Are AI Stocks in a Bubble That's About to Burst?

We've seen a handful of bubbles in recent decades. The most famous, of course, is the dot-com bubble early in the 21st century. Cryptocurrencies were in bubble territory not too long ago.

And now the frenzy over artificial intelligence (AI) advances is sending several stocks into the stratosphere. Are AI stocks in a bubble that's about to burst?

Image source: Getty Images.

A textbook bubble?

The definition of a stock market bubble is "a significant run-up in stock prices without a corresponding increase in the value of the businesses they represent." Bubbles are typically caused by overexuberant speculation about future share price growth with little regard to business fundamentals.

Some might argue that what we're seeing with some AI stocks right now is a textbook bubble. Let's look at two examples, in particular.

Shares of enterprise AI platform developer C3.ai (NYSE:AI) have skyrocketed close to 140% so far in 2023. Its market cap currently stands at roughly $3 billion. But C3.ai's revenue declined 5% year over year in its latest quarter. The company also remains unprofitable.

Then there's Nvidia (NASDAQ:NVDA). Investors have been wildly enthusiastic about the company's prospects in large part because its graphics processing units are ideally suited for running AI apps.

The stock has soared more than 110% year to date. Nvidia's shares now trade at a whopping 26.5 times sales and 63 times forward earnings.

C3.ai and Nvidia aren't the only AI stocks that have taken off. Shares of Meta Platforms (NASDAQ:META) have more than doubled so far this year. Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN), and Microsoft (NASDAQ:MSFT) stocks have all jumped over 30%.

But are the gains for these stocks more the result of overexuberant speculation? Are investors pushing business fundamentals to the side? There are certainly reasons to believe the answer to these questions is a resounding "yes."

More room to run?

All bubbles eventually burst. That could be about to happen with AI stocks. However, there is an argument that these stocks actually have more room to run.

C3.ai's shares currently trade at 9.2 times sales. That's not too terribly high of a multiple -- if the AI market explodes as many people expect it will.

As for Nvidia, one fund manager believes the stock could grow by 5x over the next 10 years with the rising adoption of AI. Analysts at Oppenheimer and Susquehanna just raised their 12-month price targets for Nvidia to reflect an upside potential of around 12%.

Meta's huge gain this year needs to be put into context. Even after more than doubling in 2023, the stock still hasn't climbed back to its peak set nearly two years ago. Also, Meta's price-to-earnings-to-growth (PEG) ratio of 1.15 actually looks relatively attractive.

It's a similar story for Alphabet: The tech giant's PEG ratio is only 1.13. Microsoft's forward earnings multiple is a seemingly high 28, but this level is well within its normal range in recent years.

Amazon is an outlier, with its shares trading at 62 times expected earnings. However, using earnings multiples is notoriously tricky with the stock because Amazon invests in growth initiatives so heavily. With the company's free cash flow likely to improve dramatically over the next few years, Amazon is arguably much more attractively valued than it might appear at first glance.

The best answer

So are AI stocks in a bubble that's about to burst? As is often the case with challenging questions, the best answer is... it depends.

Most importantly, it depends on which stocks we're talking about. I don't think that every AI stock is in a bubble. For example, Meta, Alphabet, Amazon, and Microsoft haven't had unjustified run-ups, in my view.

On the other hand, I suspect that the huge moves for C3.ai and Nvidia stocks probably have gotten ahead of the companies' near-term growth prospects. It won't surprise me in the least if gravity kicks in for both stocks this year.

Still, I don't think investors are wrong to be excited about the long-term prospects for AI. This technology will almost certainly impact nearly every area of business and personal life over the next decade and beyond.

C3.ai, Nvidia, Meta, Alphabet, Amazon, and Microsoft could (and arguably should) all be big winners in the AI boom. Just don't expect their share prices to continue going up indefinitely without some pullbacks along the way.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Keith Speights has positions in Alphabet, Amazon.com, Meta Platforms, Microsoft, and Nvidia. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Meta Platforms, Microsoft, and Nvidia. The Motley Fool recommends C3.ai. The Motley Fool has a disclosure policy.