Oracle Stock Falls After AI Day, but Don't Bite Just Yet

Software giant Oracle (ORCL 2.02%) has been an early winner at the dawn of generative artificial intelligence (AI). Before ChatGPT went viral in late 2022, the old software service provider announced a groundbreaking deal to load up its small Oracle Cloud Infrastructure (OCI) service with Nvidia GPUs. It then announced it would be the first to host Nvidia's DGX Cloud used to train AI models. 

But after hitting fresh all-time highs earlier this summer, Oracle stock is falling -- and a recent AI event sent shares falling further still. Don't be quick to buy the dip. Here's why.

The simple reason Oracle is falling

Oracle and Nvidia announced in mid-October that the DGX Cloud service for training and deploying generative AI is now available. As I've written about before, Nvidia's pioneering AI work has leveled the playing field in cloud infrastructure, and Oracle has been a big beneficiary as it has sought to play catch-up with leaders Amazon Web Services, Microsoft Azure, and Alphabet Google Cloud. OCI is reporting stellar growth.  

Data sources: Amazon, Microsoft, Alphabet, and Oracle. YOY = year over year.

But at the Oracle AI event, executives discussed how its buildout of new data center infrastructure is going to take some time. As you may have heard, an explosion of demand for Nvidia GPUs means there simply isn't enough generative AI hardware to go around. That goes for the GPUs themselves, but also related data networking and other components.

This is exposing some unrealistic expectations the market had for Oracle's growth trajectory. For a year now, Oracle had been reporting a surge in revenue expansion. OCI was of course helping fuel this growth, but OCI is still a small chunk of Oracle overall. Rather, the inclusion of big healthcare software provider Cerner, acquired over the summer of 2022, was the primary reason for the big jump in year-over-year growth.  

Data by YCharts.

There must have been hopes that the double-digit pace of expansion would continue, but management shot down those hopes on the last earnings call when it said revenue would cool to just a high-single-digit-percentage growth rate (5% to 7% year over year, including Cerner, in the next quarter).

Paired with the AI event stating ongoing hardware shortages are keeping a bottle on OCI growth, the market is starting to come to terms with the outlook. Oracle will be a single-digit-percentage revenue growth business again, with earnings-per-share growth coming in just slightly higher, for the foreseeable future.  

Why Oracle stock deserves attention anyway

Even after falling from highs, Oracle still fetches a premium valuation of about 31 times trailing-12-month earnings and free cash flow. It's a solid business that could continue to be a beneficiary of generative AI, but the price tag still looks too rich to me given comments that AI buildout and full monetization from customers could take years.  

So why bother watching Oracle at all? First, there's that acquisition of Cerner, a mega-software provider that will take some time to fully integrate into Oracle and migrate over to the cloud. While Oracle works at it and migrates customers over to cloud-based billing, Cerner is actually turning into a growth headwind versus the benefit it provided last year. This is a short-term effect that has impacted all legacy software providers at some point. 

And second, Oracle management has said demand for OCI with Nvidia AI is more than can be kept up with now. To quote CEO Safra Catz, "The level of demand [OCI has] is stunning." The sooner Oracle can get those hands on GPUs and get them running in OCI, the better. Investors are betting this will translate into stable sales and profit growth for quite some time.

I'm still calling it too soon to nibble on Oracle stock after this dip, but it deserves to be on watch lists after it has shot up the ranks of top cloud software companies over the last couple of years.