These AI stocks may be at a tipping point.
As even the most casual observer knows by now, artificial intelligence is benefiting stocks. Many companies in this space have seen their stock prices rise significantly, often by triple-digit percentages.
The problem with this growth is that investors may wonder if it’s too late to buy. AI may drive cutting-edge technology for years to come, but each stock still needs to be evaluated individually. These two Motley Fool contributors have thoughts on two major stocks to watch: Microsoft (MSFT -0.76%) and Nvidia (NVDA -2.13%).
AI alone does not justify this price
Justin Pope (Microsoft): Microsoft continues to reward shareholders with market-beating profits, and there seems to be no end in sight. The company’s stock has risen 37% over the past year, far outpacing the S&P 500’s 34% rise.
There is a reason for the sudden rise. Artificial intelligence (AI) could spark years of growth in the technology sector, and investors will be hard-pressed to find a company more focused on AI than Microsoft. The company’s Azure cloud platform is already the world’s second-largest cloud provider, and now it’s even riding on the AI tailwinds.
That said, investors need to start thinking a little bit about stock valuation. AI may be new and exciting and could drive growth for Microsoft, but Microsoft is a $3.2 trillion company. Your business may become so large that it becomes difficult to grow and justify a higher valuation. Is Microsoft getting closer to this stage?
Analysts expect Microsoft’s revenue to grow an average of 13% a year over the next three to five years. Frankly, it’s remarkable for a company of this size to grow profits by a double-digit percentage.
However, it is becoming increasingly difficult to justify ever-increasing valuations. After a year of gains, Microsoft’s 2024 earnings forecast is now about 33 times higher.
This gives it a price-to-earnings ratio (PEG) of almost 2.4. I typically buy stocks with a PEG ratio of around 2.0 or less. Even if Microsoft claims it deserves recognition for its high-quality business, it is starting to pay a high price for expected growth. If something happens and growth slows, there is a risk that prices will plummet.
Microsoft isn’t so expensive that you should rush out of the stock, but it’s hard to make the case to continue buying after a strong year for the stock.
Treat this market leader with caution
Will Healy (Nvidia): Nvidia has soared 193% over the past year due to its key role in the AI boom. Both demand for the company’s AI chips and its stock price have skyrocketed since investors discovered that the company’s AI chips power the ChatGPT AI platform.
Much of this gain is due to its advantage in AI chips. AMD, Qualcomm, and Intel rushed to bring AI chips to market, but none could match Nvidia’s technological prowess. Additionally, the company plans to release its next-generation Blackwell graphics processing units (GPUs) during the fourth quarter of this year as it continues to strive to maintain this lead.
Financial status supports this popularity. Revenue for the first two quarters of fiscal 2025 (ending July 28) was $56 billion, an increase of 171% year over year. Net income increased 284% to more than $31 billion.
Unfortunately for would-be buyers, this growth has sent valuations into the stratosphere. A trailing 12-month price-to-earnings ratio of 58x is unlikely to deter some investors, but a price-to-earnings ratio of 32x is expensive regardless of business performance.
And its price-to-book ratio of 52x is more than 10x AMD’s multiple of 5. This gives NVIDIA no margin for error and perhaps explains why its stock price has fallen even though the company posted impressive growth in its fiscal second quarter. .
That’s the problem. Expectations and valuations are so high that the company must provide shareholders with a near-perfect earnings report, which is a high hurdle even for Nvidia.
This doesn’t mean the company’s growth story is over. Allied Market Research estimates the AI chip industry’s compound annual growth rate through 2032 to be 38%, and Nvidia should continue to grow in the long term.
However, given the high valuation, the short-term outlook is uncertain. You should probably hold off on adding stocks until valuations have fallen significantly.
Justin Pope has no position in any stocks mentioned. Will Healy has held positions at Advanced Micro Devices, Intel, and Qualcomm. The Motley Fool has positions in and recommends Advanced Micro Devices, Microsoft, Nvidia, and Qualcomm. The Motley Fool recommends Intel and recommends the following options: A January 2026 $395 long call on Microsoft, a January 2026 $405 short call on Microsoft, and a November 2024 $24 short call on Intel. The Motley Fool has a disclosure policy.
