Artificial intelligence (AI) promises to be a game changer for many industries. And chatbots such as OpenAI's ChatGPT are at the forefront of the innovation, making it easy for companies to do more with less and automate repetitive tasks with ease.
The problem, however, is that expectations can become overblown, potentially setting investors up for disappointment. With generative AI in its early innings, there's still a lot to be proven. Will it lead to job losses and radically change day-to-day operations, as many people are both anticipating and fearing? That's still up for debate.
Even OpenAI CEO Sam Altman thinks that expectations may be getting too high. He has warned investors in the past about getting their hopes up, and he recently reiterated his concerns.
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Is an AI bubble already here?
Worries of an AI bubble aren't new, as valuations haven't been skyrocketing for many stocks. And even Altman believes the market may indeed be in one. While he does believe AI will be transformative and incredibly important for innovation, he does worry that expectations are getting a bit too ambitious.
"Are we in a phase where investors as a whole are overexcited about AI?," he said. "My opinion is yes. Is AI the most important thing to happen in a very long time? My opinion is also yes."
A few years ago, when OpenAI was in the midst of developing GPT-4, Altman said that "people are begging to be disappointed." And while the chatbot has been improved since then, it may not be up to the level that many people were expecting by now. But that hasn't stopped valuations from becoming incredibly inflated.
Many AI stocks are trading at excessive valuations
Finding overvalued AI stocks isn't hard right now. Perhaps the best example is Palantir Technologies (PLTR -0.83%). While the data analytics company has benefited from enhancing its platform to use AI, its valuation has gotten excessive. At a market cap of around $370 billion, it's now one of the most valuable companies in the world, worth more than blue chip stocks such as Coca-Cola, Wells Fargo, and T-Mobile US.
While Palantir's business has been growing at a fast rate of around 50% year over year, it still has generated a fairly modest $3.4 billion in revenue over the trailing 12 months, putting it at a price-to-sales multiple of around 110. And its price-to-earnings (P/E) multiple of 520 is gargantuan.
Palantir is perhaps the most recognizable example of a company whose valuation has taken off to obscene levels due to AI, but there are other cases as well.
Microsoft, for instance, is trading close to 40 times its trailing earnings, which is a higher-than-typical valuation for the tech stock. But with its Copilot assistant and AI-powered personal computers, expectations are also elevated that Microsoft's growth may soar due to AI in the future. In its most recent quarter, it grew at a rate of 18%, which is solid but arguably not worth such a high P/E multiple, suggesting that expectations are sky high for Microsoft as well.
Investors should tread carefully with AI stocks
AI has the potential to truly change businesses in meaningful ways, and many tech companies are ramping up spending and investments in anticipation of that. But that doesn't mean that the payoff will line up with investor expectations. And if that doesn't happen, it can make a stock vulnerable to a sizable sell-off in the future.
Whether it's Palantir, Microsoft, or another AI stock, it's always important to consider a stock's valuation when buying it. Even if the business may be performing well, that doesn't mean it's a good investment at any price. Valuation matters, which is why when it comes to AI, investors should consider Altman's warnings carefully.
