Big Short investor claims technology firms are inflating profits

Michael Burry shot to fame after the book The Big Short by Michael Lewis was turned into the Academy Award winning 2015 film of the same name with actor Christian Bale playing Burry’s character.

Burry was one of the first people to spot the US housing market bubble and reportedly made $800 million profit from betting against sub-prime mortgages.

What is Burry arguing?

More recently Burry, who founded Scion Asset Management, said he believed the AI boom was a bubble and he accused US technology companies of inflating their profits with aggressive accounting.

"Understating depreciation by extending useful life of assets artificially boosts earnings," writes Burry.

To understand Burry’s arguments, we must jump from the exciting world of artificial intelligence to the mundane world of accountancy.

Under US GAAP (Generally Accepted Accounting Principles) companies must depreciate fixed assets over their useful lives. The key thing to note is that the people running these businesses can estimate different useful lives for different assets.

To see how this can make a difference, let’s say a company buys a new fleet of trucks for £1 million and it estimates they have a useful life of 10 years. Using the straight-line method, each year the annual depreciation charge will be £100,000 (£1 million divided by 10).

If, however, the trucks need replacing every five years, the depreciation charge should be £200,000 a year (£1 million divided by five), and arguably the company is overstating the true profitability of the business.

Burry is making a similar claim about Nvidia’s semiconductor chips for AI data centres. While older, less advanced chips might have a useful life of five or six years, the state-of-the-art Blackwell chips might need replacing every 18 months to two years.

This is due to the unique nature of building large-language AI models which require vast amounts of data and computing power.

Going back to the truck example, it is the equivalent of driving the trucks 35,000 miles a year compared with 20,000 miles. The former fleet will wear out much faster, and therefore, have a shorter useful life.

What impact does he claim it will have?

Burry estimates aggressive accounting will understate depreciation by around $176 billion over the next three years, thereby inflating AI industry profits by the same amount. The fund manager singled out Meta Platforms and Oracle, which he estimates could overstate their profits by 21% and 27% respectively over the next three years.

Depreciation explained

Depreciation spreads the cost of a physical asset over its useful life, reflecting the loss of value from use and wear. Instead of expensing the full amount at purchase, costs are matched with revenue over time.

This reduces the asset’s book value on the balance sheet and appears as a non-cash expense on the profit and loss statement.