Jim Covello, the head of equity research at Goldman Sachs with more than 3 decades of Wall Street experience, believes that AI stocks, including the frontrunner Nvidia Corporation (NVDA), are in bubble territory. According to the analyst, it may take a few months or even years before the expensive AI technologies are replaced by cheap solutions, which would be the catalyst for the bursting of the AI bubble. Jim Covello is joined by a few other notable Wall Street figures as well. For instance, David Bahnsen, the Chief Investment Officer of Bahnsen Group, also believes that investing in large tech stocks such as Nvidia will lead to disastrous investment returns in the future.

Reasons For Pessimism

Many leading AI stocks are trading at substantially high valuation levels, which gives reason to remain cautious. For example, Nvidia is currently valued at a P/E of 70, significantly above the Information Technology sector median P/E of just 32. This above-average valuation makes Nvidia susceptible to any negative development. The substantial investments committed to AI by big tech companies also spell trouble given that some of these investments may not yield positive returns in the long run. According to Barclays, tech companies have incurred approximately $167 billion in AI spending since the launch of ChatGPT almost two years ago, and failure to profit from these investments may lead to a decline in profitability in the future. Another risk stems from the fact that most of the promising use cases of AI technology are yet to be proven in the real world. Failure to achieve the expected results from these technologies may deteriorate investor sentiment toward AI stocks in the future.

... On The Other Hand

On the flip side, several arguments can be made in favor of AI stocks. For instance, despite trading at high valuations, AI companies are seeing notable revenue growth too. Nvidia is a classic example. From just $10.9 billion in 2020, Nvidia’s revenue increased to over $60 billion in 2023, which highlights the exponential growth the company has seen since the emergence of AI technology. This profitability boom separates the AI stock market rally from that of the dotcom bubble in 2001 where thinly profitable internet stocks with no meaningful revenue growth crashed after reaching unsustainable highs.

The positive economic impact expected from the broad adoption of AI also separates the AI stock rally from previous bubbles. AI can be used in the medical field to diagnose diseases and treat them effectively, the technology can revolutionize the way underprivileged students approach education, especially in regions where there is a significant lack of resources, and AI can also be used for precision farming to enhance agricultural productivity. The potential for these positive outcomes has incentivized companies and governments to invest in AI aggressively, which may boost the revenue of companies that support the adoption of this technology such as Nvidia, Microsoft Corporation (MSFT), and Alphabet Inc. (GOOG).

Both Dilantha DeSilva and Stocks.News have positions in MSFT. Stocks.News also has positions in GOOG.