Those who do not learn from history are doomed to repeat it, or so they say. Wise words and wise advice for investors. When the market seems to be hitting new all-time highs every week and there is tremendous enthusiasm on Wall Street and in the world of amateur investors, it can seem as if stock prices are going up forever and valuations are irrelevant. But in such cases, investors should be cautious.
The most recent example is the tech bubble of 2021. The economy was full of stimulus, interest rates were near zero, and stocks were trading at ridiculous valuations. For example, the edge computing company Cloudflare‘S (NYSE:NET) The stock valuation reached an astonishing 114 times sales, as shown below.
As you can see, it now trades at a more reasonable price-to-sales ratio of 19 and the stock is 62% below its all-time high. And guess what? Cloudflare is a great company, but it wasn’t a good investment at that high valuation.
In the current artificial intelligence (AI) boom, there are undervalued and overvalued stocks. Here are my take on three popular companies.
Amazon stock appears to have excellent investment potential.
Amazon‘S (NASDAQ:AMZN) The stock fell after the release of the second quarter earnings report as revenue growth was disappointing. Total revenue rose 10% to $148 billion, and third quarter guidance called for only an 8% to 11% increase. Product revenue was the anchor, rising just 4% in the quarter.
Consumer spending is declining as planned across the economy. Interest rates remain above 5% while the Federal Reserve reins in inflation. Some investors are concerned about a potential recession and a further decline in consumer spending. However, the Federal Reserve is widely expected to cut interest rates soon. In addition, most of Amazon’s profits come from Amazon Web Services (AWS), not product sales.
AWS is the straw that broke the camel’s back for Amazon, and growth is back. As shown below, AWS’s revenue growth has accelerated for four consecutive quarters after a weak year in 2023.
Cloud data providers like AWS will continue to see growth due to the need for AI data and continued migration to the cloud.
Amazon stock is undervalued by several metrics. My preferred metric is price-to-earnings from operations. In other words, what am I paying for the cash flow generated by the company’s core business? The stock hasn’t been this cheap by this metric in more than 10 years, as shown below, and is 50% below the 10-year average.
Given AWS’s accelerating growth, strong tailwinds in AI, and the stock’s historical undervaluation, Amazon now appears to offer excellent long-term value.
Two great companies seem too expensive
AI has enormous advantages and Arm Holdings (NASDAQ:ARM) And Palantir (NYSE:PLTR) drive them up.
Arm Holdings designs the “architecture” for semiconductors sold by the biggest names in technology. More than 99% of smartphones use its technology, and the company said it has sold 287 billion Arm-based chips to date. It expects to ship another 100 billion by the end of fiscal 2026. The company earns royalties and licensing fees from companies that use its designs. It will benefit hugely from the rise of AI, which requires powerful chips.
Revenue rose 39% to $939 million last quarter, and Arm expects revenue of $3.8 billion to $4.1 billion this fiscal year, with diluted earnings per share of $1.45 to $1.65. These are excellent results, but they still do not justify the current valuation. Arm trades at 40 times sales and 85 times expected earnings.
That’s far too expensive for me. However, I would be happy to buy the stock back if its price falls below 25 times sales again.
Palantir helps companies harness massive amounts of data so their customers can visualize, analyze, and use it to make better decisions. The company is well established with government customers, especially defense departments, and is also expanding into the private sector. Thanks to its new artificial intelligence platform (AIP), the number of commercial customers increased 83% year-on-year to 295 last quarter. Revenue increased 27% to $678 million, and Palantir is now consistently profitable.
However, just like Arm, the valuation doesn’t leave much room for error. Palantir’s price-to-sales ratio of 31 is the highest since the 2021 tech bubble and is 60% above its historical average, as shown below.
Given the excellent results and AI tailwinds, the stock deserves a higher price, but not to this extent. Patient investors will likely have a better entry point.
The enthusiasm for AI is real, and so is the significant tailwind for Amazon, Arm and Palantir. But valuations remain key in the long term. Of this trio of tech titans, only Amazon is attractive at the moment.
Should you invest $1,000 in Amazon now?
Before you buy Amazon stock, consider the following:
The Motley Fool Stock Advisor The analyst team has just published what they believe to be The 10 best stocks for investors to buy now… and Amazon wasn’t among them. The 10 stocks that made the cut could deliver huge returns in the years to come.
Consider when NVIDIA created this list on April 15, 2005… if you had invested $1,000 at the time of our recommendation, You would have $758,227!*
Stock Advisor offers investors an easy-to-understand plan for success, including instructions on how to build a portfolio, regular updates from analysts, and two new stock recommendations per month. The Stock Advisor Service has more than quadrupled the return of the S&P 500 since 2002*.
View the 10 stocks »
*Stock Advisor returns as of August 22, 2024
John Mackey, former CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Bradley Guichard holds positions in Amazon. The Motley Fool holds positions in and recommends Amazon, Cloudflare, and Palantir Technologies. The Motley Fool has a disclosure policy.
1 Artificial Intelligence (AI) Stock to Buy Now and 2 to Wait for a Decline was originally published by The Motley Fool.
