AI stocks are growing parabolically, so skeptics see such companies as bubbles. However, considering several factors, the term "bubble" is too severe for a group of companies with greater potential earnings potential.
AI stocks have shown a strong growth trend in recent years, which has attracted some attention and doubt. While the stock prices of these companies may show parabolic growth, classifying them as "bubbles" may be too aggressive.
Here are some factors that explain why share price growth for AI companies may be more than just a bubble: potential earnings potential:
AI technology has great potential applications in many fields, such as healthcare, finance, retail, and autonomous driving. The growth of these companies may be based on expectations of future earnings potential, not just short-term hype.
Technological advancement: The rapid development and advancement of artificial intelligence technology has brought more business opportunities and innovative solutions to the company. This technological advancement and innovation may be the basis for the growth of these companies' share prices.
Market Demand: The global demand for AI technology is increasing. The company has been successful in meeting this demand and is expected to gain market share in different industries.
Long-term investment perspective: Some investors may have confidence in AI companies that have the ability to continue to grow and create value in the coming years and decades.
Companies like Microsoft, Nvidia, AMD, Meta Platforms, and GOOGL have the biggest impact on AI, and their stocks have jumped.
Microsoft has added artificial intelligence to its cloud computing services, thus enhancing its competitiveness in the field. It also released ChatGPT and expressed optimism about the earnings outlook for the most recent quarter. Microsoft's stock is up more than 35% so far this year. Alphabet has added artificial intelligence to its advertising products and launched its competitor, Bard.
By 2023, the shares of Meta and Nvidia will more than double. Meta's stock price, the parent company of Facebook and Instagram, has already experienced a big crash in 2022, so their stock looks particularly cheap before the AI rally. Nvidia expects to sell more chips in its data center business to drive cloud computing technology in artificial intelligence. The news has also pushed AMD's stock up more than 80 percent year-to-date, and sales in the company's data center business have also grown significantly.
On the surface, this growth seems to be out of control. Evercore strategists recently pointed out that these big tech stocks have outperformed other stocks in the market recently, outperforming past bubbles. According to Bank of America, the seven largest U.S. technology companies now account for less than 30 percent of the S&P 500, the highest since at least 2013. Strategists at the World Bank have dubbed this rise in the AI market a "baby bubble."
Regardless of its size, it's tempting to compare it to bubbles, but some key factors don't prove it.
First, while the value of AI stocks has risen, it has not yet reached the point of a bubble. According to the Royal Bank of Canada (RBC), the Nasdaq Institute Index, which is made up of these AI stocks, is currently trading at about 27 times earnings, up from 35 times before the pandemic in 2020, a far cry from the peak of the dot-com bubble in early 2000 (60 times). Lori Kafrasina, chief U.S. securities strategist at Royal Bank of Canada, said in a study, "At those times, the pressure on the NASDAQ seemed great, but that's not the case anymore." ”
Moreover, these P/E ratios are already reasonable. According to FactSet, analysts predict that Nasdaq will grow earnings per share at an annual rate of nearly 18% over the next three years or so, meaning that the current price-to-earnings ratio is about 1.5 times the growth figure.
Simply put, this "PEG ratio" refers to the ratio of the price-to-earnings ratio to the economic growth rate, meaning that investors need to pay 1.5 percentage points to get a return. This is not high considering that the current PEG ratio of the S&P 500 is just over 2.
With both earnings and stock prices rising, the P/E ratio is likely to remain stable for years to come as more investors enter the market. For example, if Nvidia's stock price remains at its current price-to-earnings ratio of 45 and earnings per share are expected to reach $11.84 by 2025, its stock price will be just over $530 by the end of next year, about 39% higher than the current $381.
To put that into perspective, the current price-to-earnings ratio looks reasonable, as it's less than double the 50% annual EPS growth analysts have forecast over the next three years. This is very different from the real bubble of the Internet age, when unprofitable companies overestimated their sales.
Admittedly, it may be time for AI stocks to take a breather. They've made some corrections near recent highs and may even have a small short-term decline, but this could be a drop in the bucket relative to the larger uptrend of these stocks going forward, while buying at the low levels could be far-sighted.