Buffet bought the AI bubble

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Welcome to FinSoar. Warren Buffett just bought billions in AI stocks. Michael Burry just bet billions against them.Eli Lilly became the first pharma company worth a trillion dollars, and AI's eating so much electricity that power companies can name their price: 

I’m a big, big fan of Warren Buffett, who has long preached a simple rule: never invest in a business you don't understand. That principle kept Berkshire Hathaway out of the internet bubble in the late 1990s and saved shareholders from the subsequent crash. 

Take a look at the top Berkshire Hathaway stocks:

So when Berkshire disclosed it had purchased 17.8 million Alphabet shares in the third quarter, worth $4.93 billion by mid-November, analysts did a double take. The purchase looked decidedly un-Buffett-like.

Bloomberg Opinion's Nir Kaissar put it bluntly: AI is "orders of magnitude more complicated than selling books or pet food online." Combine that opacity with premium valuations and you're sure to lose Buffett.

Just look at the numbers: Berkshire paid roughly 40 times trailing free cash flow for Alphabet, compared to an S&P 500 average of 26 times since 1991. 

Alphabet trades at about 25 times forward earnings. It needs free cash flow growth of 13% to 23% over the next three to five years just to bring its valuation back to reasonable levels.

Compare that to Buffett's 2016 Apple purchase. Back then, Apple traded at 9 times free cash flow with a 27% FCF margin. The valuation-to-profitability ratio was so favorable that Berkshire was virtually guaranteed to make money. Apple has since returned 28% annually, including dividends.

However, Alphabet's situation is different. The company boasts a 19% FCF margin, respectable but not elite. Future returns will have to come from growth, not valuation expansion. If that growth doesn't materialize, investors face a valuation contraction.

The timing adds intrigue. Buffett steps down as CEO on December 31, handing the reins to Greg Abel. Buffett also announced he's "going quiet" and will no longer write annual reports or talk endlessly at shareholder meetings.

It's unclear whether Buffett, Abel, or portfolio managers Todd Combs or Ted Weschler made the Alphabet call. Berkshire almost never reveals who bought what. 

But the purchase certainly previews what Bloomberg called "a very different approach than Berkshire's shareholders are used to" — notably, a willingness to pay more now for potentially higher growth down the road.

The Markets loved it. Alphabet shares jumped 6% on the news and have since raced toward a $4 trillion valuation, up nearly 70% this year. "The market is still in the mindset of anything Berkshire does is worth emulating," said Steve Sosnick at Interactive Brokers.

There's history here too. In 2019, the late Charlie Munger admitted he felt "like a horse's ass for not identifying Google better."

Abel, if he's behind the move, seems game to correct that mistake. Whether it pays off is another question entirely.

Sources: Reuters, CNBC, Fortune, Bloomberg, Yahoo Finance

Eli Lilly became the first pharmaceutical company to hit a $1 trillion market capitalization on Friday. The milestone, driven by explosive demand for weight loss drugs, came the same week Novo Nordisk's stock crashed to a four-year low.

Lilly's stock has climbed more than 37% this year as investors applauded gains it's made over Novo in the booming GLP-1 space. 

The Indianapolis company's Mounjaro drew $6.52 billion in third quarter revenue, a 109% jump. Zepbound posted $3.59 billion, up 184%. Combined, the obesity and diabetes portfolio generated more than half of Lilly's total $17.6 billion quarterly revenue.

Lilly is only the second non-tech company in the US to reach the trillion-dollar mark, joining Warren Buffett's Berkshire Hathaway. It now trades at about 50 times forward earnings, one of the richest valuations in big pharma.

The rapid rise was partly due to investors rotating away from AI stocks. "You have seen a broad-based outperformance in healthcare," said Rick Bradt at Neuberger Berman. "Lilly stands alone in the pharmaceutical pack on all levels."

Meanwhile, Novo Nordisk is imploding. 

The Danish drugmaker's stock plunged to 274 kroner on Monday, its lowest level since mid-2021, after an Alzheimer's trial failed. The company tested whether semaglutide, the active ingredient in Ozempic and Wegovy, could slow cognitive decline by at least 20%. It didn't.

Analysts had called the trial a "long shot" and a "lottery ticket." The failure removed a near-term upside scenario for investors who'd hoped it might reignite the battered share price.

Novo's stock is down 45% this year. The company has cut guidance multiple times, replaced its CEO, overhauled half its board, and announced plans to slash more than 10% of its workforce. 

Competition from Lilly has been devastating. Even though Ozempic hit the market four years before Mounjaro, Lilly quickly grabbed bigger market share in the US.

Wall Street estimates the weight loss drug market will be worth $150 billion by 2030. Lilly expects an oral version of its drugs to hit the market next year, which could give patients a more convenient option and make production easier.

BMO Capital Markets analyst Evan Seigerman said he prefers Lilly over Novo. "Fundamentally, it highlights real confidence in the longevity of, not just their metabolic businesses, but all the businesses that they run."

Morgan Stanley raised its price target on Lilly to $1,290, suggesting more than 10% upside. The firm's survey projects ongoing GLP-1 market growth with Lilly continuing to gain share. Bernstein went even higher, raising its target to $1,300.

Not everyone is giving up on Novo. JPMorgan called Monday's selloff an "overreaction" and maintained its overweight rating. But the damage is done. Lilly has won this round decisively.

Sources: CNBC, Financial Times, Al Jazeera

Michael Burry, the investor who made his name betting against subprime mortgages before 2008, has closed his hedge fund and launched a $379-per-year Substack newsletter to warn about an AI bubble. 

The timing is pointed. His fund, Scion Asset Management, had just disclosed more than $1 billion in put options against Nvidia and Palantir.

"I am not retired," Burry wrote on his new publication, "Cassandra Unchained." The newsletter already has more than 21,000 subscribers.

Burry explained he closed the fund because regulatory constraints "effectively muzzled" his ability to communicate. Running money professionally meant he could only share "cryptic fragments publicly, if at all." 

Now he's free to elaborate.

His thesis is straightforward. The AI boom mirrors the late 1990s dot-com mania. Back then, four companies dominated tech: Microsoft, Intel, Dell, and Cisco. Today, five public companies lead the AI charge: Microsoft, Google, Meta, Amazon, and Oracle. 

These firms are promising nearly $3 trillion in AI infrastructure spending over the next three years.

Burry singled out Nvidia as today's Cisco. During the dot-com boom, Cisco's stock surged 3,800% between 1995 and 2000, becoming the world's most valuable company at $560 billion. Then it collapsed more than 80%.

Sources: Reuters, The Observer, Fortune, CNBC

That’s all for today