"Be fearful when others are greedy and greedy when others are fearful." That's one of famous investor Warren Buffett's most popular quotes. Although it's well known, investors may need to be reminded of it right now, especially when it comes to artificial intelligence (AI). AI stocks have been skyrocketing this year thanks to ChatGPT and businesses rushing out to announce they have new AI-powered products and services.
But with valuations now soaring to obscene levels and investors becoming incredibly greedy when it comes to buying AI stocks, now may be the time to be fearful of these types of investments.
'Biggest bubble of all time'?
Bubbles can happen when there's a lot of hype, especially when it comes to tech. A few years ago it was blockchain and metaverse stocks that were all the rage. Now the excitement appears to have shifted to AI. Even people involved with AI can see how valuations are getting out of control.
The founder of Stability AI, which makes images based on text descriptions and uses deep learning, believes that investors are getting ahead of themselves when it comes to AI. "I think this will be the biggest bubble of all time." That's what CEO Emad Mostaque said referring to the hype around AI right now.
He cautions that while there will be opportunities in AI, it's still in its early stages. While it can change businesses and industries, investors may be overestimating the impact right now. And it could be far too early to know which companies will be successful in AI.
Valuations are getting out of hand
Share prices of many tech stocks related to AI have soared this year. Nvidia (NVDA 6.18%), C3.ai (AI 3.02%), and Upstart Holdings (UPST 2.76%) are up over 200% since January. Nvidia in particular has been one of the hottest tech investments, hitting a $1 trillion market cap this year. Its AI chips could play a key role in the industry's long-term growth. The problem is that investors are already paying for a lot of that future growth, and it's a similar situation for C3.ai and Upstart:
NVDA PS Ratio data by YCharts
Neither Upstart nor C3.ai is profitable at this point. And while Nvidia is in the black, at 237 times earnings, investors are also paying a huge multiple for profitability as well.
Plus, there are risks to consider with these stocks:
- U.S.-China relations aren't great, and there's a risk that the U.S. could put export restrictions on what chips can be exported to China. That's a key market for Nvidia.
- C3.ai is a pure-play AI stock that can offer solutions to a variety of industries. But with its forecast calling for as little as 10% growth for the current fiscal year (which ends in April), the company's forecast was arguably a little light for the year ahead despite all the apparent excitement. If the business doesn't dominate as it should, the stock could quickly give back its gains.
- Upstart's business centers around using AI to help issue loans and keep risk down for lenders. But the problem is lenders aren't all that eager to issue loans at a time when the economy isn't in great shape, with inflation still a problem for the country. If macroeconomic conditions don't improve, Upstart's sales won't necessarily soar just because AI is more popular.
Despite all of these risks, investors are still willing to pay huge premiums for these stocks.
Should investors step back from AI stocks?
AI is a big opportunity, but investors should be careful not to expect too much, too soon from some of these businesses. There are many companies offering AI-based products and services, but that doesn't mean they will all generate significant revenue growth or turn an unprofitable business into a profitable one.
Valuations are important considerations investors should take into account when buying stocks. Even though a business may grow, at a high price the stock may not generate a positive return if it already has a lot of future growth baked into its valuation. While AI isn't something for investors to fear, the valuations for many AI stocks have become frightfully high, and growth investors may be better off looking elsewhere right now.
