As even the most casual observers know by now, artificial intelligence has been a boon to stocks. Numerous companies in this field have seen their shares register huge gains — often by triple-digit percentages.
The problem with this growth is that it can leave investors wondering whether it is too late to buy. AI could drive the cutting edge of technology for years to come, but each stock still has to be evaluated individually. These two Motley Fool contributors have ideas about Microsoft (NASDAQ: MSFT) and Nvidia (NASDAQ: NVDA), two key stocks to watch.
AI alone can’t justify this price tag
Justin Pope (Microsoft): Microsoft continues to reward shareholders with market-beating returns, seemingly to no end. The stock is up 37% during the past year, nudging past the S&P 500‘s 34% gain.
There’s a reason for the run-up: Artificial intelligence (AI) could trigger years of growth in the technology sector, and investors will be hard-pressed to find a company that is more plugged into AI than Microsoft. The company’s Azure cloud platform was already the world’s second-leading cloud provider and is now riding AI tailwinds higher.
That said, investors should start to sweat the stock’s valuation a bit. AI is new and exciting and could help Microsoft cultivate growth, but this is a $3.2 trillion company. A business can become so big that it gets harder to grow and justify a higher valuation. Is Microsoft approaching this point?
Analysts estimate that Microsoft’s earnings will rise by an average of 13% annually for the next three to five years. Frankly, it’s remarkable for a company of its size to increase earnings at a double-digit percentage rate.
That said, it’s getting harder to justify the increasingly higher valuation. After a year of gains, Microsoft trades at almost 33 times 2024 earnings estimates.
That gives it a price/earnings-to-growth ratio (PEG) of almost 2.4. I generally buy stocks with PEG ratios of about 2.0 or less. Even if you argue that Microsoft deserves a premium for its high-quality business, you’re starting to pay a high price for its expected growth. There is a risk of a steep price retreat if something happens and growth falls short.
Microsoft isn’t so expensive that you should rush to dump the shares, but it’s hard to make the case to continue buying after the strong year the stock has had.
Tread carefully with this market leader
Will Healy (Nvidia): Nvidia surged 193% during the past year due to its crucial role in the AI boom. Since investors discovered that its AI chips powered the ChatGPT AI platform, both demand for its AI chips and its stock price have spiked.
Much of this gain can be traced to its dominance in AI chips. Although AMD, Qualcomm, and Intel have scrambled to bring AI chips to market, they have not matched Nvidia’s technical prowess. Moreover, it plans to release its next-generation Blackwell graphic processing unit (GPU) sometime in the fourth quarter this year, so it continues to work to maintain this lead.
The financials confirm this popularity: Revenue for the first two quarters of fiscal 2025 (ended July 28) was $56 billion, a 171% increase from year-ago levels. Its net income surpassed $31 billion, a 284% increase.
Unfortunately for those who want to buy, such growth has driven valuations into the stratosphere. Although its trailing 12-month price-to-earnings ratio of 58 is unlikely to deter some investors, a 32 price-to-sales ratio is expensive no matter the performance.
And the price-to-book-value ratio of 52 is more than 10 times AMD’s multiple of 5. That leaves Nvidia with no margin for error, likely explaining why the stock fell even after the company posted impressive growth numbers for the fiscal second quarter.
And that’s the problem. Expectations and valuations are so high that the stock has to give its shareholders a near-perfect earnings report, a high bar even for Nvidia.
This is not to say that its growth story is over. With Allied Market Research estimating a compound annual growth rate of 38% for the AI chip industry through 2032, Nvidia should still grow in the long term.
However, the high valuation makes the near-term picture uncertain. Until valuations pull back significantly, you should probably refrain from adding shares.
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Justin Pope has no position in any of the stocks mentioned. Will Healy has positions in Advanced Micro Devices, Intel, and Qualcomm. The Motley Fool has positions in and recommends Advanced Micro Devices, Microsoft, Nvidia, and Qualcomm. The Motley Fool recommends Intel and recommends the following options: long January 2026 $395 calls on Microsoft, short January 2026 $405 calls on Microsoft, and short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.
Is There Still Time to Buy These 2 Artificial Intelligence (AI) Stocks That Are Up 37% and 190%? was originally published by The Motley Fool
