There's no denying that recent advances in artificial intelligence (AI) have been a secular tailwind driving the market higher since early 2023. Businesses and investors alike are keen to profit from the potential of these advanced algorithms to unleash a wave of employee productivity. Despite that potential, these changes will occur over years and decades, not weeks and months.
With that as a backdrop, semiconductor specialist Nvidia (NVDA 3.58%) slumped 3.1%, chip designer Arm Holdings (ARM -2.56%) dropped 2.9%, and memory and storage chipmaker Micron Technology (MU 2.40%) tumbled 1.4%, as of 2:40 p.m. ET on Wednesday.
A check of all the usual suspects -- financial reports, regulatory filings, and changes to analysts' price targets -- showed little in the way of news to explain the falling stocks (more on that in a bit), which suggests investors were focused on the results of one of the standard-bearers for the AI movement.
Image source: Getty Images.
When robust results are not enough
Super Micro Computer (SMCI 15.81%), also known as Supermicro, has been among the best-performing stocks of the AI revolution. The maker of high-performance servers and storage solutions -- which are key to the continued adoption of AI -- has gained more than 700% over the past year, headed into the release of its financial report. While those results were robust by almost any measure, investors wanted more, sending the stock into a tailspin.
For Supermicro's fiscal 2024 third quarter (ended March 31), the company generated revenue of $3.85 billion, which soared 200% year over year. That helped drive adjusted earnings per share (EPS) of $6.65, up 308%.
While results of that magnitude would be cause for celebration for most companies, Supermicro investors found them lacking, as analysts' consensus estimates were for revenue of $3.95 billion and EPS of $5.78.
CEO Charles Liang provided context to the results, noting that Supermicro continued to "face some supply chain challenges" and had difficulty obtaining all the components necessary to build its direct liquid-cooled (DLC) servers which run generative AI models used by cloud infrastructure providers and in data centers. Liang noted he expects the supply chain issues to ease over the next few quarters.
Still, that wasn't enough to satisfy fair-weather investors, many of whom sold off their Supermicro shares to chase the next shiny thing.
The forest for the trees
So, what does this have to do with our trio of AI stocks? In short, nothing. Investors have bid up AI-related stocks over the past year or more and have set unrealistic views about the timeline for AI adoption.
- Nvidia provides the graphics processing units (GPUs) that are instrumental in the training and use of AI systems. These GPUs have underpinned the adoption of AI and have experienced unprecedented demand.
- Arm Holdings designs the architecture upon which many of the most widely used semiconductors are based. The company earns royalties and licensing fees from companies that use its chip designs.
- Micron Technology makes flash memory and storage processors, which are necessary components of the GPUs used for AI processing, so it, too, is impacted directly by the speed at which AI is being adopted.
Of this group, the only company-specific news involved Micron -- and the news was decidedly positive. The company announced in a press release today that it's the "first to ship critical memory" used for AI. Micron said the company is "validating and shipping its high-capacity monolithic 32Gb DRAM die-based 128GB DDR5 RDIMM memory." These chips are key components in the high-performance central processing units (CPUs) used to run generative AI and machine learning in cloud computing and data centers, where much of AI is processed. This is good news, so it doesn't provide any reason for the stock to be languishing today.
On the subject of valuation, beauty is in the eye of the beholder, or so the saying goes. None of these stocks is particularly cheap when measured using the most widely used valuation metrics.
Micron, Arm Holdings, and Nvidia are currently selling for 160 times, 64 times, and 33 times forward earnings, respectively -- so Nvidia is the least expensive of the three. On a price-to-sales basis, Arm, Nvidia, and Micron clock in at 21 times, 15 times, and 3 times forward sales, respectively, making Micron the most attractively priced. However, neither of these metrics accounts for current growth prospects.
When measured using a forward price/earnings-to-growth (PEG) ratio -- which factors in a company's current growth rate -- Nvidia, Arm Holdings, and Micron all boast a multiple of less than 1, the standard for an undervalued stock -- which makes them all buys in my book.
It's still early days in the adoption of AI, so there's a long runway ahead. However, as today's market reaction illustrates, investing in AI isn't for the faint of heart, and the significant volatility is expected to continue, so investors should take those factors into consideration.
