Growth Equity: Why Investors Underestimate Transformative Technology

Key Takeaways:

Investors tend to expect a current rate of growth to continue in the future—a propensity that has led to underestimating actual growth in emerging technologies.
Today, we believe another wave of technological advancements is underway, led by generative artificial intelligence (AI) and, in healthcare, therapies for type 2 diabetes management.
We think an active approach to investing in innovation that seeks companies with improving fundamentals that are recognized by the market may provide upside potential while helping to mitigate downside risks associated with short-term exuberance or speculative activity.

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Throughout history, the advent of new technologies has been met with an underestimation of their transformative potential. Examples of this dynamic include smartphones, cloud computing, and the internet. Their accelerated growth is part of a broader phenomenon of the exponential growth of technology and its impact on the investment landscape.

Addressing the Challenges of Linear and Short-Term Expectations

Several frameworks have been introduced to illustrate the inherent challenges present in predicting the growth trajectory of technological progress, often compounded by human tendencies to perceive advancements linearly instead of extrapolating future growth exponentially. Ray Kurzweil, an author and inventor, is known for his theories on the exponential growth of technological progress. However, people assume a current rate of progress will continue and thus extrapolate future growth on a linear basis. This leads to an underestimation of the rate of progress and poor forecasting around technological advancements.¹

Gordon Moore, former Chairman of Intel and one of the inventors of the integrated circuit, noted the exponential growth of integrated circuits over time. From that observation came Moore’s Law, which is based on the idea that the number of transistors on a microchip doubles every two years, while the cost is halved over the same timeframe.² The implications of Moore’s Law are broader than transistors and imply that advancements in technology tend to be marked by exponential progress in speed and power but also in cost efficiency.

Amara’s Law, named after Roy Amara, states that there is a common tendency to overestimate the short-term impacts of emerging technologies, while underestimating the long-term potential.³ Foundationally, Amara’s Law mirrors much of what Gordon Moore and Ray Kurzweil highlighted in terms of long-term underestimation but is also similar to Bill Gates’s thoughts on the topic, as the founder of Microsoft noted in 1996 that “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” Like Gates, Amara also emphasized the overestimation that we tend to see in the short run, where transformative, emerging technologies may be met with exuberance.

All these observations serve as a reminder to approach technological innovations with a balanced perspective and inform us in our belief that the implications are twofold:

Companies that embrace technological change will likely be better positioned for success.
The broader market is likely underappreciating the rate of change of emerging technologies, especially in the long run.

Long-Term Growth Exceeded Expectations

Looking over the past two decades, we have seen this phenomenon unfold with the advent of new technologies, including personal computing (PC), internet, mobile, and cloud computing. In each of these instances, industry estimates grossly underestimated the adoption rate, and actual growth exceeded forecasts.⁴ These underestimates are profound in terms of the nominal value of miscalculation, potentially leaving millions if not billions of dollars unaccounted for.

Figure 1. Key Innovations That Were Initially Underappreciated

Source: Morgan Stanley and Lord Abbett. Data as of January 23, 2024. Past performance is not a reliable indicator or guarantee of future results. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett.

While the four innovation waves shown in Figure 1 have largely centered on the information technology space, we believe we are on the threshold of a series of new advancements in areas including healthcare, such as GLP-1s, as well as generative artificial intelligence.

GLP-1 Sales Estimates Revised Upward

Within the healthcare space, GLP-1 (glucagon-like peptide-1 agonists) drugs commonly used to treat type 2 diabetes have also shown promise in managing obesity. The actual impact and market penetration of GLP-1 therapies have been exceeding initial expectations. In the case of Mounjaro®, Eli Lilly’s brand of tirzepatide, consensus sales estimates have been materially adjusted upward, indicating a collective realization that the sell side initially undervalued the drug’s total addressable market (see Figure 2). For example, in July 2021, it was estimated that sales of tirzepatide in 2030 would be less than $10 billion, as indicated by the green bar under 2030 in Figure 2. As of February 2023, consensus estimates for 2030 Mounjaro® sales rose to over $25 billion, as indicated by the purple bar under 2030 in Figure 2. This highlights the challenges faced in gauging the true potential of novel advancement and the importance of continuous reassessment in the innovation space.

Figure 2. Mounjaro Sales Estimates Have Consistently Been Adjusted Higher

Mounjaro sales estimates for the calendar years shown, as of the indicated dates

Source: Jefferies Global Research. Data as of March 31, 2024. Mentions of specific companies are for reference purposes only and are not meant to describe the investment merits of, or potential or actual portfolio changes related to, securities of those companies. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett.

NVIDIA’s Earnings Grew More Than Expected, Propelled by AI

AI is following a similar track of outpacing limited expectations. One of the early winners of the AI trade has been NVIDIA. ChatGPT runs on Microsoft’s Azure infrastructure and relies on NVIDIA’s graphic processing units (GPUs) for model training and responses. So, it seems obvious the proliferation of AI, both from OpenAI and from competitors, could potentially drive strong demand for NVIDIA’s product. And yet, actual earnings-per-share (EPS) for 2023 came in well ahead of analyst EPS estimates, leading to substantial appreciation in the stock price the same year (see Figure 3). Note: EPS estimates are analysts’ forecasts for a company's future quarterly or annual EPS.

Valuation levels for NVIDIA also rose to a high of 70 times (x) forward 1-year (FY1) price-to-earnings (P/E) ratio by February 2023. However, as NVIDIA continued to grow its earnings, valuation levels compressed to 30x FY1 P/E by April 2024. What equity markets have demonstrated is that innovators can both command higher multiples and be considered cheap when the company continues to meet or exceed already high expectations.

Figure 3. Earnings Grew as Valuation Compressed

Quarterly reported EPS versus consensus estimates as of the indicated dates (top table) and P/E FY1 versus actual EPS growth rates, December 31, 2022-April 24, 2024 (bottom graph)

Source: Factset and Bloomberg. Data as of quarterly reporting dates (top table) and April 24, 2024 (bottom graph). EPS=earnings per share. Forward 1-year price-to-earnings ratio (P/E FY1) is used to measure a relative value based on a company’s level of earnings. Forward P/E is calculated using future, estimated earnings. Past performance is not a reliable indicator or guarantee of future results. Mentions of specific companies are for reference purposes only and are not meant to describe the investment merits of, or potential or actual portfolio changes related to, securities of those companies. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett.

Investors’ underestimation of NVIDIA’s growth trajectory illustrates an early example of the transformative power of AI. Given the early stage and novel character of useful generative AI, it’s difficult to predict the particular path of adoption and impact on growth, but it is likely that we will have a future that is profoundly influenced by the power of artificial intelligence. This revolution will likely usher in a future of technological progress and reshape potential winners and losers, in our view.

Summing Up

The technology revolution includes examples of both underestimation and overestimation of potential. While some technologies, such as smartphones and the internet, surpassed expectations and reshaped entire industries, others have failed to realize their envisioned impact despite initial enthusiasm. This underscores the challenges investors face in accurately forecasting the growth trajectory of emerging technologies.

We believe there are opportunities to potentially monetize the underappreciated exponential growth of emerging innovations. But differentiating between innovative companies with strengthening fundamentals that are also recognized for their positive operating metrics over the short-term—or unsustainable increases in a company’s stock influenced by exuberant or speculative activity—may be essential to mitigating downside risks.

To learn more on this topic, visit: Rethinking Momentum Investing for Today’s Market at LordAbbett.com.

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About the Author

Melanie Coffin, CFA

Institutional Relationship Director

Melanie Coffin is an Institutional Relationship Director at Lord Abbett, dedicated to serving the firm’s largest institutional clients—including public plans, endowments, foundations, and hospitals. She partners closely with allocators to understand their investment pools, objectives, constraints, and decision-making processes. With this insight, she ensures clients can access the full breadth of Lord Abbett’s resources, tailored to their specific needs. Melanie also collaborates with internal teams to deliver market updates, portfolio reviews, and guidance aligned with each client’s unique goals.

Important Information

¹Kurzweil, R. (2004). The Law of Accelerating Returns. In: Teuscher, C. (eds) Alan Turing: Life and Legacy of a Great Thinker. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-05642-4_16

²Max Roser, Hannah Ritchie and Edouard Mathieu (2023), “What is Moore's Law?” Published online at OurWorldInData.org. Retrieved from: https://ourworldindata.org/moores-law

³“What is Amara’s Law and why it’s more important now than ever” Published online at TheVirtualLab.com, January 26, 2022. Retrieved from https://thevirtulab.com/what-is-amaras-law.

⁴Morgan Stanley Research, Global Technology, North America, (2024), Morgan Stanley AI Guidebook: Fourth Edition, January 23, 2024.

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Glossary & Index Definitions

Tirzepatide is an antidiabetic medication used for the treatment of type 2 diabetes and for weight loss. Tirzepatide is administered via subcutaneous injections.

Consensus estimate is an aggregate forecast of a public company's expected earnings based on the combined estimates of all analysts that cover the stock.

Earnings-per-share is the monetary value of earnings per outstanding share of common stock for a company. It is a key measure of corporate profitability.

Forward 1-year price-to-earnings ratio (P/E FY1) is used to measure a relative value based on a company’s level of earnings. Forward P/E is calculated using future, estimated earnings.

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