Technological developments in artificial intelligence (AI) might be the most exciting investment theme of the decade. Astronomic growth in many AI shares indicates that they’ve recently been among the most popular stocks to buy.
Yet soaring share prices are fuelling fears of a bubble. Based on traditional valuation metrics, many stocks in the sector look rather expensive, suggesting there’s good reason to be cautious.
Nevertheless, I think these AI stocks still represent good value. Here’s why investors should consider buying them.
Alphabet
First on my list is US tech titan Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL), the parent company of Google.
Among the ‘Magnificent Seven’ stocks, Alphabet has the lowest price-to-earnings (P/E) ratio at 28.4. That’s in stark contrast to semiconductor supremo Nvidia, which trades at a multiple of 75.6.
This could be an attractive entry point provided Alphabet can capitalise on AI’s potential to revolutionise online search. After all, the company claims a 90%-plus market share.
Encouragingly, Alphabet’s making rapid progress in this area. From AI-powered search tools to tensor processing units and its flagship AI model, Gemini, the business is on the cusp of a significant transformation.
Granted, the pace of technological change leaves the group vulnerable to competition risks from the likes of Microsoft. Moreover, Alphabet’s path to monetising its AI product suite is still unclear given its current dependency on advertising revenues.
That said, the company’s already a major player in the AI arms race and will likely remain so.
Kainos Group
Closer to home, Belfast-based Kainos Group (LSE:KNOS) is an IT stock that helps government and commercial customers digitise their operations.
The FTSE 250 company might not have pockets as deep as Alphabet, but a recent £10m investment in generative AI shows it believes the technology can enhance its business across all divisions.
In fact, the company already makes use of generative AI in more than 30% of its projects. Although challenges exist around the quality of datasets, Kainos Group aims to train more than 1,000 employees in AI tooling and co-pilots.
In addition, a strategic partnership with Ulster University’s Artificial Intelligence Research Centre shows promise.
Demand for the firm’s software services can be unpredictable. Budgetary constraints for key clients, such as the NHS, could act as a headwind for further growth.
However, today’s P/E ratio of 28 is well below the five-year average above 40. A cheaper valuation might compensate investors for taking on the risks.
TSMC
To complete the journey around the globe, Taiwan Semiconductor Manufacturing Company (NYSE:TSM) is the last AI stock in the trio.
TSMC is a key supplier to many of the world’s leading AI chipmakers. An extensive patent portfolio protects the Taiwanese company’s advanced chip packaging process, giving it a wide competitive moat.
This allows the business to adopt a premium pricing model, further bolstered by its economies of scale. Gross margins above 53% are testament to TSMC’s domination of the world’s semiconductor foundry market, of which it claims a 62% share.
Geopolitical risks should be borne in mind. It’s no secret that China has territorial ambitions to bring Taiwan under Beijing’s control. A potential invasion would severely hurt the TSMC share price.
Nonetheless, the company’s edge over its rivals doesn’t show any signs of narrowing for now.
