There’s no denying that Microsoft (NASDAQ:MSFT) is currently winning the battle between Big Tech firms to dominate the world of artificial intelligence. In recent weeks, MSFT stock has moved higher due to its success in this area relative to other tech giants.
Microsoft has invested $10 billion into OpenAI, the developer of AI chatbot ChatGPT, and is now integrating OpenAI’s technology into products such as its Bing search engine.
The company may be poised to grab substantial market share from Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google search business. As I discussed recently, the market has been disappointed with Alphabet’s response to this competitive threat.
That said, it’s possible that investors have gotten carried away with MSFT and with other top AI stocks. This enthusiasm could wane, with focus shifting back to nearer-term factors. This may leave shares at risk of a pullback.
MSFT Stock and AI Mania
Microsoft’s aforementioned AI catalyst has thus far only resulted in moderate gains for its shares. Since the start of the year, MSFT has moved around 11% higher. This reaction makes sense, given Microsoft’s large size.
Relatively smaller stocks with AI exposure have experienced even sharper rallies compared to MSFT stock. Nvidia (NASDAQ:NVDA) has surged by around 55% since the start of January. The market’s rebound during this timeframe has of course played a role, but excitement about Nvidia supplying the chips for the AI Wars has definitely been a factor.
C3.ai (NYSE:AI), a mid-cap AI stock, has experienced an even greater liftoff in price year-to-date. AI stock has rallied by more than 130%, as speculators wager that this megatrend is a game changer for this for-now unprofitable enterprise AI provider.
Yet while buying into AI mania has been a profitable trade lately, that may soon cease to be the case. Much like with metaverse stocks in 2021, investors may be prematurely pricing in future possibilities as near certainties into AI stocks. Commentators are now calling it an “AI bubble,” and it may be just ready to pop.
If the Bubble Bursts
It’s near impossible to call the top of a bubble, except in hindsight. AI mania could carry on, even as it appears as if the trend has lost momentum in recent trading days.
Yet even as it is difficult to determine whether this investing trend has peaked, the current speculative frenzy surrounding AI stock may serve as a warning to tread carefully. What does this have to do with Microsoft stock?
Yes, MSFT, unlike NVDA, AI, and other names, has experienced just a modest near-term rally. Still a post-bubble selloff may not only erase Microsoft’s gains, it may push it to even lower prices. Why? Like I mentioned above, if excitement over the company’s artificial intelligence catalyst takes a breather, focus may shift back to near-term factors.
Namely, negatives such as the prospect of slowing growth. As InvestorPlace analyst Louis Navellier argued earlier this month, the tech slowdown is affecting Microsoft’s current results, a trend that could continue in the quarters ahead. Subsequent results and guidance updates may lead more investors to doubt current forecasts for next fiscal year (ending June 2024), which call for a reacceleration in growth.
Microsoft may be the tech company best-positioned to benefit from the rise of AI, but don’t assume that means shares are a buy at any price.
Right now, MSFT trades for around 30 times trailing 12 month (or TTM) earnings. This is a sharp premium to GOOG, which you buy today for only 21.1 times TTM earnings.
Although Microsoft’s current edge in AI, coupled with its greater competitive edge relative to Alphabet in areas like cloud computing, helps to justify a higher multiple, MSFT’s valuation may be excessive. It fails to factor in the uncertainty surrounding the tech slowdown.
If you currently own this stock, don’t take this to mean it’s time to take profit.
However, if you have yet to buy MSFT stock, and are looking to do so for AI exposure, consider it best to wait until the next round of weakness.
On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.