Artificial intelligence (AI) stocks have been a cut above the rest in 2023. So much so that some investors might worry it's too late to buy shares, given how far some have climbed year to date.
So let's take a step back and see if it's time to buy, sell, or hold three AI-related stocks: Microsoft (MSFT 2.13%), Palantir (PLTR 0.26%), and Nvidia (NVDA 8.15%).
Microsoft's much-hyped partnership with OpenAI is already paying off
Jake Lerch (Microsoft): Up 35% year to date, Microsoft is one of the big reasons why major indexes like the S&P 500 and Dow Jones Industrial Average are in positive territory this year.
The company has been riding high thanks to its much-hyped partnership with OpenAI, the maker of ChatGPT and GPT-4. However, investors shouldn't ignore Microsoft's outstanding fundamentals, which have really taken off in 2023.
In its most recent quarter (the three months ending on March 31, 2023), Microsoft reported $53 billion in revenue -- far exceeding Wall Street estimates for $51 billion. Moreover, earnings per share of $2.45 beat expectations by more than $0.20 and were up 10% year over year.
Unsurprisingly, Microsoft management is crediting the rise of AI (and the company's relationship with OpenAI) for the excellent first-quarter results. What's more, leadership is bullish that as the AI wave continues to roll across the business landscape, Microsoft will be able to profit from it.
The company already has more than 2,500 Azure OpenAI Service customers, and 36,000 organizations utilize AI-powered capabilities through its Power Platform.
In fact, Microsoft's diverse business segments lend weight to the argument that the company is far more than an AI one-trick pony. The rapid adoption of AI applications will undoubtedly help Microsoft, but the company isn't solely dependent on AI for success. And that should make investors far more comfortable buying shares now, even after its big rally.
This AI innovator is up 137% and hungry for more
Justin Pope (Palantir Technologies): While much of the world is celebrating AI that can write an essay or generate images, Palantir is unleashing AI that could help run countries and companies. Palantir's software platforms help government (Gotham) and private sector (Foundry) organizations analyze data to make better decisions. It jumped into AI with two feet, recently launching a third platform called AIP (artificial intelligence platform) that can help customers securely use large language models and other AI on its platforms.
Why is the stock up so much this year? Palantir hit a tremendous milestone when it announced Q1 earnings, turning a profit under generally accepted accounting principles (GAAP) for the second straight quarter. More importantly, CEO Alex Karp told investors that the company should remain profitable every quarter through the rest of 2023 (and potentially beyond). This means that continued revenue growth should help accelerate earnings growth as revenue outgrows the company's expenses.
That future growth should come from picking up new customers -- Palantir's customer count grew 41% year over year in the first quarter. Government business should also remain strong; the company recently won a $463 million contract from the U.S. Special Operations Command. Analysts believe Palantir can grow earnings per share (EPS) by a scorching 56% annually over the next three to five years.
Yes, the stock has soared, especially over the past month. But rapid earnings growth could burn off a near-term premium and still give investors solid long-term returns. The stock's price/earnings-to-growth (PEG) ratio is still just 1.3, meaning its valuation is reasonable considering its potential earnings growth. Of course, stock prices are often volatile in the near term, so investors should buy slowly with a multiyear holding period in mind.
The GPU maker riding high on AI chip dominance
Will Healy (Nvidia): After a brutal 2022, Nvidia has enjoyed a phenomenal run since it began 2023 at a near-term low. Since Jan. 1, the AI stock has risen an astounding 169%.
That rising stock price hit a fever pitch when Nvidia reported earnings for the fiscal first quarter of 2024 (ended April 30). Although fiscal Q1 revenue fell 13% year over year, the fiscal second-quarter forecast called for revenue of $11 billion. That prediction, which would amount to a 64% increase year over year, took the stock 24% higher in the following trading session amid an anticipated surge in demand for AI chips.
Nvidia's advantage in graphics processing units (GPUs) has spearheaded this dominance. Its largest revenue source is now its data center segment, which accounted for almost 60% of the company's revenue in fiscal Q1.
Data centers support AI applications and workloads in the cloud, giving the company a critical role in making AI possible. Also, Nvidia solidifies that support by its market share in the enterprise GPU industry, which exceeds 90%, according to IDC.
Nvidia's professional visualization, automotive, and gaming segments also rely heavily on AI. Even though automotive was the only one of these segments to register positive growth in fiscal Q1, all three should bolster Nvidia's AI capabilities in its targeted industries.
Moreover, Precedence Research estimates that the global AI chip industry will grow at a compound annual growth rate (CAGR) of 30% through 2032, taking the market size to $227 billion by that year. With Nvidia's market share dominance and the consensus revenue forecast of $43 billion for fiscal 2024, that would imply massive revenue growth for the next eight years.
Unfortunately for prospective shareholders, the rise in the stock price has taken the P/E ratio to almost 200. Also, its price-to-sales (P/S) ratio, which now stands at 36, has reached an all-time high and is well above its 10 P/S ratio from last October. Such valuations significantly diminish Nvidia's near-term growth potential.
NVDA PS Ratio data by YCharts
Admittedly, all indications point to further long-term gains for Nvidia as it asserts its industry dominance. Nonetheless, investors should probably wait for the sales multiple to fall into the teens before they even consider buying shares.
