With artificial intelligence (AI) becoming the latest hot topic in investing, investors should stay well informed on what's new to avoid investing in companies that don't have a bright future. If there's any lesson the tech hype of 2020 and 2021 has taught us (or even the dot-com burst in the early 2000s), it's that a lot of companies won't work out, but a select few will.
Finding those businesses in the AI space will be critical. I've got three you should keep an eye on during May.
1. Alphabet
Although Alphabet (GOOGL 0.35%) (GOOG 0.37%) was the butt of many AI jokes when ChatGPT caught it off guard, its AI resources are likely more significant than any other company. With an AI tool kit for developers that includes TensorFlow (a machine learning platform), a library full of datasets to train AI models, and a cloud computing wing that can help companies train their models, Alphabet has set the foundation to be an AI force to be reckoned with.
The main topic investors worry about with Alphabet is how it will integrate AI into search after the rollout of Bard, Alphabet's AI chatbot, was botched. With competitors like Microsoft's Bing integrating a chatbot feature, the stakes couldn't be higher, especially since $40 billion of Alphabet's $70 billion in Q1 revenue came from search.
While this is a valid concern, the resolution of the battle won't come for at least another couple of years. This means leaving Alphabet stock for dead isn't a great idea, especially since its Google Search revenue rose in Q1, during a period where revenue was expected to fall.
In the meantime, Alphabet's Google Cloud division, which is a vital piece of AI infrastructure (because it can store data, run computations, and train AI models), continues to do well. Its revenue was up 28% to $7.5 billion in Q1, and it posted its first operating profit, generating $191 million.
While Alphabet stumbled out of the gate, it has the building blocks to be a successful AI investment. And with the stock trading at a historically low price-to-free cash flow ratio, it looks like a strong buy here.
GOOGL Price to Free Cash Flow data by YCharts
2. Nvidia
Another company vital to AI is Nvidia (NVDA 0.76%), as its graphics processing units (GPUs) are utilized to train and power AI models.
It's not like companies can buy one or two GPUs and call it a day when building an AI-dedicated computing center. For example, Meta Platforms' AI Research SuperCluster uses 6,080 GPUs in its current configuration.
As the scramble for AI-powering GPUs kicks off, Nvidia should see a spike in demand, which it desperately needs. After demand evaporated for its gaming GPUs (thanks to a weak PC market and the cryptocurrency crash), Nvidia's Q4 of FY 2023 (ending Jan. 29) revenue fell 21% to $6 billion.
Looking deeper into the company, Nvidia's Data Center revenue (which captures some of its AI demand) rose 11% year over year but fell 6% quarter over quarter. This segment hasn't historically displayed seasonality, so a quarterly revenue drop is a red flag for investors.
Despite Nvidia's relatively poor performance, the stock trades at high valuation levels. At 61 times forward earnings and 23 times forward sales, Nvidia doesn't have room for error when it reports its Q1 of FY 2024 results later in May.
While I think Nvidia's business will be a long-term AI winner, the stock is priced as if that victory has already occurred. As a result, I'd err on the side of caution with this stock. But Nvidia is not one to let slip off your radar, as its results will give investors a pulse on the demand of the AI industry.
3. Palantir
Switching to the application side of AI, Palantir (PLTR -0.84%) creates AI-powered software that helps its clients crunch mounds of data and derive actionable insights. While multiple software companies harness AI for their offerings, few have built AI as the center point, as has Palantir.
When it reports earnings on May 8, I'll be watching to see if its customer count or number of deals closed spikes. While it's just one data point, it will clue me in to the appetite for AI demand in the current environment.
With an uncertain economic outlook, few companies are willing to spend large sums of money to roll out a trendy AI product. But if they can see a monetary benefit in using the software, it may sway companies to adopt programs like Palantir.
AI is a powerful, trendy technology, but companies like Palantir, Nvidia, and Alphabet won't have the immediate success some investors expect if corporate demand isn't there for it. Tuning into Palantir's report will give me a vital piece of information to determine how quickly AI adoption is occurring.
