I do not know whether we are in a bubble or not. What I do know is that some AI stock valuations seem very hard to justify as far as I am concerned. Still, could that caution mean I’m missing out on some potentially brilliant shares? As I try to resolve this conundrum, I am taking some cues from legendary investor Warren Buffett.
We’ve been here before
The current market environment reminds me in some ways of the peak of the dotcom bubble in early 2000.
Some shares had been soaring. Simply adding an internet domain to your company name could send the valuation soaring.
As shares rose, many commentators said that Warren Buffett – who was not participating in the feeding frenzy – had lost his touch.
Fast-forward just a few months: the market crashed and some hot dotcom stocks went to zero. Buffett was unconcerned, as he had not participated in the buying boom.
Principles-based investing
That was not because he saw no potential in the internet. Indeed, in his 2001 letter to Berkshire Hathaway shareholders, he referred to steady growth in internet business at one of the company’s insurance operations.
It was because Buffett was using a few core principles when investing.
One is to stick to areas you know. Buffett continued to shun tech stocks for years after the dotcom crash simply because he claimed not to know enough to understand them.
The Buffett approach involves buying into a great company at an attractive price. A company with no business plan but a fancy new name has not proven itself to be a great business.
Unlike some market participants in 2000, Warren Buffett remained level-headed enough to see that.
Taking the long view
But what if there are some winners from the AI boom and staying out of the market means I miss them?
That does not bother me if I stay out for the reasons I mentioned, of not understanding a stock or not finding it attractively valued.
If the company really is a good one, then as a long-term investor like Warren Buffett, I believe that over time its value ought to reflect that. Even if missing out on the initial flurry of excitement about a company, there can usually still be more opportunities to invest.
Valuation always matters
As an example, I can point to chip giant Nvidia (NASDAQ: NVDA).
Not owning the stock means that I have missed out on a 1,297% price gain over the past five years (and even more over the longer term).
So, have I missed my chance altogether? Not necessarily.
I like the Nvidia business. It has proprietary technology, a large installed base of users, and is seeing soaring demand as companies kit themselves out for heavy AI use.
But, at 47 times earnings, Nvidia is too pricey for my tastes.
Like Warren Buffett, I like a margin of safety when investing. I do not think the current Nvidia stock price offers me one given the risks it faces, such as companies having to cut back on Ai spend due to investor backlashes, or a rival chipmaker offering much cheaper products.
I will wait to see whether, once the market tide changes, Nvidia stock becomes available at a price I see as attractive.
