as it doesn't replace their job, because they will have nothing to do financial independence with. I mean, I think that's a scary thought, right? This is not a benign technological shift. This is a technological shift which will have major consequences at the personal level. This is not a business tool, at least the way it's being sold. It is something that's going to change the way we live and change the way we invest and finance our lives. So I think it's something that's going to affect every aspect of your lives.

1:00:55That's a really interesting thing now. I know we just said we're going to get out of here, but I have a pessimism, I think, about the ability for the AI complex to generate strong returns for investors over the next 10 years and a huge optimism for the effect of AI on the broader economy. I agree with the real risk. People are going to get their life disrupted. There's going to be terrible outcomes in certain specific areas. And I also think there are broad gains, right? We should see better distribution, more efficient distribution and logistics in many companies. I think that many companies out there who suffer from weak functions in various departments, they should have their floors rise from AI.

1:01:34But the one problem is if everybody has it, nobody has it. So let's say grocers are able to get more efficient, but everybody's sold an AI tool that makes them all efficient. We benefit as consumers. That's the consumer surplus, but the businesses don't gain. The one thing about net effects of any of these technologies is I'm old enough to remember when PCs were a new technology and we were promised how this would relieve us of the tedium of work because we now have computers that lead to that. And how did that work out, right? And then we were told the internet would be this world of information.

1:02:06We'd have this amazing information. We'd all be more informed and we would have fewer bad arguments. How did that work out? And when social media was introduced, it was how we all connected across the, you know, my experience with these technologies is there's a lot of social stuff that they create and changes in the way we operate that we look back and say, I wish we hadn't done that. But the problem is, these are like genies out of a bottle. Once the technology is up, you can't put it back. You can't regulate it away. The U keeps trying, but it keeps failing. So 20 years from now, I might not be around, but if I'm around, I'd love to come back and talk about the net effects of AI.

1:02:47But I'm worried. I'm worried that the net effect might actually be a negative for all of us rather than a positive because it might take away things we do as human beings. And over time, we might lose them. I look at my grandchildren, I wonder what the world will look like and how they will learn a world full of AI. I am not particularly happy about the kinds of things AI will do to their learning processes. But as I said, that might be just because I'm old and contagious, but it's also, I think, a reflection of having lived through technological changes that in hindsight always leave more negative debris than we thought they were when they were introduced.

1:03:26Well, that's very sobering. Like I said, this has been an absolute privilege to get a chance to meet you and talk with you. Thank you so much for coming on and sharing your wisdom about valuation principles, about the AI complex and warning. I think that, hey, this, it may not be another, you know, a few decades of wonderful gains and booms. There could be real risks associated with this that could disrupt your life. Yes. Thank you so much for your time today. And we'll talk to you again soon. Take care. Bye-bye. All right. That was Aswath Damadaran, and that was a really, really fascinating conversation.

1:03:55Scott, I am coming at AI from two kind of opposing viewpoints. First off, I saw Terminator 2, so that is really, really, really scary to me. But on the other hand, I don't want to be one of those, no, horses are great, we don't need cars, people that were anti the Industrial Revolution way back when and not want to embrace AI. Aswath makes a really great, compelling argument that this is going to have a massive impact on the stock market over the next few years. And I kind of wonder if maybe these tech companies are setting us up for a really big crash. And I know you have been there already ahead of me saying, I'm pulling my money out of the stock market and I'm going to put it in a different direction because I think it's going to crash.

1:04:41And we say, oh, this time is different and this time is never different. It's always the same. But do you feel like this time is different? I won't know if I'm saying AI will crash. I'm saying I find it very hard to personally believe that the 40 % of the S &P 500 that comprises these companies, many of which we discussed today, can produce a 10 % return over the next 10 to 15 years. Very few forecasters or analysts are saying that that will happen. Professor DeMateran seems to be pretty pessimistic on the aggregation's ability to generate very strong revenue growth that's required to justify the bet on the factory here.

1:05:19But that's my bet. It's not that it's going to crash. It's that it will be very challenging for this group of companies to produce satisfactory returns over the next 10 years. And I have to believe much less for the equal cap weighted index or my factor tilts or my real estate to produce a 10 % return. There's not really robust assumptions that have to go in there. So I could certainly be wrong. I'm certainly losing badly in the last 18 months. We'll certainly pay attention to this over the next couple of years. And we can laugh at me in hindsight, but that's how I feel. And that's what my analysis says.

1:05:50And I think Professor DeMondrens seems to be directionally aligned with some of that. Yeah, it was difficult to listen to this episode and not agree with what you guys were saying. I mean, just the spending$2 trillion on building out the infrastructure and these data centers and whatever. And right now, the income is$250 billion. I mean, these numbers seem ridiculous. Well, and it's really hard to get those numbers, right? I tried to aggregate those in some way. And I would assume that even Professor DeModeran is going to say that's a fuzzy number. That's the best estimate that you can cobble together right now.

1:06:26It's really hard to understand how revenue is moving in and out and investment dollars are moving in and out of this complex because you have to separate out the factory, which I really struggled to do when I was analyzing this. And he seemed to have a very clear framework for it. That's the biggest challenge there. And yes, then you have to have enormous cash flow growth to justify just that factory bet. But you've got to have even bigger for growth going on in order to justify the valuations of the companies that make this up, right? There's a$2.5 trillion factory investment that has been made, as he put it.

1:06:58But these companies combined are$30 trillion in enterprise value. I believe fundamentally someday cash flow has to materialize from that complex to justify the valuation. So maybe that's wrong. Maybe that's just the world has changed and you no longer need that. It's no longer about that. Something else drives the price in perpetuity. But I'm not putting my fire plan on that particular assumption that dependence ultimately on cash flow has evaporated going forward. I mean, you both make a really compelling argument, Scott. Now it's time to dive into a rabbit hole and go into a bunch of different research projects.

1:07:35So Mindy, I think the$10 million question here is, are you going to draw a line in the sand about how much of your portfolio one stock is allowed to be at this point? Or are you going to keep riding the SpaceX and Tesla wave? Well, I pulled up our spreadsheet and SpaceX specifically is about 43%. I am starting to get a little uncomfortable with that much in one stock. And it has skewed all the rest of the percentages because so much is in that one stock. It's time to have a conversation with Carl about, you know, how much do we really need? And maybe we carve off a portion of that, take it out completely.

1:08:19And okay, this is the money that we are going to be able to live off of for the rest of our lives. And then everything else we can continue to experiment with because we do have far more than we need. And we want to leave a legacy to our kids, but it's going to sound kind of snotty, but it's hard to walk away from a position that you believe in. And we're not investing in SpaceX for today. We're investing in SpaceX for, you know, five years from now. Mindy, what would you tell a listener who came in and said, here's my position and here's where I'm at? What would you tell them to do? You have too much money in one stock and you need to diversify.

1:08:56It's funny, like it's very hard to move off, for example, in my position from the buy VOO or buy VTI in those areas. I can defend, I think, the, hey, if you're comfortable with mega cap complex, equal weight and factor tilts are well-researched areas to go into in there. But I think that's something that that's a struggle for you guys is this is not a position you could justify ever saying to somebody else to hold. It's interesting in this particular context how that works. I really like, for what it's worth, his rule of there's a number. You don't have to be 15%, but there's a number beyond which I will prune this and move into other plays here.

1:09:34Because even if your confidence, let's say that your next level of confidence, SpaceX is 10 out of 10 confidence. That's what you think is going to be the home run over the next 10 years. And then there's something else that's a 7 out of 10. It's a big gap that's not SpaceX or Tesla. Just moving your money into that probably gives your portfolio a much better risk adjusted. I need to explore this mathematical concept, but I think that that will give your portfolio a much better risk adjusted set of returns than just having this large of a single bet on your highest conviction investment. Yeah, we're in that position, though.

1:10:04We believe it's going to go up. So you don't pull your money out of a company that you believe is going to go up. I think that's what he said you do. Well, that's what he said he does. Yeah. So, Scott, Carl and I, we're literally wrapping up this week the move from the old house to the new house. I'm in my new studio. You can see if you're watching on YouTube. And then next week, we're going to FinCon. So the trip to FinCon while we're there, the trip home is going to be a lot of conversations about this. So I'm going to play this conversation for Carl so he can hear what Professor Damodaran has to say about all of these different things and get his opinion on what he wants us to do with our money, because it is getting to the point where it's hard to justify.

1:10:49So, ooh, more money conversations. Yay, my favorite. Some last parting thoughts on AI because I am an AI power user unlike everybody else in the discussion. I'm like the guy who's like, hey, I've used it all the time and I'm kind of bearish on that investment profile for the factory here, but I love the product. What I observe as a user is a continuous leapfrogging of one model to the next. You know, Grok is great. Astra 6, new GPT version that just came out is phenomenal in terms of what I use it for. Fable 5 from Claw was an incredible leap forward. And all I can project is better and better use cases for this stuff.

1:11:26A couple of months ago, I was saying I spent$169 and got all the AI I wanted from these things. I think that has since increased like 250 bucks a month. Again, I'm a power user here at BiggerPocketsMoney. But I shifted it. I shifted it from Fable 5 to OpenAI, the Astra 6 model from Claw to ChatGPT, basically, for those who are using the products. Because Astra 6 just got better. And so that's the game I think here is I'm building everything I'm doing, everything I'm working on. I build it to be portable because I'm betting on the next AI model coming from out of nowhere for the next provider. Maybe Grock leaps it in a few months.

1:12:02Maybe Gemini does in a couple of months, maybe perplexity, or maybe all of these guys get arrows in their backs, as is common in technology pioneering. And a new one that doesn't exist yet takes over in two years. I'm not going to build a business or any of my work streams in such a way that they're dependent on any one model. I'm going to build them so that as soon as the next one leaps forward, I can port it all over to the new one. And I don't think that should scare the investor here because I'm very price sensitive and usage sensitive to this stuff. And I think a lot of people are going to, there's no reason why the market in a general sense can't be as well.

1:12:37Yeah, I do think price sensitivity is going to come into play, but I have to think that somebody is just going to knock it out of the park and it's going to be so good that people are going to go use that one. But I am not a power user of AI. Let's get out of here, Mindy, and see what the world looks like. And we'll invite it back in 20 years, see how it all turned out. That sounds great. I would love to talk to him in 20 years. All right. Would you like more financial independence information? Follow us on Instagram, Facebook, and YouTube at BiggerPocketsMoney. Or you can head on over to BiggerPocketsMoney.com to sign up for our newsletter.

1:13:10and you can also find free resources, calculators, and templates to help you accelerate your FI journey. And that is free. That wraps up this episode of the Bigger Pockets Money podcast. He is Scott Trench. I am Mindy Jensen saying see ya, Chia. If you've been putting off life insurance, I get it. The old process was miserable. Phone calls with an agent, a nurse coming to your house for a blood draw, then waiting weeks to find out what you'd pay for. That friction is exactly why so many people who should have coverage don't. Here's what I believe. Most BP money listeners need term life, and the right move is to build a ladder.

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