Since early last year, stocks related to artificial intelligence (AI) have risen considerably. Consequently, investors who bought these companies during the 2022 bear market have undoubtedly benefited from massive returns.
However, some of these stocks have risen to elevated valuations. Unfortunately, such multiples have made these stocks risky to buy right now, despite considerable long-term growth potential.
Regarding these three stocks, investors may want to wait rather than buy under current market conditions.
1. Arm Holdings
Semiconductor investors undoubtedly welcomed the debut of U.K.-based Arm Holdings (NASDAQ: ARM). Arm creates the architecture for CPUs that are energy efficient, low cost, and high performance. Its chip designs are especially popular in the data center, automotive, and smartphone spaces. The company licenses its technology to the likes of Nvidia and Qualcomm, making it an essential part of the world’s technology infrastructure.
Interestingly, the stock quickly faltered after introducing shares at $51 per share in September. But in November, it began gaining traction amid a positive earnings report and growth in the segment.
Investors began to bid its share price dramatically higher after the company released its latest earnings report on Feb. 7. In just three trading sessions, Arm’s stock price increased by 85%.
The stock is newly profitable, meaning its P/E ratio may not reflect its value well. But with a forward P/E ratio of nearly 110 and a price-to-sales (P/S) ratio of 45, its valuations leave little room for error. That also means that at its all-time low of $46.50 per share, investors still paid a lofty premium for this stock.
Admittedly, given Arm’s role in the industry, the company will likely drive considerable returns longer term. But investors would more likely earn higher returns for the stock if they had held out for a bear market and, by extension, a lower share price.
2. Cloudflare
Cloudflare (NYSE: NET) leverages the cloud to give users a faster, safer experience. The company operates more than 300 data centers worldwide and covers approximately one-third of the world’s unique internet networks.
Since almost every user is close to at least one of its data centers, the company can support edge computing networks in most of the world’s locations. Consequently, its customer base grew 35% over the last year. Also, net revenue retention was 115%, meaning long-term customers increased spending with Cloudflare by an average of 15% over the previous year.
As a result of this success, its stock is up by more than 65% over the last year, with about half of the increase occurring after its Q4 2023 earnings call on Feb. 8.
Cloudflare is also nowhere near generally accepted accounting principles (GAAP) profitability, meaning investors have to rely on its P/S ratio to measure valuation. Its P/S ratio of 25 is nowhere near a record, but unless the investment environment starts to match that of the 2021 bull market, a move to a 100 P/S ratio is unlikely.
Also, investors should remember that Cloudflare lost more than 80% of its value at one point in the 2022 bear market. Indeed, the benefits of Cloudflare’s network will likely continue to drive robust customer growth. Still, if investors turn against money-losing companies again, those who buy now could endure years of losses.
3. Super Micro Computer
Super Micro Computer (NASDAQ: SMCI) is one of the more compelling growth stories of the current bull market. It has experienced the most significant growth spurt in its 30-year history, as its partnership with Nvidia dramatically increased demand for its servers.
Moreover, its past and present endeavors meant it secured 6 million square feet of manufacturing space and a book of business spanning 100 countries. That allows the company to sell and distribute its technology almost anywhere clients demand it.
Its success led to a yearly gain of just under 750%. Additionally, due to the stock’s rising popularity, it has grown by over 165% since the beginning of 2024.
Admittedly, on the surface, the valuation may not seem as elevated as some stocks. It supports a P/E ratio of more than 60 and sells for around 5 times sales.
Nonetheless, it was only about a year ago that the company traded at a P/S ratio of 1, and equipment manufacturers often do not attract high valuation premiums, so the likelihood of a pullback has increased.
Since the need for AI hardware will grow, Super Micro is probably a stock that tech investors will want to own. Nonetheless, with its massive gains in the last year, investors may want to hold out for a significant pullback before they start to add shares.
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Michael Healy has positions in Qualcomm. The Motley Fool has positions in and recommends Cloudflare, Nvidia, and Qualcomm. The Motley Fool recommends Super Micro Computer. The Motley Fool has a disclosure policy.
3 High-Flying AI Stocks Investors Should Stop Buying (for Now) was originally published by The Motley Fool
