AI Stocks: Falling Knife or Once-in-a-Decade Buying Opportunity?

Key Points

• AI stocks have fueled the market’s overall gain over the past few years.

• But investors have become more cautious lately, amid concerns about the broader economic environment and the AI growth story.

• 10 stocks we like better than Nvidia ›

In recent years, when investors looked for major growth potential, they turned to artificial intelligence (AI) stocks. These players have driven gains in the S&P 500 as AI has been viewed as the next game-changing technology. With the ability to make companies more efficient and innovative, AI could supercharge earnings growth.

And some players, such as chip designer Nvidia (NASDAQ: NVDA) and cloud computing giant Amazon, have already generated significant revenue growth as they’ve been playing key roles in the early stages of the AI boom. A look at funds invested in a broad range of AI players further illustrates this point. The Dan Ives Wedbush AI Revolution ETF has jumped nearly 50% from its launch a year ago, and the iShares Semiconductor ETF has soared more than 200% over the past three years.

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But, in recent times, the path of AI stocks hasn’t been as surefooted as it was in the past. The general geopolitical and economic environment has made investors more cautious. And investors have questioned the level of spending by tech companies on AI — and whether it will all be worthwhile.

All of this has weighed on AI stocks periodically since late last year. And over the past few weeks, this downward trend has returned. So now investors may be wondering whether AI stocks, after declines, are a falling knife — or a once-in-a-decade buying opportunity. Let’s find out.

Image source: Getty Images.

Early phases of AI

As mentioned, AI stocks drove market gains in recent years amid excitement about the technology’s potential and as initial chapters of the boom unfolded. Companies trained AI models, a step requiring massive compute, and began applying AI to real-world problems — though we remain early in the AI use story.

Technology leaders have been spending billions as part of the AI infrastructure build-out, with plans to invest nearly $700 billion this year alone. This is as demand for capacity to run AI workloads explodes higher. And technology companies’ earnings reports have reflected this high demand, with AI revenue climbing.

Though this demand story remains positive, investors have still worried about the possibility of the revenue opportunity falling short — particularly considering this enormous investment in infrastructure. Meanwhile, ongoing turmoil in Iran and worries about rising inflation in the U.S. have also preoccupied investors.

I’ll again use the Ives and iShares ETFs as examples to illustrate the movement of AI stocks. The Ives ETF has slipped 10% since June 1, and the iShares Semiconductor ETF has dropped 15% since a peak on June 22. This is as of the July 13 market close.

What may lie ahead

Now, let’s return to our question: Are AI stocks a falling knife that you should avoid — or could this be a once-in-a-decade buying opportunity? It’s impossible to predict whether recent declines will continue or if AI stocks will quickly rebound and soar. But the full AI story is in its early stages, as companies and individuals are just beginning to regularly use AI and apply it to their needs. And certain industries, such as robotics and pharmaceuticals, may heavily rely on AI in the years to come to make significant advancements.

Much of the activity we’ve seen so far in AI is the actual development of the technology and the training of models — but the use cases should drive a major and long-lasting wave of growth for many companies. The infrastructure winners that already have delivered earnings growth in the earlier stages of the boom are likely to continue to generate growth as their products are needed on an ongoing basis. On top of this, the AI winners may multiply as companies that use the technology gain in efficiency, lower costs, and become more innovative.

All of this means that, even if AI stocks experience a period of declines, the quality players are well-positioned to go on and climb over the long term. So, right now, with stocks like Nvidia trading at 22x forward earnings estimates and tech powerhouse Microsoft trading at only 20x estimates, it’s a great time to go bargain hunting. This may be a once-in-a-decade opportunity.

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Adria Cimino has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Microsoft, Nvidia, and iShares Trust-iShares Semiconductor ETF. The Motley Fool has a disclosure policy.