The launch of OpenAI's ChatGPT in late 2022 spurred a tidal wave of interest in generative artificial intelligence (AI) companies, sending many of their stock prices parabolic. Palantir Technologies (PLTR 1.86%) and Arm Holdings (ARM 0.68%) were major beneficiaries.
However, while early investors made millions from both companies, it might be wise to take profits before 2025. Let's dig deeper to find out why.
Palantir Technologies
A great company doesn't always make a great investment. And with shares up by an eye-watering 370% year to date, Palantir's sky-high valuation overshadows its exciting data analytics business niche and respectable top-line growth rate.
NASDAQ: PLTR
Key Data Points
Palantir's third-quarter earnings grew 30% year over year to $726 million, while its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) increased 39% to $283.6 million. On the surface, these aren't bad numbers. But they look absurd compared to the company's forward price-to-earnings (P/E) multiple of 172.
For context, the S&P 500 index has an average forward estimate of just 24 while the AI industry leader, Nvidia, trades for just 31 times projected earnings despite seeing its profits grow 168% in its third quarter.
Perhaps Palantir's optimistic price tag would make sense if it boasted a "secret sauce" that other companies couldn't replicate. But this isn't the case. Rivals like Microsoft Fabric and Snowflake offer alternative enterprise data analytics solutions integrated into their existing cloud computing platforms. And nothing is stopping these companies from enhancing their software with generative AI, just like Palantir did.
Arm Holdings
With shares up 75% so far this year, Arm Holdings is another tech stock that has seen AI hype overshadow its fundamentals. While the company plays an important role in the global hardware ecosystem through its industry-leading chip architecture, it might not benefit as much from AI-related demand as some market participants seem to think.
Arm designs central processing units (CPUs), often known as the brains behind a computer. Its architecture tends to be energy efficient, making it popular in devices ranging from laptops to smartphones (where it boasts a 99% market share, according to the company's website). But Arm's popularity is a double-edged sword because it makes it difficult for new opportunities like AI chips to generate enough growth to move the needle.
Image source: Getty Images.
Arm's fiscal second-quarter revenue only increased by 5% year over year to $844 million, driven by smartphone demand (which makes up 35% of its royalty revenue). The smartphone industry is mature (likely peaking in 2016), so investors should expect this business to decline over the long term, potentially draining Arm's growth potential.
Like Palantir, Arm's valuation doesn't seem to match its fundamentals. With a forward P/E of 67, new investors should look for better opportunities elsewhere.
NASDAQ: ARM
Key Data Points
Is the AI hype cycle over?
While it is impossible to time the stock market, the current AI hype cycle probably won't last forever. High-profile AI start-ups like ChatGPT maker OpenAI are still burning through billions of dollars. According to CNBC, many in Silicon Valley are increasingly concerned that the technology's pace of advancement is already slowing down.
The year 2025 could be one of reckoning for the AI industry as the market starts prioritizing fundamentals over hype. Investors can position themselves to weather the potential storm by avoiding companies like Palantir and Arm Holdings, which may struggle to justify their sky-high valuations.
