The AI-Rally for software manufacturers will require the patience of investors

(Bloomberg) — Investors need more patience for artificial intelligence euphoria to lift shares of software makers.

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At a time when growing demand for AI infrastructure is prompting marketers to bid on hardware makers such as Dell Technologies Inc. and Micron Technology Inc., software companies are having trouble convincing the market that similar growth is on the horizon.

The Philadelphia Stock Exchange Semiconductor Index has climbed 16% this year, supported by chip and server makers such as Nvidia Corp. and others related to artificial intelligence. Meanwhile, an index of software stocks whose members are Adobe Inc. and Salesforce Inc. it has gained less than 4% so far this year.

The software index fell 1.1% on Wednesday, while the chip index fell 0.9%.

“We’re not seeing tangible earnings growth,” said Scott Yuschak, managing director of equity strategy at Truist Advisory Services. “Many companies are talking about the use and benefits of AI, but we still need to see the use cases and how much their customers will be willing to pay. That clarity may not come until next year.”

Although artificial intelligence is expected to reshape entire economies, these hopes have yet to be fundamentally justified.

Adobe, for example, beat expectations to raise generative artificial intelligence for its creative-arts software in a weak sales forecast last month, sending its shares down more than 20% from this year’s record high.

Salesforce, which is investing in AI-based features to boost sales of its customer relationship management software, also gave a lackluster forecast when it reported earnings in February.

Even Alphabet Inc. struggled with offerings that were dogged by accuracy issues and internal criticism about the usefulness of its AI tools.

Revenue contribution from artificial intelligence remains minimal even though users are interested in the technology, wrote Brian White, an analyst at Monness Crespi Hardt & Co. Markets will “become increasingly suspicious of generative AI propaganda,” he said.

Overall, software companies are expected to generate less than half the earnings growth of semiconductor companies in 2024, according to Bloomberg Intelligence. Last earnings season also showed it was more likely to miss consensus compared to its hardware peers, according to data compiled by Bloomberg.

“Short-term expectations for generative artificial intelligence could outpace fundamentals,” wrote Tyler Radke, an analyst at Citigroup Inc. While AI remains a focus for software executives, “project sizes and use cases remain smaller in nature rather than large-scale transformational changes.”

The waiting game

Still, while AI may not be showing up in results yet, investors see the coming impact as a matter of time.

Take Adobe. While its forecast may have been disappointing, recent product announcements have highlighted its competitive position. For Alphabet, talks with Apple Inc. on the use of Google’s parent’s AI model in the iPhone line, they consider it a win for both.

Microsoft Corp is already highlighting the technology as a growth driver, and efforts to build artificial intelligence into a variety of high-end products, including Azure, Office and Windows, are starting to pay off.

“Every company realizes there’s a lot of potential here, so they’re building applications and doing trials,” said Jonathan Curtis, chief investment officer for Franklin Equity Group. “The impact is absolutely coming, and the concern that we haven’t seen it yet is too short-term a view.”

Technical table of the day

The Nasdaq 100 fell 0.9% on Tuesday, sinking into a broad-based decline amid speculation about when interest rates will be cut. Only 15 components of the high-tech index rose, making for one of the weakest days of the year by this measure, as well as the fewest gains since mid-February.