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Terry Smith, the prominent investor who manages the £22.8 billion ($29.33 billion) Fundsmith Equity Fund, has made a notable decision to stay away from Nvidia, despite the company’s strong performance and leadership in the AI space. Smith’s reasoning? He believes that consumers have yet to demonstrate a willingness to pay for AI technology at the scale needed to support such high stock valuations.

A Cautious View on AI Demand

Smith has earned the nickname “Britain’s Warren Buffett” for his value-investing approach, and his skepticism toward Nvidia stems from concerns over the future of artificial intelligence and its commercial viability. While the company has become a dominant force in AI hardware, Nvidia’s potential for future growth relies on widespread consumer adoption of AI technology, which Smith argues is far from certain.

“I’m not confident that we know what the future of AI is because there are almost no applications that people are paying for,” Smith told Bloomberg in a recent interview. “Will consumers be willing to pay at a scale and price that justifies these high valuations? Because if not, the chip suppliers, including Nvidia, could face significant challenges.”

Smith’s caution is supported by recent survey data. A TechPowerUp survey of over 22,000 PC users in May revealed that 84% of respondents said they wouldn’t be willing to pay more for hardware featuring AI capabilities. This suggests a gap between the hype surrounding AI and consumer willingness to invest in the necessary infrastructure.

Contradictory Evidence of AI Adoption

However, it’s important to note that there are instances where consumers are indeed willing to pay for AI-related products. For example, OpenAI’s ChatGPT has seen over 11 million subscribers, with the company generating an estimated $3.4 billion in annual revenue from paid subscriptions. Even Nvidia’s own CEO, Jensen Huang, has publicly stated that he personally pays for a ChatGPT subscription and uses the tool as a personal tutor.

Despite these examples of AI adoption, Smith remains unconvinced about Nvidia’s long-term outlook. He has repeatedly expressed reservations about the predictability of the company’s future growth, citing concerns that its reliance on uncertain AI demand could lead to volatility.

Missed Gains and a Reluctant Underperformance

Smith’s decision to avoid Nvidia has cost his fund in terms of missed opportunities. Between January 1 and June 30, 2024, the Fundsmith Equity Fund delivered a 9.3% return, lagging behind the MSCI World Index, which returned 12.7% over the same period. While acknowledging that it was difficult to match the index’s performance without Nvidia, Smith has remained firm in his stance.

“We do not own any Nvidia as we have yet to convince ourselves that its outlook is as predictable as we seek,” Smith wrote in a recent fund update.

The Fundsmith Equity Fund does hold significant positions in other tech giants, such as Apple, Meta, and Microsoft, which also stand to benefit from the growth of AI in various forms.

Nvidia’s Dominance in the AI Market

Despite Smith’s hesitancy, Nvidia remains one of the most influential players in the AI sector, with a market share ranging from 70% to 95% of the global AI chip market. The company has seen “insane demand” for its products, particularly its new Blackwell AI chips, according to CEO Jensen Huang. As part of the “Magnificent Seven” — a group of tech stocks that also includes Amazon, Apple, Meta, Microsoft, Google, and Tesla — Nvidia continues to benefit from strong demand from these major tech companies, which account for over 40% of Nvidia’s total revenue.

However, while Nvidia’s role in the AI ecosystem is undeniable, Smith’s cautious approach reflects a broader concern over whether the market for AI products is truly sustainable and profitable for suppliers in the long run. Until there’s more clarity on consumer demand and the broader economics of AI, Smith appears content to watch from the sidelines.

Conclusion

Terry Smith’s decision to stay away from Nvidia, despite its dominant position in AI hardware, highlights the uncertainty that still surrounds the future of AI consumer adoption. While Nvidia is benefiting from immense demand in the AI space, Smith is holding off on investing, awaiting clearer signs of sustainable, scalable demand from consumers. His approach underscores the importance of long-term predictability in investing and a reluctance to chase speculative trends without sufficient evidence of profitability.