Over the past 30 years, Wall Street has enjoyed no shortage of next-big-thing investment trends. Innovations and high-interest trends such as the advent of the internet, genome decoding, business-to-business commerce, China stocks, 3-D printing, cannabis, blockchain technology, and the metaverse, have captivated the attention, and wallets, of professional and retail investors.
At the moment, nothing is garnering more hoopla than the rise of artificial intelligence (AI).
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When I say "AI," I'm referring to the use of software and systems to handle tasks that humans would typically undertake. The secret sauce to AI is machine learning, which allows these software and system to evolve over time and become more efficient at their tasks. Given that AI has application in virtually every sector and industry, it's not really a surprise that the analysts at PwC anticipate it could add a staggering $15.7 trillion to global gross domestic product by 2030.
Although dozens of AI stocks have benefited from the early stages of the AI revolution, it's semiconductor company Nvidia (NVDA 6.18%) that's truly become the face of the movement.
Despite the early success of the AI revolution, Nvidia may be in a giant bubble
The way I regularly describe Nvidia's role is as the "infrastructure backbone" of the AI revolution. The company's A100 and H100 graphics processing units (GPUs) are used by businesses in high-compute data centers. Nvidia's GPUs are the foundation that allows for the split-second decision-making required of AI software and systems. The analysts at Citigroup have suggested that Nvidia could account for a 90% share of GPU's deployed in AI-accelerated data centers this year.
What's been particularly beneficial for Nvidia is that demand for its high-powered AI chips has overwhelmed supply. It's enjoyed exceptional pricing power on its A100 and H100 GPUs, which is largely responsible for its skyrocketing data center sales.
Unfortunately, there are also reasons to believe Nvidia -- and potentially even the AI movement as a whole -- is in a sizable bubble. For instance, every next-big-thing trend over the past three decades has endured an early stage bubble. Investors have a terrible habit of overestimating the adoption of new technology, and AI is unlikely to be the exception to this unwritten rule.
More specific to Nvidia, it's set to face a monumental increase in external and internal competition. Advanced Micro Devices and Intel have AI-focused GPUs they're rolling out this year to directly compete with Nvidia in high-compute data centers. Additionally, some of Nvidia's largest customers are developing AI chips of their own, which could lessen their future reliance on the current king of AI.
Nvidia also anticipates production for its A100 and H100 chips will increase, which would be expected to lessen AI-GPU scarcity. Since scarcity has been the company's core catalyst on the pricing front, it's quite possible Nvidia will cannibalize its own margins as its data center segment scales.
Instead of putting your money to work in an AI stock that may very well be in a bubble at a multiple of 34 times last year's sales, consider investing in the following two AI stocks that aren't at risk of a collapse if history rhymes, once more.
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Meta Platforms
The first AI stock that offers a considerably better value proposition than Nvidia and isn't at risk of a collapse if the AI bubble bursts is social media titan Meta Platforms (META 0.43%).
Meta is using Ai in a variety of ways. It's monitoring comments on its various social sites for noncompliance, and giving businesses access to generative AI solutions that can help tailor their messages to individual users to (ideally) improve sales.
While Meta's stock has undeniably enjoyed a hearty boost because of the AI revolution, many of the company's investments are geared at moving the needle years from now. It's why CEO Mark Zuckerburg has been perfectly content with Reality Labs losing more than $10 billion annually to further Meta's virtual/augmented reality and metaverse ambitions.
What would ultimately protect Meta from an AI collapse is the company's top-notch social media real estate, which includes the most-popular social media platform on the planet, Facebook, along with Instagram, WhatsApp, Facebook Messenger, and Threads. Collectively, Meta's family of apps attracted almost 4 billion monthly active users to its sites during the December-ended quarter. Businesses realize that Meta's social sites reach the broadest audience, which is what typically affords the company exceptional ad-pricing power.
Another reason investors don't have to worry about Meta being in a bubble is the company's cash flow and balance sheet. It closed out 2023 with $65.4 billion in cash, cash equivalents, and marketable securities, and ultimately generated more than $71 billion in net cash from its operating activities for the year. Meta has the luxury of taking chances since its foundational business is a cash-printing machine.
Despite crossing above the $500-per-share mark to end last week, Meta stock remains considerably cheaper than Nvidia. Shares can be picked up right now for 22 times forward-year earnings and roughly 13 times forecast cash flow in 2025. By comparison, Nvidia trades at nearly 28 times Wall Street's consensus cash flow for the following year.
Baidu
A second AI stock that's demonstrably cheaper than Nvidia and not at risk of collapse if the AI bubble were to burst is China-based Baidu (BIDU 0.62%).
Similar to Meta, Baidu has quite a few applications for artificial intelligence. The company's AI Cloud held the fourth-highest share of cloud infrastructure service spending in China, as of March 2023, based on estimates from tech-analysis firm Canalys. Meanwhile, Apollo Go is the most-successful autonomous ride-hailing service in the world, with more than 5 million accumulated rides since inception.
Despite making aggressive investments in AI, Baidu's bread-and-butter operating segment continues to be its internet search engine. In January, Baidu accounted for approximately 60% of internet search within China, which was 44 percentage points higher than its next-closest competitor. With few exceptions, Baidu's search engine has sustained a 60% to 85% share of internet search for the world's No. 2 economy dating back nine years. This makes Baidu the logical go-to for businesses wanting to target users with their message(s).
Baidu should also benefit from the reopening of the Chinese economy following the worst of the COVID-19 pandemic. Three years of stringent and unpredictable lockdowns that attempted to mitigate the spread of COVID-19 have led to sizable supply chain kinks in China's economy. These are steadily being worked out, which is good news for Baidu's revenue and profit trajectory.
The company also has a veritable treasure chest of cash to cushion any potential bubble-popping event in AI. Baidu closed out 2023 with more than $28 billion in cash, cash equivalents, restricted cash, and short-term investments, which is more than enough capital to fuel innovation in all facets of its operations.
The final piece of the puzzle is that Baidu is historically cheap. Shares closed out the previous week at just 8 times forward-year consensus earnings and a little north of 7 times estimated cash flow in 2025. It makes for a smarter buy than Nvidia considering the history of bubbles associated with next-big-thing investment trends.
