Here’s how the Fed’s big rate cut could affect these two artificial intelligence (AI) stocks

Go big or go home. That seemed to be the Federal Reserve’s mantra as it cut its benchmark rate by 0.5%, the most since the pandemic began and above the 0.25% many had anticipated. Rate cuts are expected to continue this year and into 2025. This has major implications for the economy and stocks. Lower rates give companies easier access to capital and generally increase the value of stocks. When Wall Street evaluates companies’ future earnings (called discounted cash flow analysis), lower rates boost valuations.

All of this has implications for artificial intelligence (AI) companies. Here are some examples.

Is SoundHound AI now a purchase?

It’s hard to overstate the positive effect low rates can have on small, cash-strapped companies like SoundHound AI (SOUND 0.41%). SoundHound has financed its recent growth primarily by issuing stock, which dilutes existing shareholders. As shown below, the number of shares has exploded in the past two years.

SOUN Diluted Average Shares Outstanding (Quarterly) by YCharts

The stock conversion and sale allowed SoundHound to build a $200 million war chest as of the second quarter; however, as you can see below, the company is burning through a lot of cash from operations.

SOUN Cash and Equivalents Data (Quarterly) by YCharts

Cash burn is normal for a small, fast-growing company, so easier access to capital through lower interest rates is crucial.

Many fast-food and fast-casual restaurants are turning to AI-based conversational and voice recognition software to automate ordering. Auto companies are also implementing cutting-edge conversational intelligence in their vehicles, and many brands such as White Castle, Jersey Mike’s, Hyundai Motorand Honda engineuse the SoundHound software.

SoundHound reported revenue of $13.5 million in Q2, a 54% gain from a year earlier. The company has forecast revenue of $80 million for 2024 and has a market cap of $1.8 billion, or 24 times estimated sales. The stock is not cheap, considering that SoundHound is unprofitable; however, the market potential is gigantic. SoundHound puts its addressable market at over $140 billion and expects sales to reach $150 million by 2025. This huge growth potential is challenging many investors, making SoundHound a buy for speculative investors.

Is Palantir stock overvalued?

Many companies and defense departments are turning to Palantir (PLTR -0.05%) when considering tabulating, visualizing and using data to make informed decisions. Palantir’s latest product is its new AI platform, AIP. It uses generative AI to help customers optimize decision-making with a conversational interface. Palantir relies heavily on government contracts, but is focused on expanding its commercial business. Lower interest rates can help.

Lower rates can incentivize companies to invest in products from companies like Palantir, because credit is less expensive and low rates accelerate economic activity. This may add to Palantir’s already robust commercial growth. In Q2, trade growth was stellar, while US trade growth was even better, as you can see below.

Image source: Palantir.

Rate cuts are another tailwind here.

Palantir has silenced doubters in other ways recently, notably by moving to profitability. It achieved sales of $678 million last quarter and was profitable for the seventh consecutive quarter with net income of $134 million (its highest ever). Those results and excitement for AI pushed the stock near all-time highs. But did it go too far?

The stock is trading at 36 times sales, which, as shown below, is well above its historical average and close to its 2021 bubble valuation.

PLTR PS report data by YCharts

The valuation drops to 31 times sales on a forward basis, but that’s still very rich. Palantir is a great company with a great future (and rate cuts should help), but the valuation is too high for my money right now.