1 AI action to buy right now and 2 to wait for a pullback

Those who don’t learn from history are doomed to repeat it, or so they say. Wise words and sage advice for investors. When the market seems to be hitting new all-time highs every week and there is tremendous excitement on Wall Street and in the world of amateur investors, it can feel like stocks will go up forever and valuations are irrelevant. But now investors should be cautious.

The most recent example is the tech bubble of 2021. The economy was full of economic stimulus, interest rates were close to zero, and stocks were trading at ridiculous valuations. For example, an edge-computing company Cloudflarehis (NYSE: NET) The stock’s valuation has reached a whopping 114 times sales, as shown below.

As you can see, it’s now trading at a more reasonable 19 times sales, and the stock is down 62% from its all-time high. And guess what? Cloudflare is a great company, but it wasn’t a great investment at that high valuation.

There are undervalued and overvalued stocks in the current artificial intelligence (AI) boom. Here is where I deal with three popular companies.

Amazon stock looks like a tremendous value.

Amazonhis (NASDAQ: AMZN) Shares fell after the second-quarter earnings report as top-line growth disappointed. Total sales rose 10% to $148 billion, and Q3 guidance calls for growth of just 8% to 11%. Product sales were the anchor, growing just 4% in the quarter.

Consumer spending slows economy-wide by design. Interest rates remain above 5% as the Federal Reserve controls inflation. Some investors are worried about a potential recession and a further decline in consumer spending. However, the Federal Reserve is expected to cut rates soon. Additionally, most of Amazon’s profits come from Amazon Web Services (AWS), not product sales.

AWS is the straw that stirs the drink for Amazon, and growth is back. As shown below, AWS sales growth accelerated for four consecutive quarters after a year of decline in 2023.

Cloud data providers like AWS will continue to see growth driven by AI data needs and continued migration to the cloud.

Amazon stock is undervalued on several measures. My preferred metric is the cash price from operations. In other words, what are they paying for the cash generated by the core business operations? The stock hasn’t been this cheap by this metric in more than 10 years, as shown below, and it’s 50% off its 10-year average.

Given the accelerated growth of AWS, the headwinds of AI, and the stock’s historical undervaluation, Amazon now looks like a great long-term value.

The story continues

Two great companies that look overpriced

AI has huge tails and Arm holds (NASDAQ: ARM) and Palantir (NYSE: PLTR) lead them to high ratings.

Arm Holdings designs the “architecture” for semiconductors sold by the biggest names in technology. More than 99 percent of smartphones use its technology, and the company reported that 287 billion Arm-based chips have been sold to date. Another 100 billion are expected to ship by the end of fiscal 2026. The company earns revenue from royalties and licensing fees from companies that use its designs. It will benefit enormously from the increase in AI, which requires high-powered chips.

Revenue rose 39% last quarter to $939 million, and Arm expects sales of $3.8 billion to $4.1 billion this fiscal year, with earnings per share diluted $1.45 to $1.65. These are excellent results, but still do not justify the current rating. Arm trades at nearly 40 times sales and 85 times forward earnings.

It is way too expensive for me; however, I would like to buy back this stock if it were to pull back below 25x sales.

Palantir helps companies harness massive amounts of data so their customers can visualize, analyze and use their data to make better decisions. It has a strong position with government customers, mainly defense departments, and is proliferating in the private sector. Its new artificial intelligence platform (AIP) helped grow the number of commercial customers by 83% over last year to 295. Revenues rose 27% to $678 million, and Palantir is now consistently profitable.

However, like Arm, the rating doesn’t allow much room for error. Palantir’s price-to-sales ratio of 31 is the highest since the tech bubble of 2021 and is 60% above its historical average, as shown below.

The action deserves a premium price because of its outstanding results and AI tailwind, but not to this extent. Patient investors will likely have a better entry point.

The AI ​​fervor is real, and so are significant tailwinds for Amazon, Arm and Palantir. However, valuations are still crucial in the long run. Among this trio of tech titans, only Amazon is attractive right now.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Bradley Guichard has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Cloudflare, and Palantir Technologies. The Motley Fool has a disclosure policy.

1 artificial intelligence (AI) stock to buy right now and 2 to wait for a pullback was originally published by The Motley Fool