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Shares of Microsoft, Nvidia, AMD, Meta Platforms and Alphabet are soaring. However, they are not in bubble territory.
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The parabolic rise of artificial intelligence stocks leads skeptics to say these names are in a bubble. Considering a few factors, “bubble” is just too strong a word for a group with more potential profits.
Microsoft
(ticker: MSFT),
Nvidia
(NVDA), advanced microdevices (AMD),
Meta platforms
(META), and
Alphabet
(GOOGL) are among the companies most exposed to AI, and their shares have soared.
Microsoft is adding AI to its cloud offerings, making it even more competitive in the space. It’s also launching ChatGPT – and the earnings outlook in the last quarter has been great. Shares of the software giant are up more than 35% so far. Alphabet, which is integrating AI into its ad offerings and launching Bard, a competitor to ChatGPT, has seen shares soar nearly 40% so far this year.
Meta and Nvidia shares will more than double by 2023. Meta, the parent company of Facebook and Instagram, had seen stocks plummet in 2022, so they were mostly cheap before the AI rally. Nvidia is expected to sell more chips in its data center operations to enable AI-related cloud developments. That’s an increase of AMD stock by more than 80% year-to-date, as this chipmaker also sees some of its revenue coming from its data center.
At first glance, these gains seem out of control. The recent outperformance of these large-cap technology stocks relative to the rest of the market was similar to that of past bubbles, as Evercore strategists recently pointed out. The total market value of seven of the largest US technology stocks now represents just under 30% of the
S&P 500s
market value, the highest rate since at least 2013, according to Bank of America. Strategists at the bank are calling the AI rally a “baby bubble.”
Making an analogy to a bubble, regardless of size, seems tempting, but some key factors just don’t support that argument.
First, valuations have risen, but they are not in bubble territory. The aggregated forward price/earnings multiple on the technology heavy
Nasdaq composite index,
which includes these AI stocks is about 27 times. That’s down from the 35 times before the pandemic-era bubble began to burst in 2020, and nowhere near the early 2000s dot-com peak of more than 60 times, according to RBC. In those earlier days, the Nasdaq “looked very stretched, but that’s not the case today,” Lori Cavlasina, chief US equity strategist at RBC, wrote in an investigative report.
Moreover, these multiples are fundamentally justified. Analysts expect the Nasdaq’s annualized earnings per share growth to reach nearly 18% over the next three years, according to FactSet. That means the current multiple is about 1.5 times the growth rate. Simply put, this “PEG ratio,” which stands for price-to-earnings-to-earnings growth ratio, means that investors pay 1.5 P/E multiple points for every percentage point of earnings growth they achieve. That’s not that high when you consider that the S&P 500’s PEG ratio is just above 2.
Multiples over the next few years could be stable as both earnings and stock prices rise as more investors pile up. For example, Nvidia shares could trade at just over $530 by the end of next year, about 39% above the current $381; that assumes stocks continue to trade at current 45 times earnings, and maintain 2025 earnings per share estimates of $11.84. The current multiple seems justified given that it’s not even 1 times the 50% annualized earnings per share growth that analysts expect for roughly the next three years. That’s a far cry from the real bubble of the dot-com era, when unprofitable companies traded at high valuations for estimated sales.
To be sure, AI stocks may need to take a breather. They are already moderating near their recent peaks. They may even see a small drop in the near term, but that may be just a drop in the ocean compared to the larger upsides these stocks are in – and buying dips can be prescient.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
