Investing on Wall Street has been a challenge since the start of 2022. Last year, all three major U.S. stock indexes tumbled into a bear market, with growth stocks getting hit particularly hard. The innovation-driven Nasdaq Composite ended the year lower by 33%.
But when dark clouds are hovering over Wall Street, investors have a way of finding even the slightest glimmer of hope. In 2023, investors have turned their attention to the next-big-thing investment, artificial intelligence (AI).
Image source: Getty Images.
Artificial intelligence: The next-big-thing investment that could disappoint
AI involves using software and systems to handle tasks normally overseen by humans. What makes AI so intriguing is the machine-learning (ML) aspect. Specifically, ML allows software and systems to learn and evolve over time, just as a human would, in order to become more efficient at a task. Best of all, AI has broad application across all sectors of the market.
Investors would probably struggle to find a growth opportunity bigger than AI this decade. According to a report from Grand View Research, worldwide AI sales are expected to catapult from nearly $197 billion to $1.81 trillion by 2030. That's a compound annual growth rate of a cool 37.3%.
But as we've learned from next-big-thing investments over the past 30 years, not every company is necessarily going to be a winner. Investor expectations with next-big-thing investments almost always outpace the ramp of adoption. In simpler terms, next-big-thing investments can be phenomenal long-term wealth creators, but they have a tendency to be initially overhyped.
Furthermore, the Federal Reserve is modeling a "mild recession" into its outlook for later this year. When U.S. economic growth weakens, investors have less tolerance for premium valuations and companies that fail to deliver. This is especially true for businesses involved in next-big-thing investments.
Despite AI being the hottest thing since sliced bread, there are three ultra-popular artificial intelligence stocks I wouldn't buy with free money.
Nvidia
The first widely held AI stock I wouldn't touch with a 10-foot pole is graphics processing unit (GPU) and networking solutions provider Nvidia (NVDA -0.68%).
Nvidia is best-known for its GPUs, which are popular among hardcore personal-computing gamers. However, it's Nvidia's data center GPUs that are gaining the company notoriety. Nvidia's AI-inspired A100 GPUs for data centers are effectively the foundation that allows AI-based software and systems to make split-second decisions. Back in March, CEO Jensen Huang noted in an interview with Yahoo Finance that his company has seen an uptick in demand for the company's generative AI solutions.
Although Nvidia is profitable and its stock is absolutely on fire in 2023, it's not a stock I'd want to put any money to work in at the moment for three reasons.
To begin with, Nvidia's products are cyclical. This means demand for its products tends to ebb and flow with the U.S. and global economy. With the nation's central bank and a laundry list of economic indicators signaling a recession is likely at some point in the future, cyclical tech stocks near a 52-week high isn't where I want my money.
Secondly, Nvidia's most-profitable operating segment has been a dud over the previous three fiscal quarters. While gaming revenue popped during the pandemic, a return to some semblance of normal has sent gaming revenue down by as much as 51% on a year-over-year basis. This slump in gaming GPU sales is weighing on sales and profits.
The third factor is valuation. Nvidia's growth engine completely stalled in fiscal 2023 (Nvidia's fiscal year ends in late January), with sales expected to grow by just 11.5% in fiscal 2024, assuming demand keeps up with inventory. However, investors are paying 63 times forecast earnings for an 11.5% sales growth rate that I believe is at risk of being reduced. Despite being the face of AI innovation, Nvidia stock simply isn't worth the risk at its lofty valuation.
Snowflake
A second artificial intelligence stock I wouldn't touch with free money is cloud-based data warehousing company Snowflake (SNOW -0.36%).
Snowflake has been all the rage among cloud-computing investors since its initial public offering in September 2020. That's because it brings well-defined competitive advantages to the table in a space that's still considered to be in the very early innings of its growth ramp. As an example, Snowflake's infrastructure is built atop the most-popular cloud-service infrastructure platforms, which allows its members to seamlessly share data across competing platforms.
Where Snowflake gets its AI chops is through the incorporation of machine-learning tools in its data cloud. As my Foolish colleague Anders Bylund laid out last month, Snowflake has forged partnerships and made acquisitions to further its AI ambitions and support the rapid processing speeds needed for AI solutions to run optimally.
Unfortunately, Snowflake shares many of the headwinds that Nvidia is contending with. Namely, it's a cyclical tech stock that's already begun to see order demand slow.
When the company reported its fiscal third-quarter results at the end of November, management called for 47% full-year sales growth in fiscal 2024, which was, at the time, a tad shy of Wall Street's expectations. Following its fourth-quarter results, which were released in early March, full-year sales growth projections had dropped to 40% for fiscal 2024 (Snowflake's fiscal year ends Jan. 31). Though 40% growth would still be pretty stellar, Snowflake commands a nosebleed valuation because of its superior growth prospects. If sales forecasts are falling, the company's lofty valuation will likely follow.
The other important factor to consider with Snowflake is that it's not even close to profitability on the basis of generally accepted accounting principles (GAAP). Despite a 65% gross margin and a gross profit that increased 77% in fiscal 2023, the company's operating loss swelled by $127.2 million to $842.3 million. There's no reason to pay over 17 times sales for a company whose operating performance is worsening on a GAAP basis as we potentially head into a recession.
The Model 3 is Tesla's flagship electric sedan. Image source: Tesla.
Tesla
The third ultra-popular artificial intelligence stock I wouldn't buy with free money is none other than electric-vehicle (EV) manufacturer Tesla (TSLA 11.03%).
Tesla's rise to becoming one of the largest publicly traded companies in the world was built on first-mover advantages in the EV space. It's the first automaker in more than a half-century to build itself from the ground up to mass production. After producing 1.37 million EVs in 2022, the ramp-up in production activity at the Austin and Berlin gigafactories should lift the company's output to 1.8 million EVs this year.
Another key to Tesla's success has been its incorporation of AI. Specifically, AI is the foundation of Tesla's Level 2 full self-driving (FSD) software. Tesla's FSD uses sensors and machine vision cameras to safely navigate its EVs around surrounding traffic and pedestrians. Although not fully autonomous, the company's Level 2 FSD allows for partial automation with the driver able to assist if needed.
Although we've witnessed a big advancement in the technology used in vehicles in recent years, Tesla is a stock I'd avoid for three reasons.
The first mirrors what I said earlier about Nvidia and Snowflake: auto stocks are cyclical. Vehicle-buying demand tends to move in lockstep with the U.S. economy, which doesn't bode well for Tesla over the near-term. Whereas auto stocks typically trade at mid-to-high-single-digit earnings multiples, Tesla is commanding a price-to-earnings ratio of almost 50. That's far too much for a company that's, thus far, failed to become more than a just a car company.
Another warning for current and prospective shareholders is the company's pricing action in 2023. Putting aside the token price hike of $250 Tesla implemented on its EVs last week, the company had enacted six price reductions since the year began. Even with these price cuts, inventory levels have been soaring. Chances are good that Tesla's automotive gross margin is going to sink further in the coming quarters.
Lastly, I wouldn't touch Tesla stock with a 10-foot pole because I don't trust CEO Elon Musk. While I recognize that he's a visionary, I'd also note that he's made a mountain of promises about new innovations that he hasn't kept or were eventually delayed. As more of these unmet promises pile up, my expectation is we'll see Tesla stock come under increased pressure.
