2023-07-03 03:22:59 ET
Summary
- AI stocks are currently popular, but many are trading at high multiples, making them unsuitable for value investors. However, there are some AI stocks that are more affordable.
- Many foreign AI stocks fall squarely in the "value" basket.
- It's possible to find foreign AI stocks trading at close to 10 times earnings.
- In this article, I explore 3 AI stocks that value investors could consider investing in.
AI stocks are very much in vogue these days. NVIDIA (NASDAQ: NVDA ) has been rallying ever since an earnings release revealed it was going to make a lot of money selling AI chips to AI app developers. Other AI companies have rallied to different extents. On the whole, the NASDAQ-100 is up 39.7% this year on the strength of its AI-developing constituents.
Certainly, AI is a powerful technology that will bring in a lot of money for companies that develop it. There’s just one problem:
The obvious “AI beneficiary” stocks are extremely expensive. NVIDIA famously trades at 138 times earnings, 40 times sales and 29 times book value. Microsoft ( MSFT ) for its part is at 36 times earnings , 12.2 times sales and 13 times book value.
For a value investor, these stocks really stretch the limits of what can be considered conservative. If a company trades at 40 times sales, then it would have to give you 40 years' worth of revenue to you back what you invested in it--to say nothing about profit! Of course, growth can overcome steep valuations, but the growth rate must be truly rapid to catch up with a 40 price/sales ratio.
Fortunately, there are some AI stocks out there that are surprisingly cheap. From semiconductors to Chinese internet stocks, AI stocks below 20 times earnings can be found and bought. In this article I will explore three such stocks that look especially promising at today’s prices.
Taiwan Semiconductor
Taiwan Semiconductor Manufacturing (NYSE: TSM ) is NVDIA’s manufacturer. It also manufactures chips for most other chip design companies, and for big tech companies that manufacture their own chips .
The play with TSM is fairly obvious:
It makes money off NVIDIA's orders. If NVIDIA really is seeing a massive increase in AI chip orders, then that should show up in TSM’s results as well – albeit to a lesser extent.
We may be seeing that happening. In March and April, TSM’s revenue declined 15.4% then 14.3%. In May, the rate of revenue decline abruptly shrank to 4.9%. This is consistent with the thesis that TSM is getting an increase in orders from NVIDIA. No, there is no big jump in revenue like the one NVIDIA guided for, but there is a marked deceleration in the revenue decline. TSM’s June monthly sales come out on July 10 , so that should tell us whether NVIDIA’s chip orders helped turn things around for the whole quarter.
How is TSM in terms of valuation?
Pretty well by the standards of an AI beneficiary stock. According to Seeking Alpha Quant, it trades at 15.6 times earnings, 6.4 times sales and 4.7 times book value. Compared to the likes of NVIDIA, that’s a bargain.
Baidu
Baidu, Inc. (NASDAQ: BIDU ) is an internet company best known as China’s biggest search engine provider. It is well known for being the developer of Ernie Bot , China’s best known ChatGPT competitor.
Recently it was revealed that Ernie Bot outperformed ChatGPT for Chinese language queries across a number of tests. Specifically, its Ernie 3.5 outperformed ChatGPT on comprehensive ability scores and Chinese language comprehension. These results were not obtained by the company itself, but by China Science Daily, a third party source. Ernie Bot’s success on Chinese queries is significant because it shows that Baidu could collect the revenue on ChatBots in China, without having to pay fees to OpenAI. The bottom line impact could be substantial.
Despite its successes in AI, Baidu stock is fairly cheap, trading at 15 times earnings, 2.6 times sales and 1.43 times book value.
Alibaba
Alibaba (NYSE: BABA ) is a Chinese tech company that’s involved in AI in several different ways.
First, Alibaba Cloud offers a number of AI tools to developers to help them improve their hosted applications. For example, for financial applications, it offers conversational AI and information review–the latter is a major cost for banks, so BABA’s tools could be very valuable to them.
Second, Alibaba is now rolling out its own chatbot for consumers, dubbed Tongyi Qianwen . It can analyze audio and video, and generate text summaries based on these inputs. Early reviewers found that it outperformed ChatGPT on complex Chinese language queries .
So, Alibaba is doing big things in AI. Nevertheless, its stock is fairly cheap, trading at just 10.6 times earnings, 1.7 times sales and 1.5 times book value. If you’re looking for a true bargain of an AI stock, this would have to be the one.
The Bottom Line
The bottom line on AI stocks is this:
Most of them are quite expensive. It’s become common for companies involved in AI to trade at 36 to 138 times earnings, and that’s despite interest rates rising continuously over the last 12 months. Nevertheless, bargains can be found in the AI space. If you’re willing to look into the foreign stock basket, you can find AI stocks trading close to 10 times earnings. Cheaper doesn’t always mean better. On the contrary, it sometimes signals problems. Nevertheless, the 3 companies mentioned in this article appear to have bright futures ahead of them. They're all solidly profitable, with healthy margins and modest valuations. Any one of them would be a worthwhile addition to a value-oriented portfolio.
For further details see:
3 Cheap Value Stocks Making AI Money