Beware of This AI Stock’s Smoke and Mirrors

On the heels of the worst economic downturn since 2008, things are finally starting to look up. Each of the major market indexes has recovered at least 20% from their recent lows. The only thing standing between Wall Street and the next bull market is the market indexes reaching new all-time highs.

Helping drive the rebound are recent advances in the field of artificial intelligence (AI) and the promise of vast productivity gains, though estimates vary wildly. Cathie Wood's Ark Investment Management estimates that AI could represent a $14 trillion opportunity by the end of the decade. More conservative predictions from Morgan Stanley and Goldman Sachs estimate the market opportunity at $6 trillion and $7 trillion, respectively, by 2030. 

The potential for soaring profits isn't lost on investors, who have been scrambling to buy stocks best positioned to benefit from the accelerating adoption of AI. Unfortunately, not all AI stocks are created equal, and while buying some will be like minting money, others will be like setting your money on fire.

Nvidia is not as expensive as it looks 

Nvidia (NVDA) is best known as the pioneer for the graphics processing units (GPUs) that generate realistic images in video games. However, researchers discovered that the sheer number-crunching capacity that made that possible could also be used to move vast amounts of data at lightning speeds through data centers and cloud-computing platforms, making them a natural fit for training and running AI systems.

The company's recent results highlight the unprecedented demand. In its fiscal 2024 second quarter (ended July 30), Nvidia generated record revenue of $13.5 billion, an increase of 101% year over year, while earnings per share (EPS) of $2.48 climbed 854%. 

Management expects the company's growth spurt to continue, albeit at a more moderate pace. Nvidia is forecasting third-quarter revenue of roughly $16 billion, which would not only mark an all-time high but also represent growth of 317% year over year and 18% sequentially. It's worth noting that the comps are partially skewed by last year's market downturn, but the growth is nonetheless extraordinary.

CFO Colette Kress was clear that the “Strong demand … was primarily driven by the development of large language models and generative AI.” Leading the charge were cloud-service providers and large consumer-internet companies scrambling to meet the increasing demand to leverage AI.

Easy comps from last year's downturn notwithstanding, this suggests the AI boom is only just beginning for Nvidia. This has driven its stock price up more than 200% so far this year.

While Nvidia isn't without competition, its processors are the gold standard in the industry. This likely explains the company's market dominance, controlling an estimated 95% share of the machine learning market, according to New Street Research. 

Nvidia will continue to benefit as cloud providers and data-center operators fortify their systems with the latest AI-enabled semiconductors to meet this increasing demand.

Some investors will scoff at Nvidia's lofty valuation, but the stock isn't nearly as expensive as it looks. While the stock's price-to-earnings (P/E) ratio of 110 might seem outlandish at first glance, the recent steep decline was the result of Nvidia's blowout earnings, which cut its valuation by more than half.

Given the multitrillion-dollar opportunity and its dominant market share, I'd argue the stock is still worth every penny.

C3.ai: Pay no attention to the man behind the curtain

Given its name and telltale ticker, it isn't surprising that investors might consider C3.ai (AI) a potential winner of the AI revolution. After all, the company boasts of having “over 40 turnkey enterprise AI applications that meet the business-critical needs of global enterprises” across a variety of industries. C3.ai's stock has gotten caught up in the frenzy for all things AI, with its shares soaring 148% year to date. By outward appearances, it seems pretty cut and dry, but problems lurk just below the surface, showing why this stock is a flaming dumpster fire.

A glance at C3.ai's recent financial results paints an ugly picture. For its fiscal 2024 first quarter (ended July 31), C3.ai delivered revenue of $72.4 million, up 11% year over year, resulting in a loss per share of $0.56, just slightly better than the $0.67 loss it delivered this time last year. 

Given the mad rush for AI tools, you'd think C3.ai would be a primary beneficiary of those expenditures, but the financial results provide evidence to the contrary. This illustrates that during an unprecedented time for AI adoption, C3.ai has failed to capitalize on the opportunity.

While the company's forecast shows improvement, it still flies in the face of the soaring demand for AI. C3.ai is guiding for revenue growth of 19% year over year in Q2 and just 15% for the full fiscal year while its operating losses continue. Yet, despite its tepid growth, weak outlook, and mounting losses, the stock still sells for 11 times sales.

If that's the best C3.ai can do during a period of unparalleled demand for AI, there are much better places for investors to put their money.


Originally published on Fool.com

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