Few companies have seen their value increase as much as Nvidia (NVDA 2.48%) or Palantir Technologies (PLTR 2.64%) amid the artificial intelligence (AI) boom.
Since OpenAI released its advanced AI chatbot ChatGPT back in late 2022, Nvidia's market capitalization has climbed tenfold to become the world's first $4 trillion company. Palantir shares have performed even better, climbing over 22x in the same period.
And there's a good reason for those gains. Both companies have seen their revenue and profits soar amid increased demand for their products. Nvidia's GPUs are essential infrastructure for AI training and inference, while Palantir's software is a critical layer, enabling enterprises to harness the power of AI.
While both companies have been big winners, there may be an even bigger opportunity for long-term investors, in my opinion, especially those looking to put new capital to work today.
Image source: Getty Images.
Looking beyond the first-order winners of artificial intelligence
It's easy to identify who can benefit in the near term from increased spending on AI development. It's right there in the quarterly earnings reports and financial outlooks. There's no denying Nvidia nearly quintupled its revenue between 2022 and 2025 as a result of hyperscalers building more data centers full of GPUs.
Even Palantir could be considered a first-order winner. Its sales got a huge boost from its development of its Artificial Intelligence Platform (AIP), which uses large language models to make its software more powerful and accessible.
But Palantir's product is still a facilitator for businesses to use AI more effectively in their operations. And those are the second-order winners of the artificial intelligence boom.
NASDAQ: PLTR
Key Data Points
Businesses that can gain the most operational leverage from generative AI could see their earnings grow much faster over the next decade. And if history is anything to go by, the biggest winners of any technological revolution tend to be smaller companies, not just tech companies. Here's why investors should pay more attention to smaller businesses taking advantage of AI.
The dot-com bubble all over again?
The widespread adoption of the World Wide Web led to the creation of many new internet-based companies. Many of those companies received extremely high valuations based on expectations for the future of the web, leading to the dot-com bubble. OpenAI CEO Sam Altman thinks we may be in another bubble right now -- an AI bubble.
Whether or not you think the AI industry is in a bubble like Altman contends, there's no denying the technological advancements AI companies have made over the last few years. Even if this stock market isn't directly comparable to the dot-com bubble, the AI revolution is arguably similar to the internet revolution.
The internet was a boon for small businesses. As Wall Street Journal columnist Jason Zweig points out: "Most of the beneficiaries of the internet boom weren't the online providers, but rather the consumers: manufacturers, healthcare, service and materials companies that used the emerging technology to streamline their own operations."
The internet enabled smaller companies to expand their addressable market while reducing expenses. You can have 24-hour customer service over email. You can market your business with a simple website, an email list, and Alphabet's Google advertising or SEO. You could build an e-commerce site or use a third-party marketplace to sell items anywhere in the world instead of opening hundreds of storefronts.
In other words, the internet leveled the playing field, and small businesses ultimately saw huge benefits from moving online.
Image source: Getty Images.
Generative AI offers similar promises for small businesses. It can enable more attentive customer service, and in any language. It can create entire social media marketing campaigns for any given business objective. And it can manage inventory -- predicting demand and placing orders -- ensuring a business never misses a sale.
The operational gains can be much bigger for smaller companies versus larger businesses, as they stand to benefit from both cost reduction and market expansion. The impact may not be as big on an absolute scale, as few businesses will see tens of billions of new sales like Nvidia. But on a relative basis, AI's impact could boost profits significantly for smaller companies that learn how to use the technology to effectively reduce costs and increase sales.
Will history repeat itself?
The S&P 600 small-cap index mostly kept pace with the large-cap S&P 500 (^GSPC 1.34%) in the mid-'90s. It wasn't until the late '90s that large-caps separated themselves as investor fervor continued to pile capital into dot-com darlings. That led to a historic valuation gap between large caps and small caps.
As a result, small-cap stocks held up much better in the 2000s, as they continued to see improved financial results amid growing internet adoption. The S&P 600 returned 85% in the 2000s compared to a negative 9% total return for the S&P 500.
History may be repeating itself. Small-cap stocks look particularly appealing at today's valuations, especially relative to the high prices of large-cap stocks, and AI-related stocks in particular. If they can realize operational gains from AI, they should be able to grow much faster than in the recent past, boosting their share prices on higher earnings and potential multiple expansion.
NYSEMKT: AVUV
Key Data Points
Investors who want to dive into the details of small-cap companies may be able to identify unique opportunities where the AI potential is underappreciated by the market. However, gathering information on smaller businesses can still be challenging (perhaps AI can help).
Another option is to buy a small-cap index fund. I prefer small businesses that are already profitable. An S&P 600 index fund fits the bill, but the Avantis U.S. Small Cap Value ETF (AVUV 1.18%) holds more stocks and uses stricter criteria for profitability for inclusion. That makes it my preferred way to invest in small-cap stocks and take advantage of the opportunity ahead.
