The artificial intelligence (AI) boom in stocks is here. As companies roll out and announce new AI initiatives, investors appear to be jumping on them, expecting there to be significant growth opportunities (and returns) ahead.
There are some exciting developments in AI that could improve workflows and change jobs and industries, but that could be years away from becoming a reality.
Is there too much hype in AI right now?
Billionaire hedge fund manager Ken Griffin is bullish on AI in the long term. But he preached caution in a recent interview with CNBC, saying, "I do think the AI community is making a terrible mistake by being full of hype on the near-term implications of generative AI."
He went on to say that while the information can be useful, it might not always be relevant: "Here's the problem with large language models: They are built on the past. Everything we do is about the future."
He also points to the errors that AI is prone to making as proof that it can still be awhile before it could truly take jobs away from professionals. A great example of that is in New York, where a lawyer recently used ChatGPT to cite cases, not realizing that several of them did not exist, and is now facing disciplinary action for relying on the chatbot in lieu of doing real research.
Are AI stocks creating the next bubble?
In the past few years, there has been hype around blockchain stocks, then the metaverse, and now AI appears to be the next big thing that investors are piling money into. The danger with jumping onto these bandwagons is that it can send stock prices soaring to levels that might become unsustainable.
Three stocks that are benefiting from the AI trend include C3.ai (AI 3.02%), Palantir Technologies (PLTR 3.73%), and Nvidia (NVDA 6.18%). All of them are up at least 140% since the start of the year. Below is a look at their respective price-to-sales (P/S) multiples, comparing them to Alphabet, Apple, and Microsoft, which are generally less-volatile tech investments:
PLTR PS ratio, data by YCharts.
While Nvidia was at a premium even at the start of the year, the delta between its valuation and the other tech stocks on this chart has grown. Palantir and C3.ai were both trading at more modest multiples in line with the big tech giants but are now trading at significantly higher P/S ratios.
I wouldn't go so far as to say that these valuations have risen to the extent that they are bubbles due to pop, but there's no doubt that a stock such as Nvidia is trading at a very high multiple, with perhaps too much future growth baked into its valuation right now.
At these elevated valuations, investors are taking on risk by purchasing these stocks. Because if the AI hype dies down, as it did with blockchain and as it did with the metaverse, they could end up holding the bag, with investments in their portfolios that could be at sky-high price tags.
Should investors hold off buying AI stocks?
Given the hype and how quickly some of these stocks have been soaring, I would certainly be thinking twice about whether these investments are really worth all the bullishness.
Nvidia is at the forefront of AI because its chips can help companies develop next-gen technologies. Palantir introduced a new AI platform that can take advantage of machine learning and provide customers with better data-driven insights. C3.ai is a business that serves multiple industries through its AI solutions, and it could be a big benefactor from the growing prevalence of AI.
All of these companies might be great investments if you're looking for exposure to AI. But the key thing to remember is that it could take years for them to cash in on these opportunities. The exceptional returns these stocks have generated this year could mean that future returns will be limited since the gains have likely outpaced the real growth in these businesses.
If you're willing to hang on to these and other AI stocks for years, then you could still enjoy a good return in the long run. But it's important to not expect too much too fast.
