Shares of AI-related stocks Arm Holdings (ARM 5.19%), SoundHound AI (SOUN 15.78%), and Bigbear.ai (BBAI 1.34%) rallied this week, appreciating 15.4%, 21.7%, and 22.8% on the week, respectively, as of 12:13 p.m. ET, Friday, according to data from S&P Global Market .
There wasn't much in the way of company-specific news for these three names this week. However, the positive commentary from several Magnificent Seven tech giants, especially around AI investment, was enough to reboot enthusiasm for more speculative AI-related names after a month's-long sell-off.
Due for a bounce?
It should be noted that a big reason these three bounced this week was because each was also caught up in the big tech sell-off over the past month. After a big run to start the year, recent higher-than-expected inflation readings caused a big pullback in highly valued artificial intelligence (AI) names heading into earnings season.
Sticky inflation and rising long-term interest rates especially affect less-profitable or unprofitable stocks. That fits with these three names: Arm currently trades at a price-to-earnings (P/E) ratio over 1,000 and a forward P/E ratio close to 70, which is very expensive. Meanwhile, despite SoundHound's impressive 80% revenue growth last quarter, it's still generating operating losses. And the same goes for Bigbear.ai, although Bigbear.ai did note that it generated its second straight quarter of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and its first positive operating cash-flow quarter since 2021. But Bigbear.ai also has a fair amount of debt of about $195 million. So Bigbear.ai may be especially sensitive to movements in interest rates.
So after the past month's decline, these three were perhaps due for a bounce on any good news. And earnings commentary from Meta Platforms (NASDAQ: META), Microsoft (NASDAQ: MSFT), and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) this week delivered that good news, it seems. While some investors remain skeptical of the AI boom over the past year, the commentary from these tech giants indicated the AI wars aren't slowing down; in fact, they may be just beginning.
Although it sold off after earnings, Meta kicked off the enthusiasm for AI stocks after it increased its forecast for capital expenditures for the year, increasing it to a range of $35 billion to $40 billion, up from prior estimates of $30 billion to $37 billion. Moreover, CEO Mark Zuckerberg seemed to indicate robust AI investment would continue regardless of how revenue trended.
The enthusiasm continued Thursday evening when both Microsoft and Alphabet beat Q1 analyst expectations on the back of accelerating cloud growth. Microsoft's Azure cloud accelerated to 31% growth in constant currency relative to 28% in the prior quarter. And Alphabet's cloud growth accelerated to 28% versus the 26% figure recorded in the prior quarter.
Microsoft and Alphabet both recorded huge increases in their capital expenditures, likely related to AI data-center investment. Alphabet's capital expenditures nearly doubled relative to the prior year to just over $12 billion, and Microsoft's capital expenditures grew from $6.6 billion in the year-ago quarter to nearly $11 billion.
Of these three, the only company directly affected by all that spending may be Arm, which licenses its IP to Nvidia (NVDA 3.77%) for Nvidia's Grace central processing unit (CPU), part of Nvidia's Grace Hopper superchips these companies are likely buying.
However, accelerating cloud revenue and massive capex increases indicate a favorable general outlook for AI applications going forward. And if the AI tailwinds are real, companies like SoundHound, which makes AI voice applications in partnership with Nvidia, and Bigbear.ai, which is an AI data-analytics company that serves both enterprises as well as the U.S. military, have the potential to benefit from that big and growing pie.
Image source: Getty Images.
These three are high-risk ways to play AI, with potentially high upside
Arm is an established company but relatively new to the public markets and the AI data-center market, with the bulk of its revenue still coming from smartphones. However, more Arm-based chips are gaining in popularity in other devices due to their energy efficiency, which is a key concern for AI applications. The growth of Nvidia's Arm-based CPUs, along with the prospect of more Arm-based PC chips coming in the next year for AI PCs, could provide further upside.
However, SoundHound and Bigbear.ai, with market caps of $1.3 billion and $430 million, respectively, have more potential upside due to the fact they are small companies today with the potential for lots of growth. Neither of these two is profitable at the moment, so they are riskier. But if AI tailwinds remain strong and their management teams execute, each has multibagger potential.
