Artificial intelligence (AI) may be all the rage on Wall Street, but not all two AI stocks are created equal.
Over the past three decades, there have been many next big trends that dangled huge profits in front of investors. However, of all these innovations, technologies, and trends, none have captured investor attention more than artificial intelligence (AI).
What’s special about the rise of AI is that AI software and systems have the potential to learn and evolve without human intervention. Because AI-powered software and systems can become more proficient at tasks and learn and evolve new skills, this technology is finding practical application in most sectors and industries around the world.
Image source: Getty Images.
The current addressable market size for AI comes from a PwC report published last year: Sizing the Prize, in which PwC analysts predict that consumer benefits combined with productivity gains could add $15.7 trillion to global gross domestic product (GDP) by 2030. That means there will be a lot of winners in the AI space.
But not all AI stocks are created equal. Some are perfectly priced after a monumental surge (ahem, Nvidia), while others remain shockingly cheap. Here are some historically cheap AI stocks that are a good time to buy in September, plus another high-flying artificial intelligence stock to avoid like the plague (no, not Nvidia!).
This Historically Cheap AI Stock Could Be a Great Buy in September
Despite the visible enthusiasm around artificial intelligence, China-based Baidu (Bidu 0.73%) is the only AI stock you can buy at a historically cheap valuation.
Baidu’s stock price is relatively cheap compared to other fast-growing AI stocks for two reasons. First, China’s economic recovery after three years of strict COVID-19 lockdowns faces many obstacles. Unwinding supply chain disruptions caused by unpredictable COVID-19 countermeasures has caused China’s once robust economy to slow.
Another problem for Baidu is the unpredictability of Chinese regulation, where potential fines or operating restrictions tend to reduce the premium investors are willing to pay for U.S.-listed Chinese stocks.
While these are all specific concerns, they do not change Baidu’s long-term growth trajectory or drivers — and more importantly, they appear to be priced into Baidu’s valuation.
Before we dig into Baidu’s AI-driven business, it’s important to note that, like Google parent Alphabet, Baidu’s core business unit is its search engine. In China, the world’s second-largest economy by GDP in August, Baidu accounted for roughly 53% of internet search activity, according to data from GlobalStats. With few exceptions, the company’s search engine has maintained a monthly share of between 50% and 85% in China for the past decade.
Baidu’s search engine is the clear first choice for companies looking to reach consumers, and as China’s economy stabilises, this fundamental business unit is sure to see improved advertising pricing power and operating cash flow.
When it comes to AI, Baidu has a presence in multiple areas. For example, it is one of the largest cloud infrastructure service platforms in China. Enterprise spending on cloud services is still in its infancy in the world’s second-largest economy. Baidu’s AI cloud growth could help the company maintain double-digit sales growth in its non-online marketing segment.
Baidu is also the parent company of Apollo Go, the world’s leading autonomous ride-hailing service, which has completed more than 7 million autonomous rides since its launch as of July 28, 2024. Self-driving capabilities are not possible without AI.
Additionally, Baidu developed its own chatbot, known as Ernie Bot. Between mid-April and the end of June, Ernie Bot saw its user base skyrocket from 200 million to 300 million, with the hope of converting some of these free users and businesses into paying subscribers to Baidu’s Large Language Model (LLM) service.
BIDU Cash and Short Term Investments (Quarterly) data from YCharts.
The final piece of Baidu’s puzzle is its treasure trove of cash. Taking into account cash, cash equivalents, short-term investments, and roughly $1.6 billion in restricted cash, and subtracting various short-term and long-term loans and convertible senior notes, Baidu has roughly $12 billion in net cash, which is equivalent to more than 40% of its current market cap.
A forward price-to-earnings multiple of 7.4 makes it a great bargain for a well-funded company with a bright future in AI.
Image source: Getty Images.
These “AI stocks” should be avoided at all costs
At the other end of the spectrum, there are the outrageously overpriced companies that have spent the past year touting their connection to AI but ultimately derive little of their value from it. The stock to avoid like the plague in September is none other than MicroStrategy. (MSTR -0.98%).
MicroStrategy has been operating its enterprise analytics software division for decades, and in October 2023, the company launched MicroStrategy AI, which leverages generative AI and LLM to help businesses with tools such as virtual chat agents and predictive forecasting.
Unfortunately, MicroStrategy’s software division has been stagnant or in decline for much of the past decade, and while recent double-digit growth in subscription services revenue is a positive sign, the company’s sales are down 14.4% over the past decade (through 2023).
MicroStrategy’s market capitalization of approximately $24 billion is almost entirely derived from Bitcoin. (BTC 0.27%) The company holds 226,500 Bitcoin as of July 31, 2024, which represents more than 1% of the 21 million tokens mined. It is the largest company holding the world’s largest cryptocurrency by market capitalization.
Even if you are optimistic about cryptocurrencies, there are some glaring flaws in MicroStrategy’s valuation and operating strategy.
First, investors are paying a tremendous premium to own MicroStrategy shares, even though they can buy Bitcoin exchange-traded funds (ETFs) or the cryptocurrency directly. With Bitcoin’s current token price (as of this writing) of $56,665, MicroStrategy’s digital asset portfolio is worth about $12.8 billion. If we apply a generous $1 billion valuation to the company’s shrinking software division, the current premium on Bitcoin assets is about $10 billion.
In other words, investors are paying roughly $98,000 per Bitcoin to own shares in MicroStrategy, compared to just $56,665 if they bought directly on a cryptocurrency exchange. This premium simply doesn’t make sense.
Second, CEO Michael Saylor has been financing his company’s bitcoin purchases through various convertible bond offerings. This strategy works great when bitcoin is in a bull market, but it’s a terrible idea when the world’s largest cryptocurrency by market cap enters a long bear market, something the company has been through several times since its founding. MicroStrategy’s software business barely generates enough operating cash flow to pay off its debt.
A third issue to consider is that Saylor has tied his company’s future to what is admittedly not a unique digital token and blockchain. Bitcoin’s first-mover advantage has largely faded, with numerous blockchain-based payment networks outperforming it in terms of settlement times and transaction costs.
I’m no fan of Bitcoin, so MicroStrategy is a stock to avoid like the plague in September, but even if you’re optimistic about the world’s largest cryptocurrency, buying shares in a heavily indebted, loss-making software company and paying a 73% premium compared to Bitcoin’s current price is probably the worst way to show your support.
