The hype around artificial intelligence (AI) stocks has reached a fever pitch.
After start-up OpenAI released its chatbot called ChatGPT to the world late last year, a new boom in AI investments began to take hold. Companies like Microsoft are leading the charge to try and build up these new tools, investing $10 billion into OpenAI and forming a partnership for consumer AI tools. Wall Street has taken notice, sending stocks up over 100% this year just because they are associated with AI.
While you might think now is the time to hop onto the AI investment train and make some short-term wealth, investing in new technologies is dangerous and extremely risky. Here are two popular AI stocks I'm holding off on buying for now.
1. Nvidia: The dangers of short-term pricing power
The poster child for the artificial intelligence boom might be Nvidia (NVDA 6.18%). The company is currently the go-to supplier for the computer chips that power these new AI tools, which are all generally computationally intensive. A single unit of Nvidia's newest AI chip is currently going for over $10K as companies rush to secure supply in order to train and run these AI models. This is giving Nvidia tremendous pricing power as it is the only scaled-up supplier of these computer chips. Nvidia's stock is up 170% this year and now trades at a market cap of over $1 trillion.
Nvidia is going to realize the financial impact of this pricing power and booming demand in the coming quarters. In the second quarter, management is expecting revenue to hit $11 billion, a significant jump from the $7.2 billion it brought in last quarter and a 64% year-over-year boost. Margins are expanding, with a first-quarter operating margin of 42% that will grow in Q2 due to the increased prices of these AI chips. If this rapid growth and margin expansion continue, the company will likely be doing north of $10 billion in annual earnings. Even if that occurs, the stock still looks to be valued at a premium. At a market cap of $1 trillion, Nvidia would have a price-to-earnings (P/E) ratio of 50 if it earned $20 billion in profits every year. Over the last 12 months, the company has generated less than $5 billion in net income.
Another problem is that Nvidia has a lot of competition coming down the pipeline and has a sole supplier that will likely increase prices on its highly profitable chips. Its cloud customers like Alphabet, Microsoft, and Amazon are all developing their own computer chips that could reduce Nvidia's market opportunity, while other chipmakers like AMD are investing heavily into AI chips as well. Its sole supplier that actually manufactures the computer chips (Nvidia just does the design and software) is Taiwan Semiconductor Manufacturing. It is a company known for increasing prices on customers and will likely not let Nvidia earn outsized profit margins on its computer chips over the long term.
Is Nvidia a great business? Yes. But the stock is extremely overvalued at a market cap of $1 trillion. If you like the business opportunity ahead for this company, it is best to keep the stock on your watchlist for the time being.
2. C3.ai: A lot of bark, no profitability
Nvidia may be a great business with an overvalued stock, but C3.ai (AI 3.02%) looks like a bad business masquerading as a beneficiary of the AI boom. The company calls itself an "Enterprise AI Application Software" company. Essentially, it sells AI products and implementations to large companies to (hopefully) increase efficiency and save them money.
The problem is that C3.ai is not making money itself and is not growing very quickly. Last fiscal year, it grew revenue by only 5% year over year and posted a $290 million operating loss on only $267 million in revenue. This is a broken business model that is destroying shareholder value and will continue to destroy shareholder value unless something gets changed.
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Despite this broken business model, C3.ai's stock is up over 200% this year, likely because it has AI in its name and the ticker symbol "AI." However, as you can see from the above paragraph, this price jump is not because the business fundamentals are improving. In fact, shares now trade at a price-to-sales (P/S) ratio of 17.75, which would be expensive even if C3.ai was profitable and rapidly growing.
If I owned shares of C3.ai today, I would probably be taking my gains and getting out. The company has not proven it has a sustainable business model and would be extremely overvalued even if it started turning a profit. There's no reason to own shares at these prices.
