If you think artificial intelligence (AI) stocks are starting to look frothy, you’re not the only one.
There’s plenty of commentary online about a bubble forming in AI stocks, and it’s not surprising investors would think that. Arm Holdings (NASDAQ: ARM), a maker of CPU chips prized for their efficiency in AI applications, jumped as much as 42% on Monday following a 48% gain last Thursday on a strong earnings report.
Super Micro Computer (NASDAQ: SMCI), a maker of servers and storage equipment that work well for running AI models, is up 169% year to date, and shares of Nvidia (NASDAQ: NVDA), the flagship for the generative AI revolution, are up 46% this year after more than tripling last year.
There’s certainly some evidence that a bubble — an irrational surge in the price of an asset that eventually leads to a crash — is forming in AI stocks, as some of the gains in some of these stocks have been divorced from any meaningful change in fundamentals.
In other words, there’s a lot of hype, but that also means opportunity for investors, as volatility represents an opportunity to make money. If you think the rapid surge in AI stock prices is a warning sign for investors, you might want to consider the advice of George Soros, the billionaire investor and chairman of Soros Fund Management who is one of the most successful investors ever. By some accounts, his Quantum fund, with $39.6 billion, was the most successful hedge fund in history. Among other things, Soros is known for making $1 billion in a single day by shorting the British pound in 1992.
George Soros’ approach to stock market bubbles
Back in 2009, Soros famously said, “When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.”
Soros has also said that there’s a “two-way reflexive connection between perception and reality which can give rise to initially self-reinforcing but eventually self-defeating boom-bust processes, or bubbles.” That explains much of the psychology that is driving AI stocks higher. These companies are delivering strong results and benefiting from the AI boom, but investors are also attracted to a momentum rally, believing that these stocks will continue to go up.
Soros’ approach has made him aggressive when he believes he’s right. As fellow billionaire investor Stanley Druckenmiller said, “As far as Soros is concerned, when you’re right on something, you can’t own enough.”
But if there is an AI bubble, Soros doesn’t seem to be following his own advice, at least as of Sept. 30 when his fund’s holdings were last reported. The Soros Fund bought 17.4 million shares of Arm in the third quarter but sold all of its Nvidia and Microsoft shares, dumping 10,000 shares of each, a sign that it may believe that gains in those stocks were exhausted. The fund also bought puts on the Invesco QQQ Trust, which tracks the Nasdaq-100, implying a bet on the top tech stocks falling, though that may have just been for hedging reasons.
Is there an AI stock bubble?
It’s easy to spot the sudden gains in stocks like Nvidia and Supermicro and conclude that an asset bubble is forming, but the results from these stocks indicate that these gains aren’t undeserved. Nvidia, for example, reported that revenue more than tripled in its third-quarter earnings report, and profits jumped by 12 times. It’s clear from those numbers that Nvidia’s business is surging along with the stock. In fact, the stock’s price-to-earnings valuation has come down over the last year as earnings growth has outpaced the stock price’s growth.
It’s also clear that Wall Street analysts have underestimated demand for essential AI infrastructure like Nvidia’s chips as Nvidia has regularly soared past Wall Street estimates. Similarly, Supermicro stock has soared since its preliminary earnings report in January was well ahead of the analyst consensus as well. The recent surge in Arm shares has also come as emerging AI demand makes it likely that analysts are significantly underestimating future earnings.
AI stock investors should be wary of a bubble forming and should keep an eye on these stocks and others, making sure that the results from the businesses justify the gains, but it also seems that at this stage, momentum in the AI hardware sector is still building. In that case, investors may want to take Soros’ advice and ride the bubble, as it’s likely to go higher.
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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Super Micro Computer. The Motley Fool has a disclosure policy.
Worried About an Artificial Intelligence (AI) Stock Bubble? Consider This Billionaire Investor’s Advice. was originally published by The Motley Fool
