Artificial intelligence (AI) may be all the rage on Wall Street, but no two AI stocks are created equally.
Over the last three decades, there’s been no shortage of next-big-thing trends that have dangled big dollar signs in front of investors. However, none of these innovations, technologies, or trends have captivated the attention of investors quite like artificial intelligence (AI).
What makes the rise of AI so special is the potential for AI software and systems to learn and evolve without human intervention. The ability for AI-fueled software and systems to become more proficient at their tasks, as well as evolve to learn new skills, gives this technology utility in most sectors and industries around the globe.
Image source: Getty Images.
The current pie-in-the-sky addressable market figure for AI comes from a PwC report issued last year. According to Sizing the Prize, PwC’s analysts see a combination of consumption-side benefits and productivity gains leading to a $15.7 trillion boost to worldwide gross domestic product (GDP) by 2030. This implies there will be numerous winners in the AI space.
But not all AI stocks are created equally. While some are priced for perfection (ahem, Nvidia) after monumental run-ups, others remain jaw-droppingly cheap. What follows is one historically inexpensive AI stock that’s ripe for the picking in September, as well as another high-flying artificial intelligence stock (no, not Nvidia!) that’s worth avoiding like the plague.
This historically cheap AI stock can be bought hand over fist in September
Despite all of the tangible euphoria surrounding artificial intelligence, China-based Baidu (BIDU -1.24%) is the one AI stock that can still be scooped up at a historically cheap valuation.
There are two reasons shares of Baidu are so relatively inexpensive, compared to other rapidly growing AI stocks. To start with, China’s economic recovery following three years of stringent COVID-19 lockdowns has hit numerous speed bumps. Untangling the supply chain kinks caused by unpredictable COVID-19 mitigation measures has caused China’s once robust economy to sputter.
The other issue for Baidu is China’s unpredictable regulatory presence. The potential for fines and/or operating restrictions tends to reduce the premium that investors are willing to pay for China-based stocks listed in the U.S.
While these are both tangible concerns, they don’t alter Baidu’s long-term growth trajectory or its catalysts. More importantly, these worries appear to be baked into Baidu’s valuation.
Before diving into Baidu’s AI-driven operations, it’s important to note that, similar to Google parent Alphabet, Baidu’s foundational operating segment is its search engine. Data from GlobalStats shows that Baidu accounted for a nearly 53% share of internet search activity in the world’s No. 2 economy by GDP in August. With few exceptions, the company’s search engine has held a 50% to 85% monthly share in China over the trailing decade.
Baidu’s search engine is the clear top choice by businesses wanting to get their messages in front of consumers. When China’s economy does find its footing, it’s a good bet that ad-pricing power and operating cash flow will pick up for this foundational operating segment.
When it comes to AI, Baidu has its fingers in multiple cookie jars. For example, it’s one of China’s largest cloud infrastructure service platforms. Enterprise spending on cloud services is arguably still in its infancy in the world’s No. 2 economy. Growth in Baidu’s AI Cloud can help sustain double-digit sales growth for its non-online marketing segment.
Baidu is also the parent of the world’s leading autonomous ride-hailing service, Apollo Go. As of July 28, 2024, the cumulative number of driverless rides since inception had surpassed 7 million. Autonomous driving capabilities aren’t possible without AI.
Furthermore, Baidu developed its own chatbot, known as Ernie Bot. Between mid-April and the end of June, Ernie Bot’s user count surged from 200 million to 300 million. The hope is to convert some of these free users and businesses into paying subscribers for Baidu’s large language model (LLM) services.
BIDU Cash and Short Term Investments (Quarterly) data by YCharts.
The final piece of the puzzle for Baidu is its treasure chest of cash. Taking into account its cash, cash equivalents, short-term investments, and roughly $1.6 billion in restricted cash, and subtracting its various short- and long-term loans and convertible senior notes, Baidu is sitting on about $12 billion in net cash, representing more than 40% of its current market cap.
A forward price-to-earnings ratio of 7.4 for a cash-rich company that has a bright future in the AI arena is a screaming bargain.
Image source: Getty Images.
This “AI stock” should be avoided at all costs
On the other end of the spectrum is an outrageously expensive company that’s been touting its AI ties over the last year, but ultimately derives little of its valuation from artificial intelligence. The stock to avoid like the plague in September is none other than MicroStrategy (MSTR 2.07%).
MicroStrategy has operated an enterprise analytics software segment for decades. In October 2023, the company launched MicroStrategy AI, which leans on generative AI and LLMs to assist businesses with virtual chat agents and predictive forecasting, among other tools.
Unfortunately, MicroStrategy’s software segment has been stuck in neutral or reverse for much of the past decade. Although recent double-digit growth in subscription-services revenue has been a bright spot, the company’s sales are down 14.4% over the trailing decade (through 2023).
Almost the entirety of MicroStrategy’s nearly $24 billion market cap can be traced to its Bitcoin (BTC 0.39%) holdings. As of July 31, 2024, it held 226,500 Bitcoin, which represents more than 1% of the 21 million tokens that’ll ever be mined. It’s the largest corporate holder of the world’s biggest cryptocurrency by market value.
Even if you’re a crypto optimist, there are some glaring flaws with MicroStrategy’s valuation and operating strategy.
For starters, investors are paying a mind-boggling premium to own shares of MicroStrategy when they could just purchase a Bitcoin exchange-traded fund (ETF) or the cryptocurrency directly. Based on a current token price (as of this writing) of $56,665 for Bitcoin, MicroStrategy’s digital asset portfolio is worth about $12.8 billion. If we generously place a $1 billion valuation on the company’s shrinking software segment, we arrive at a current premium of around $10 billion for its Bitcoin assets.
In other words, investors are paying almost $98,000 per Bitcoin to own MicroStrategy’s stock when they could be paying $56,665 by purchasing it directly on a crypto exchange. This premium makes no sense whatsoever.
Secondly, CEO Michael Saylor has been financing his company’s purchases of Bitcoin through a variety of convertible-debt offerings. While this strategy works wonders when Bitcoin is in a bull market, it’s an egregiously bad idea when the world’s largest cryptocurrency by market cap enters an extended bear market, which it’s done on a handful of occasions since its inception. MicroStrategy’s software business doesn’t generate nearly enough positive operating cash flow to service its debt.
The third issue to consider is that Saylor has tethered his company’s future to a digital token and blockchain that, to be blunt, aren’t special. Bitcoin’s first-mover advantages have largely faded, with numerous blockchain-based payment networks outperforming it based on settlement time and transaction cost.
I’m not a fan of Bitcoin, which makes MicroStrategy an easy stock to avoid like the plague in September. But even if you’re optimistic about the world’s largest cryptocurrency, buying a stake in a heavily indebted, money-losing software company and paying a 73% premium for that stake, compared to the current price of Bitcoin, is probably the worst possible way to show your support.
Add Comment