Are AI Stocks Overvalued?

After a spectacular run in 2023, AI stocks finally appear to be running out of steam. Top stocks in the field have fallen drastically in recent weeks, and the NASDAQ composite as a whole is down more than 5% in the past 30 days.

Does this mean that AI stocks have peaked, or are high-growth tech shares only taking a breather before once again moving higher?

Evidence That AI Stocks Have Already Topped Out

The strongest argument for peaking AI stock prices is the fact that leading shares have sold off despite continued earnings growth.

Over the past month, for example, shares of NVIDIA (NASDAQ:NVDA) have lost 16.3% of their value. This drop came despite the FY2023 report released in February, in which the company detailed year-over-year net income gains of 769%.

A similar situation has played out for Super Micro Computer (NASDAQ:SMCI), another popular AI hardware stock. SMCI shares have shed about 30% of their value in the last 30 days, an even more drastic selloff than NVIDIA’s. SMCI saw its earnings grow by over 68% year-over-year in Q4.

This selloff comes as several tech majors prepare to report their earnings for Q1. In the upcoming week, Meta, Tesla, Alphabet and Microsoft will all issue their first quarter earnings reports.

The general selloff in tech also reflects investors’ expectations that big tech will turn in lackluster results in what continues to be a challenging business environment.

More pessimistic views on the usefulness of AI are also beginning to take hold. Since early 2023, investors have poured money into AI stocks on inflated expectations of what the technology could accomplish in terms of raising productivity.

Now, a more somber mood appears to be taking hold. Although there is still enormous utility to generative AI assistants, research AIs and machine learning data analytics, the hype is beginning to settle down as realistic expectations settle in.

A final argument in favor of the idea that AI stocks have peaked for now is the fact that leading stocks have appeared overvalued for quite some time.

Are AI Stocks Overvalued?

AI stocks appear to be overvalued on a multiples basis with Nvidia, in particular, trading at 30 times sales and 35 times forward earnings.

Already valued at nearly $2 trillion, the company’s impressive net margin of nearly 50% means earnings growth will need to continue at a rapid pace to justify the current multiples.

Widespread overvaluation has led many observers to call AI stock prices a bubble over the last year. Now, a combination of high valuations, a difficult macro environment and global uncertainty are combining to pop the AI bubble. 

A continuation of the trend will result in further losses for technology stocks as the market re-prices them.

Why Some Investors Think AI Still Has Room to Run

Of course, there is also a more bullish take on the future of AI and the companies behind it. In the view of Goldman Sachs, for example, the run-up of stocks like NVDA and SMCI was just the first stage of a broader surge in equities associated with AI.

As the technology is deployed, bank analysts believe that the broader market will rise due to increased productivity and higher earnings.

In their view, while individual AI hardware stocks may have temporarily peaked, there is still ample room for broader indices to be driven to new heights by the benefits of AI technology.

What cannot be disputed at this time is just how monumental the growth of earnings has been for the prime AI stock in the market, Nvidia.

Forecasts from a few years ago failed to build in accurate expectations for just how high earnings would actually go, and if the market more generally is similarly being discounted the future is bright for the S&P 500.

Are Bulls or Bears Right on AI?

While there’s a good argument to be made that AI’s value will slowly filter down into the economy and raise earnings across the board, the bearish view on valuations and near-term growth appears to be stronger.

Unless the large tech companies reporting earnings over the coming weeks can beat expectations, it appears that AI stocks may plateau for the time being.

In the event of widespread earnings beats, though, it’s also entirely possible that the market could surge and drive prices for AI stocks back toward their pre-decline levels again.

A continuation of high interest rates, which is supported by March’s CPI report of a 3.5% climb, has the potential to materially hurt companies across the board, but scalable software businesses that specialize in AI are likely to be more immune.

Indeed, OpenAI CEO Sam Altman has commented that it’s only a matter of time when a single person company is worth a billion dollars, a feat that will be achieved through leveraging artificial intelligence advancements.

With all that said, expectations need to be tempered and some hitherto bullish voices in the technology space are beginning to express concern over the trajectory of AI stocks. Cathie Wood, for example, recently commented that NVIDIA is likely to contract in a similar manner to Cisco after the dot-com bubble burst. 

No doubt, companies like NVIDIA and SMCI provide the hardware needed to power the artificial intelligence revolution that seems set to occur but perhaps a short-term pause and reset is going to be necessary before they start their next ascent.

And even if they no longer lead but simply hand the baton to other stocks to power higher, the S&P 500 as a whole is likely to reap the benefits.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.