Excitement surrounding artificial intelligence (AI) has been helping fuel the market's rally over the past year or more. Businesses are eager to jump aboard AI-powered technologies in an effort to improve their operations, making them more efficient and effective. And for many companies, such as Nvidia (NVDA -0.50%), the payoff is already flowing through, with revenue and profits skyrocketing in recent quarters.
But there's undoubtedly a lot of hype in AI which has sent many stocks to obscenely high valuations. And popular hedge fund manager Ken Griffin believes investors may be getting ahead of themselves.
Incremental gains are the more likely outcome
In a recent interview with CNBC, Griffin poured cold water on the market's recent hype involving AI. "It's not clear to me that we're going to get the productivity gains out of AI that the markets are broadly hoping for," he said.
While he sees incremental benefits and the potential for AI to replace entry-level jobs (e.g. call center work), he's much more skeptical about AI replacing fund managers. And while large language models are good at "regurgitating what is available to use on the world wide web," he doesn't believe their usefulness stretches much further beyond that.
This is ultimately the crux of the debate relating to AI these days, and what has driven up valuations so high. If many AI stocks are worth their inflated multiples, the belief would have to be that AI will indeed be transformative and take over more advanced jobs, not just entry-level ones. If that doesn't happen, however, that could undermine the investment thesis behind many soaring stocks.
Have AI stocks become too hot?
Three red-hot stocks that have doubled in just the past six months and which are all dependent on a strong future in AI include Nvidia, Arm Holdings, and SoundHound AI. Amid all of that growth, their valuations have climbed significantly. Here's how those three stocks stack up with respect to their revenue numbers.
P/S Ratios data by YCharts
Investors are paying steep multiples for these stocks and essentially assuming a high level of growth in the years ahead. And if that growth doesn't pan out, the risk is that these stocks, at such high valuations, could be vulnerable to sell-offs.
According to a recent survey from software company Retool late last year, even tech workers aren't convinced of AI's effectiveness. More than half of the 1,500 tech workers surveyed believe that AI is "overrated" and that there simply isn't enough evidence to suggest it will be as transformative as people expect it to be.
While ChatGPT has become a great tool in drafting emails and creating essays, it and other chatbots have proven to be unreliable as well, "hallucinating" or making up facts at times. Although AI is showing a lot of promise, the risk is that investors may be expecting too much from these next-generation technologies too soon.
Is now the time to step back from AI stocks?
If you're investing in Nvidia or any other highly priced tech stock today, you're likely doing so because of the expectations you have for its future growth prospects, particularly with respect to AI. And as promising as that outlook may be, it's also important to consider what happens if those expectations fall short, and whether you'd still want to be holding the stock if the growth related to AI starts to slow down.
Recognizing the assumptions you're basing your investment on can help you identify the risks associated with your investment. In Nvidia's case, its business isn't entirely dependent on AI, and it can still make for a good tech stock to own for the long haul. But for other stocks, which you're investing in simply because they could do well due to AI and for which you would be paying a high premium, the safer option may indeed be to think twice about those investments.
