Do AI Moats Exist?

0:00Do moats exist in AI? Motley Fool, Jim's investing starts now. Well, good to Motley Fool, Jim's investing. I'm Travis Hoyer. I'm joined today by Lou Whitman and Matt Frankl. Guys, we have a, it's kind of an interesting time of the year because we're at the end of the calendar, third quarter, earning season hasn't begun yet. But there is a lot of moving and shaking in the world of artificial intelligence, a couple of IPOs that are potentially coming in the next month to six months with anthropically to be first. So I wanted to talk about it. If we're looking at some of these companies, let's take a big picture approach. And one of the questions that I have is, do moats really exist in artificial intelligence? If you look at the history of investing, finding companies with moats is a phenomenal way to make money. And the 80s, moats were driven by supply and big brands. So just, you know, by the biggest best brand you possibly can, the retailer with the most customers you're going to do phenomenally well as investor, aggregators kind of won the demand platforms,

1:02Amazon, Netflix, Uber in the 2000s in the 2010s. But Lou Doe moats exist in the world of artificial intelligence because it seems like it won exists for five minutes and then another model is released and everybody moves over to chat GPT and then, oh, Muse is released. So now everybody's trying out Muse. It seems like these are incredibly fragile moats or do you see it differently? So Travis, you should have given me a trigger warning here because this is a hill I'll dial in. I am a terrible person to ask this in part because I think 99% of the discussion of moats in finance is just ballad or dash. I don't think moats really exist. If they exist, they're very rare. And as an investor, they're really only recognizable in hindsight. I don't think in real time, there are plenty of examples. There was a famous 2014 book about the value of moats. And you look through, there's 20 or so companies that are mentioned in that. Half a merout of business now. Okay, so you know, everything,

2:03I mean, all we're really talking about is competitive advantage that gets to a point where you can't overcome it. I don't see any moats in AI, almost by definition because none of these companies even have pricing power. How can you have a moat? How can you have this idea that, you know, like you are, you cannot be conquered when you can't even control the terms or the customer on pricing. I don't see any permanent competitive advantages here. And I don't anticipate that happening anytime soon. Matt, do you see it the same way? I'm a little less pessimistic about the moats in AI than Lou. I mean, but the moats definitely appear fragile. So, I mean, what I mean by that is a couple of years ago, Chad G.P.T. clearly had the first mover advantage. A year ago, they had a 79% market share when it came to just, you know, this query volume. That was the start 2025. Now it's down to 54%. That's 25 percentage points of market share that's gone. And the same time, Claude went from roughly 1% to 9%.

3:06And the capability is not the moat. That's one place where Lou and I will clearly agree. All of the Frontier AI models are within a little, you know, a narrow band when it comes to capability. There's a couple of true moats that I see. I don't know if anyone's captured them completely yet. One is capturing enterprise workflow, like being ingrained in workflow. It's the same reason that some of the software companies that quote, could be disrupted by AI are still growing their revenue faster, not seeing too much customer turn. It's because they're embedded in workflow. Like, Claude code is a big example of that. I use Claude code work every day. Like, I'm not going to switch that to a more capable model because I already depend on it. The other one is distribution that I see. Think of Gemini. Gemini uses just up 450% over the past year. And why? Not because they are pricing power, not because anything of that, because Gemini is ingrained into everything Google does. It's being, you know, force fed to everyone

4:09who uses Google Maps, who uses Gmail, who uses, you know, Google search. So distribution is a big competitive advantage. I don't know how durable of a mode it is, but that seems to be something that could have some staying power here. Yes, as impressive. It's the same reason we all use Bing, right? Oh, man, bringing up. Well, so, Lou, that does bring me to my other question, which is, when we look at this space, what seems so different than in the past, whether you're looking at consumer package goods or retailers, or even just the last 20 years in technology, that was all companies, the companies ended up winning, ended up beating the competitors they had, but then they weren't competing with also all the other companies, right? Like the banana company isn't competing with the serial company. But now we have all of these tech companies, all of them, in some way competing with each other in the future of AI. So you have Anthropic takes the lead early this year, and then suddenly out of nowhere,

5:10Meta, who we thought was kind of done and dusted, is now potentially, is the most compelling product release of 2026. It seems like part of the challenge from an economics to an investing standpoint is that they're all chasing after the same puck, and in that world, margins and modes seem really tough to build. Right, and these are all companies that build their existing business, basically not monopolies, but being the dominant force in an industry. So this is not something that they dealt with, but I do think it's interesting. I made the joke about being, but I'm serious with that because yes, right now Gemini is the thing for consumers because none of it is really that good. So we're just using what's there. If this Meta Muse product is good, that's a reason to use something different, and I don't think Gemini will have a mode at all that, if there's actually a compelling case, just like Chrome, despite its disadvantage, took over the browser wars just because it was a better browser. So again, modes, and maybe I just have

6:11too high of a standard of mode. If we're just talking about, do some companies have competitive advantages in a moment? Of course they do. That's how capitalism works. But this idea that there is something to invest around, like I can trust this company because they have a competitive advantage that's strong enough that I don't have to worry about it. That is so rare in business. Just kind of the definition of capitalism is that we see that these are rare. So I just think we spend too much time talking about modes. As an industry, it's a very young industry, and to your point, two years ago, look very different than today. I don't even really know who has a durable competitive advantage right now. With those questions, a durable competitive advantage is in mind. We're going to talk about valuations in just a moment. You're listening to Motley Fool, hidden gems and investments. As a podcaster, my voice is heard by thousands of people, and now with Vanguard Investor Choice, I can be heard by the companies I invest in too.

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8:15Zero dollar commission does not apply to customers designated by Fidelity's a professional equity trader. A limited number of ETFs are subject to a service fee of $100. C details of Fidelity.com slash commissions, Fidelity brokerage services LLC, member NYSE SIPC. Welcome back to the show. The second question I have for you guys today is how do you value these AI companies? In the context for this is we had the SpaceX IPO. So that includes XAI and all the stuff that involved in that. We found out in their perspectives or in their S1 that they're actually mostly an AI company, not actually mostly a space company, which is I think a little bit ironic. But Matt, as you look at these companies, we've seen market share, ebb and flow. We've seen margins and pricing, ebb and flow. So with that in mind, how do you value some of these companies, especially, especially as they come to market? When the anthropic S1 becomes public, how do you look at that and say, here's where I would price this company to see a value or where I would maybe kind of stay away? The short answer is I don't know how to value these companies and neither does anybody else. We haven't seen a public S1.

9:17We have, I mean, anthropic uses different revenue calculations that they're revealing to the public. They're using gross revenue, not net revenue, just for example. So it's tough to value a business when revenue is growing at a run rate from $9 billion at the start of this year to $65 billion as of the end of July. That's anthropic. But like I said, we haven't seen the public S1. The accounting they use, we don't know what accounting they use because we haven't seen the public S1. We don't know what percentage of their revenue is enterprise versus consumer. That makes a big difference in the valuation. Enterprise revenue is generally higher margin and stickier. How much money will they need? How much money are they making? We can only kind of speculate how much CapEx and forapix gonna need this year. We can only really speculate how much they're losing right now other than to say lots and lots. These play into the valuation. There's simply no comparison.

10:18We don't have a basis for comparison to a public company that is growing this fast that is at this scale already. SpaceX isn't growing this fast at this scale. So I'll be looking at the S1 very closely. Once we have real numbers, I might have a better answer for you on how to value anthropic and open AI when we eventually get theirs. But it'll be really interesting. That's one of the S1s I'm really gonna be paying attention to. Matt, is there one number that you would look at? I want to ask Lou about comparisons to the 90s. But in the 90s, you would look at metrics like eyeballs, right? We're not, I don't think doing that anymore. But is revenue the number that you would look at and say, oh my gosh, they're growing revenue at 800% year over year and it's at a $65 billion run rate. So therefore, I don't know, put a reasonable multiple on that and that's where I would maybe be interested. Is that a good number to look at or is there something in profitability? Well, going back to the moat conversation, revenue retention is a number that I would really look at.

11:19How well are these companies retaining revenue? Is someone paying $20 this month for Quad? $20 next month for ChatGPT and so on and so on. Are they churning revenue really fast? And I want to see if the unit economics are getting better. As we said in the moat discussion, none of these companies have established pricing power yet. So are the unit economics as these companies scale exponentially and have to build on their compute and things like that. Are the unit economics getting better or worse? And you can see that by just looking at the gross margin trend over time. So between revenue retention and gross margin trends, you'll get a really clear picture of the real situation with these businesses. Yeah, so back to your original question, how do I value these companies? The answer is less. And like with Matt, I don't know how much less because we haven't actually seen the numbers. I don't think either of the companies seem to want to put forward the audited numbers which say something but less than what we're here. And I'll tell you why. It's not to say they're not without value. Both companies have massive amounts of value,

12:22but we are talking about numbers that would place them among the top 10 most valuable companies in the world. I will buy the argument that one day they could be. I will accept that. I might even agree, but my guess is all of these companies will not be among the most valuable in the future. Some will fail. Some will be seriously second best. So I am not willing to assume mega growth for generations to come from any of these people when I don't even know who the winner is. Yeah, it's just, there's a there there. This isn't Etoys level hype, but we never tried to make Etoys a trillion dollar company. Yeah, even some of those, you go back to pets.com. We talked about this on the show a few months ago, but its market cap was shockingly small for as much mind share as it got from the dot com bubble. These are some of the biggest companies in the world. Lou, final word on this is this an area where it's just okay to stay away for a while

13:25in any of these sort of AI related names until we get better answers on what the competitive advantages as you might call them are going to be in the industry. I mean, anything is a good deal at a price. And maybe if we one day see these numbers and they're better than I think they are, then maybe I'll reconsider. But right now I don't think we know enough. I mean, Matt was talking about it, but apparently what they're doing right now is they are reporting revenue collected, not revenue that goes to them. So if I am generating 10 billion in revenue, but six billion is going out the door to affiliates and stuff like that. So let's explain what that means. Because if you're not familiar with this, for example, Uber is a good example. If you pay $20 for an Uber ride, Uber does not count that as $20 in revenue, that is $20 in what they call gross bookings, the take rate, which is usually about 25%, is going to be Uber's revenue. So $5 in revenue, $20 in gross bookings,

14:25that's the way that they would report it. And what you're seeing is that anthropically, at least from what we know right now, is saying we have $20 in revenue. From what we know, and again, a lot of this is, really nice to see those audited financials wouldn't it? But yeah, until we know more, I just look, I don't think it's really a slam or a hot take to say, not all companies are worth $1,000,000. But right now, we are being asked to assume that all of these companies are worth $1,000,000. I think we're allowed to be a little patient and let that simmer. Yeah, to be interested in to see with too, what the obligations are for these companies, because those are measured in the hundreds of billions of dollars cash that they do not yet have. When we come back, I'm gonna actually get some stocks out of blue and matte. Where are they interested in in the ISP's today? You're listening to Motley Fool and Jim Sebastian. What's behind your quota risk? You just found out that your sales team is at risk of missing quota. Don't panic, just ask Rippling AI.

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16:28Unlocking the power of thinkorswim. The award-winning trading platforms loaded with features that let you dive deeper into the market, visualize your trades in a new light on thinkorswim desktop with robust charting and analysis tools. All while you uncover new opportunities with up to the minute market news and insights, thinkorswim is available on desktop, web, and mobile to meet you where you are. It's built by the trading obsessed to help you trade brilliantly. Learn more at Schwab.com slash trading. Welcome back to the show, guys, as you look for opportunities in the world of artificial intelligence today, what kind of stocks are you looking at right now? Yeah, so I mean, there are a lot of these AI infrastructure stocks that have cratered over the past month. Some of them did so after reporting great earnings, raising guidance, things like that. But even after that, there's a lot that are very, very expensive. I'm sure you and Lou would both agree that I'm not interested in a power company that's trading at 100 times revenue or something like that.

17:29But there are a few that are still really attractive investments. Modine manufacturing is one that I have my eye on right now. Tickersimbo is MOD. And it's, if you've ever heard of comfort systems, that's a more popular picks and shovels play. They do almost the same thing, but the valuation just makes a whole lot more sense to me. They specialize in thermal management, specifically cooling. And the data center business is not surprisingly the most exciting part of the company right now. Overall, their revenue grew 23% year every year and the latest fiscal year. The data center revenue grew 90%. They just got a $4 billion multi-year deal from one of the hyperscalers. We don't know which one, but it's for cooling products and data centers. It's a major problem. The more complex data centers get, the more cooling they're going to need. And unlike some of the other companies in the picks and shovels space that are really expensive, Modi and trades for 22 times forward earnings, they expect 50% to 70% annualized data center revenue growth

18:32over the next couple of years. Most of that's already booked. They're guiding for 20 to 35% overall sales growth in their current, the 2027 fiscal year. More than 40% growth in adjusted EBITDA. I remember there's a lot more to this business than data centers, which is kind of, if you're skeptical about how long the ad Bill Dott's gonna go on at this pace, this could be a good one to look at. Because it is a truly diversified business. Even though obviously the rest of it isn't growing as fast as the data center side. Sometimes boring is good. Lou, where are you seeing opportunities? So I am less interested in picks and shovel game right now because we're kind of late in the cycle. Picks and shovels sound great. And they are kind of a clever way to get an on a trend after the primary beneficiaries have already been. Second derivative, if you will. Yeah, yeah, so like if the first derivative is too expensive, this is a backdoor way in. But right now, why buy the picking shovels when the actual companies that they serve

19:33are trading at a discount to them? That's right, Modine is pretty cheap for a pick and shovel, but you can still, that's 22 times earnings, compare that to alphabet. And you know, why not just buy alphabet? And that's, I mean, as boring as my answer is, my answer would be the Invitias, the Alphabet, the Microsofts, mostly because they have multiple ways to win. I don't need it, it's not an all or nothing AI bet. They all have other businesses, even if AI isn't what we think, or even if their AI isn't what they want to see. It was like the worst case scenario is we just slow our spending down a little bit and we have more cash. Yeah, yeah, and we still have this other great business, but look, here's an even easier way. People have been stressing out about there's too much concentration in the S&P 500 that we know it's too heavily weighted for these AI hyper scalers. But if you were looking today to invest in AI, that's an advantage, not a weakness. So just buy the S&P 500 and you'll get plenty of exposure without having to take single party risk late in,

20:33or I shouldn't even say late, but not early in the trend. So I think honestly, the S&P 500 might be a better choice than anything. Well, I'm excited to see, it could be in the next week or two that we get the S1 from Anthropic. Oh, it seems like it keeps getting pushed back, but then we'll have more to talk about what the numbers look like, what the potential modes or competitive advantages look like, but lots to discuss here. As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy yourself stocks based solely on what you hear. All personal finance content follows the Motley Fool's editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Lou Whiteman, Matt, Frankl and Dan Boyd behind the glass, I'm Travis Williams. Thanks for listening. We'll see you here tomorrow.