Since early last year, investors have embraced the potential of artificial intelligence (AI), scooping up shares of those companies best positioned to profit from this groundbreaking technology. However, a long bull run and stretched valuations had many investors wondering if the ongoing rally could continue. In recent weeks, some have taken a step back, looking for further evidence the accelerating adoption of AI would continue.
With that as a backdrop, as of 1:08 p.m. ET on Tuesday, chipmaker Nvidia (NASDAQ: NVDA) jumped 6.4%, foundry Taiwan Semiconductor Manufacturing Company (NYSE: TSM) climbed 5.8%, semiconductor and AI specialist Broadcom (NASDAQ: AVGO) rallied 4.5%, and chip designer Arm Holdings (NASDAQ: ARM) rose 3.9%.
A check of all the usual sources — earnings results, changes to analysts’ ratings, and regulatory filings — turned up little in the way of company-specific news that helped push these AI stocks higher (more on that in a moment). That said, there was one obvious catalyst that helped spark a relief rally for AI stocks.
Solid AI-fueled results
Fellow AI specialist Palantir Technologies (NYSE: PLTR) reported its financial results, which helped put to bed fears that AI adoption is slowing. In the second quarter, the company generated revenue of $678 million, up 27% year over year, resulting in adjusted earnings per share (EPS) of $0.09. For context, analysts’ consensus estimates were calling for revenue of $652 million and EPS of $0.08, so Palantir surpassed expectations on both counts.
In addition to the company’s solid results, Palantir also increased its forecast, giving investors confidence AI still has room to run. Management now expects full-year revenue of $2.75 billion at the midpoint of its guidance, representing growth of 23%. The company cited the strong performance of its U.S. commercial business, as revenue of $159 million soared 55% year over year. Palantir now expects the segment to grow at least 47% for the year, up from its previous guidance for 45% growth issued just three months ago.
If that weren’t enough, management commentary suggested there’s more to come. CEO Alex Karp suggested the current wave of AI adoption represented “an unprecedented opportunity.”
Other developments
There were also a couple of company-specific developments in the space, but the impact would best be described as mixed:
- Analysts at New Street Research upgraded Nvidia stock to buy from neutral (hold), while simultaneously issuing a price target of $120. That represents potential upside for investors of 19% compared to the stock’s closing price on Monday. The analysts cited the recent 26% correction, saying such pullbacks are “healthy,” presenting “an opportunity to gain more exposure” to the stock.
- On the other side of the coin, noted activist investor Elliott Management said Nvidia is in a “bubble,” calling AI overhyped, according to a report in The Financial Times.
- Loop Capital analyst Ananda Baruah lowered his price target on Arm shares to $110, down from its previous level at $120, while maintaining a buy rating on the stock. He cited the company’s in-line financial results in the June quarter and in-line guidance for the September quarter, though he believes the overall thesis is “intact.”
While it’s clear that all AI companies can’t be painted with the same brush, Palantir’s robust results show that businesses are continuing to migrate to the technology, suggesting the trend is ongoing.
The recent sell-off has moderated some valuations, but value investors continue to be put off, a view I would suggest is myopic. High-growth stocks, like those involving AI, generally command a higher multiple than average, so using other valuation metrics can be informative.
For example, Arm Holdings, Nvidia, Broadcom, and TSM are selling for 73 times, 39 times, 31 times, and 24 times forward earnings, respectively. For value-minded investors, TSM might be the only one worth buying, but this fails to account for the accelerating growth trajectory of these companies resulting from AI. Using the more appropriate forward price/earnings-to-growth (PEG) ratio, which factors in that growth, each stock has a multiple of less than 1, the standard for an undervalued stock.
Furthermore, the use of generative AI has only just begun, with the adoption curve potentially lasting years. The best strategy for investing in this type of groundbreaking technology is to buy the best AI-related companies you can find and hold on for the wild ride ahead.
