Key Points
The Nasdaq slid earlier in the year amid various headwinds, but appetite for growth stocks has returned in recent days.
AI stocks drove stock market gains over the past three years.
The Nasdaq had a particularly difficult time in recent months -- some of the world's biggest artificial intelligence (AI) stocks weigh heavily in the index, and investors were rotating out of those players. The war in Iran created a general environment of uncertainty, and uncertainty often prompts investors to favor stocks seen as safe havens, from dividend players to pharmaceutical giants. And investors also worried that some tech companies were overspending on AI and that rewards would fall short of expectations. All of this dragged down the Nasdaq.
But, in recent days, sentiment improved. An extended ceasefire in Iran spurred hopes that peace may be around the corner, and ongoing evidence of high demand for AI buoyed investor confidence about the technology's long-term revenue potential. As a result, the Nasdaq surged back to all-time highs. Is now the best time to buy AI growth stocks? Let's find out.
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A history of AI momentum
First, it's important to note that this AI momentum isn't new. Prior to the turbulence in recent weeks, AI stocks had been roaring higher for three years amid excitement about the technology's potential to revolutionize how many things are done, saving companies time and money -- and boosting innovation.
You may recognize the names of some of the biggest winners, from AI chip leader Nvidia to AI software company Palantir Technologies. They registered gains in the triple and even quadruple digits over just a few years. These performances also lifted valuations of AI stocks, with many finding themselves at record levels. For example, Palantir reached beyond 240x forward earnings estimates.
And the stock market overall has reached historically expensive levels, as we can see through the S&P 500 Shiller CAPE ratio, an inflation-adjusted measure of stock price in relation to earnings per share. The Shiller CAPE earlier this year reached a level it's only surpassed once before -- during the dot-com bubble back in 2000.
S&P 500 Shiller CAPE Ratio data by YCharts
Meanwhile, recent market turbulence helped bring down the valuations of many AI stocks. For example, Nvidia is trading close to its cheapest level in a year.
NVDA PE Ratio (Forward) data by YCharts
Many stocks are cheap
Now, let's consider our question: With the Nasdaq surging to record levels, is it time to buy AI stocks? The one positive result of the market turmoil is the fact that it made many high-quality stocks -- including AI players -- a lot cheaper. And even though the Nasdaq has rebounded, many of these deals still exist. So, with the index on the rise, you can find plenty of bargain or at least reasonable prices on a variety of AI stocks. And that's one point to support the idea of investing right now.
But now you might ask: Is this just a brief recovery, or is the AI growth story set to last? Two pieces of evidence help us answer the question. First, demand from AI customers continues to explode higher. Taiwan Semiconductor Manufacturing, the leading chip manufacturer, confirmed this recently during its earnings call. TSMC offers a clear picture here since it's in touch with cloud service providers that offer compute to the final customer.
And second, we're at a point where companies are starting to apply AI to real-world problems, and AI hasn't even been fully utilized for future innovations, such as humanoid robots. This suggests that AI could deliver more growth in the years to come, making the AI growth story one that is set to last.
So right now, investors have a fantastic opportunity. Companies are offering us clues about the future of AI, and it looks very bright. AI stocks are showing renewed momentum, an element that may encourage investors to return to this high-potential area. But these stocks haven't gained enough to bring them to outrageously high valuations. All of this means that right now, with confidence that the AI growth story will march on, investors may buy AI stocks -- and in many cases, at a bargain price.
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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia, Palantir Technologies, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
