Should stock market investors be worried about an AI bubble?

Recently, there’s been quite a bit of talk about an artificial intelligence-related ‘AI bubble’ in the stock market. A bubble is where the price of an asset, or group of assets, rises rapidly and ends up well above its fundamental value.

Is this an issue that investors should be concerned about? Here’s my take.

Is this another dotcom boom?

The general view of those who’ve said there may be an AI bubble today is that market conditions are currently very similar to those seen in the dotcom boom of the late 1990s. Back then, technology stocks shot up spectacularly – to sky-high valuations – on the back of excitement around the internet, only to come crashing back down in the early 2000s, when investors realised that not many of these companies were going to make any money from the internet.

To my mind however, today’s landscape looks quite different to the late 1990s. For a start, unlike in the late 90s, a lot of the leaders of this tech revolution still have reasonable valuations. Take Google-owner Alphabet for example. It’s currently trading on a forward-looking price-to-earnings (P/E) ratio of 22. That’s a relatively low valuation for a tech company with a diversified business model, huge free cash flow, and a fortress balance sheet.

Sure, some tech stocks have valuations that look a little elevated. Microsoft, for example, is currently trading on a P/E ratio of 33. That’s hardly bubble territory though. Back in the late 1990s, this stock had a P/E ratio in the 70s.

Secondly, AI is being adopted by consumers very quickly. For example, ChatGPT now has 800m weekly active users while Google’s AI Overviews has 2bn monthly users. AI’s also being used by businesses to increase efficiency — Facebook’s using the tech to create a more powerful, targeted advertising platform.

So this is a very different set-up to the dotcom boom. Back then, there were lots of great business ideas related to the internet but few were actually viable.

So in my view, AI’s not a bubble.

Mini bubbles in the market

That said, I do see ‘mini bubbles’ in AI. I believe some stocks have run too fast too soon, and are now detached from their fundamentals.

Palantir’s (NASDAQ: PLTR) one such stock I don’t think’s worth considering. It’s a great company growing at a phenomenal rate thanks to AI (48% revenue growth last quarter). But its valuation doesn’t make sense to me. It trades at around 90 times this year’s projected sales — not earnings!

To my mind, that’s bubble territory. So I think caution’s warranted.

While the company’s growing rapidly today, I don’t think it will grow at this rate forever. And when growth slows, investors will most likely decide it’s not worth 90 times sales.

Note that I’m not the only one who sees this stock as overvalued. Recently, another media outlet ran an article entitled ’Palantir might be the most overvalued firm of all time’.

How I’m playing the AI boom

Given my take on the landscape, I’m going to keep investing in AI. But I will pick my spots, investing in companies I feel are trading at reasonable valuations.

I’ll also remain diversified. That way, if AI stocks do crash, my portfolio won’t burst with it.

The post Should stock market investors be worried about an AI bubble? appeared first on The Motley Fool UK.

More reading

• Prediction: I think this AI stock will smash Nvidia and Palantir over the next 12 months
• Up 1,576%! Could Palantir stock be a warning signal about the stock market?
• Forecast: here’s what £20,000 in Palantir stock could be worth by 2026
• Alex Karp appears to be the ‘new Elon Musk’. So should I buy Palantir stock?
• S&P 500 to surge to 7,100? Are we secretly at the start of a new bull market?

Edward Sheldon has positions in Alphabet and Microsoft. The Motley Fool UK has recommended Alphabet and Microsoft. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

See author's posts