Are AI Related Earnings Being Flattered?

As a follow up to our piece “The Arithmetic of the AI Capex Boom", we have been working to understand if there are other factors which are supporting AI infrastructure share prices which may be more transient in nature.  In the course of this work, we identified three factors which may be supporting current earnings and investor optimism, but which may not repeat going forward.

CHIPS Act Subsidies

One factor relates to government support flowing into the AI supply chain.  The CHIPS and Science Act allocated approximately $52 billion of direct subsidies plus around $75 billion of loans and tax credits.  Direct grant awards include $8.5 billion to Intel, $6.6 billion to TSMC, $6.165 billion to Micron, and $4.75 billion to Samsung, with disbursements ramping through 2024 to 2026 against project milestones.  TSMC’s subsidiaries received NT$67.1 billion (approximately $2 billion) in the first half of 2025 alone, up roughly nine-fold year-on-year.  We have seen several instances of CHIPS Act subsidies being recorded in semiconductor company profit & loss statements and although these are real cash profits, they’re not likely to recure beyond 2026.

A Future Depreciation Drag

A second factor we have noted is linked to the accounting treatment for capital expenditure versus revenue.  When a company acquires chips, networking equipment, the physical data centre etc, this capital expenditure (capex) does not flow through the profit and loss account.  It is recorded as a capital asset on the company’s balance sheet and then reduced (depreciated) over time with a charge on the profit and loss account, reducing future profit.  However, the supplier records this expenditure as revenue in the profit and loss account immediately.

Since the market level earnings per share (a measure of end profitability) only covers the profit and loss account, the suppliers of AI equipment realise higher revenue and higher profits as the capex is spent, but the customer only faces a negative impact from depreciation in future years.  Currently, depreciation schedules for servers are between five and six years, so between one fifth and one sixth of the capex will be recorded as an expense, reducing profit, each year over the next five or six years.

Microsoft’s depreciation expense has approximately doubled in two years, but it will roughly double again over the next two as the recent capex cohorts reach the profit & loss statement.  Meta has acknowledged that it has continued to underestimate its compute needs, meaning its depreciation estimates have themselves been too low.  Assuming $2 trillion in combined capital additions between 2023 and 2027 with a 20% depreciation rate (a five-year life), the annual combined depreciation expense will reach $400 billion by 2027 for the AI infrastructure companies, comparable to their combined 2025 net profits.

Retail Flows and Tax Refunds?

The third concern is the hardest to quantify but worth considering.  AI-themed ETF inflows reached $19 billion in 2025, four times more than 2024.  The graph below shows the top 10 S&P 500 index and MSCI Emerging Markets index constituents by weight.  At present, the weight is very concentrated, but what’s more concerning is that almost all of the constituents are linked to AI as a theme:

Whether US retail tax refunds are being disproportionately recycled into AI names through Robinhood and Interactive Brokers is a hypothesis that is plausible but, in our view, hard to prove from the public data.  Anecdotally, US retail brokerage trading volumes do show seasonal patterns that align with US tax refund disbursement (which mostly come in April and early May), and AI-themed flows have been consistently the dominant retail theme through 2024 to 2026  This means that US retail clients may be enjoying a one-time cash boost and funnelling these proceeds specifically into the largest companies in the index.

Our concern as fundamental investors is whether the price we pay for an investment is an attractive one.  It feels unlikely that the typical retail investor worries whether Micron can sustain a forward operating margin of 80% when the historical thirty-year average is about 4%.  Much more likely, they will ask themselves “is AI a huge growth market, and is Micron in it?”  Both answers are yes, but at no point have they considered the fundamental question of “is it the right price?”. 

Conclusion

Our view is that the market is pricing the AI boom with confidence, but there are several reasons why it may be at the wrong price.

CDAJ, EFJR, TMNF

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