On Wednesday, shares of Nvidia, Arm Holdings, and other artificial intelligence (AI) companies experienced a decline.

On Wednesday, shares of Nvidia, Arm Holdings, and other artificial intelligence (AI) companies experienced a decline.

Life has indisputably seen significant advancements in the realm of artificial intelligence (AI), serving as a sustained growth driver since early 2023. Businesses and investors alike aim to capitalize on the prospective power of these sophisticated algorithms, which could potentially ignite a surge in employee productivity. Despite this potential, these changes will occur gradually, over lengthy periods of time rather than swiftly.

Consequently, on Wednesday, at 2:40 p.m. ET, the shares of prominent AI players such as semiconductor specialist Nvidia (NVDA 2.45%), chip designer Arm Holdings (ARM 3.66%), and memory and storage chipmaker Micron Technology (MU 3.64%) depreciated, by 3.1%, 2.9%, and 1.4% respectively. Inspecting the usual sources, like financial reports, regulatory filings, and analysts' price target adjustments, revealed no significant news for an explanation. This suggests that the investors were focused predominantly on the results of a significant AI industry figurehead.

When outstanding results aren't enough

Super Micro Computer (SMCI -0.72%), commonly known as Supermicro, has been a stellar performer in the sphere of AI technologies. Known for its high-performance servers and storage solutions -- crucial for the continued growth of AI -- it has surged more than 700% over the past year, heading into the release of its financial report. Although these results were robust by any standard, investors anticipated more. This led to a downward spiral in the stock price.

During the fiscal 2024 third quarter (ending in March 31), Supermicro reported a revenue increase of $3.85 billion, boasting a staggering 200% year-over-year growth. Correspondingly, the adjusted earnings per share (EPS) saw a 308% growth, amounting to $6.65.

While such monumental figures would typically elicit jubilation from most companies, Supermicro investors considered it inadequate. Their assessment was influenced by the disparity between the actual and analysts' consensus estimates, expecting revenue of $3.95 billion and EPS of $5.78.

CEO Charles Liang elucidated the situation, citing the ongoing challenges encountered in the supply chain. The company faced hurdles in obtaining the necessary components for its DLC servers running generative AI models utilized by cloud infrastructure providers and in data centers. Liang expected resolution of these supply chain issues within the next few quarters.

This explication may not have been enough to satisfy investors who were eager for quick returns, prompting them to offload their Supermicro shares in search of new opportunities.

Getting lost in the details

Although this discussion appears to be centered on the trio of AI stocks, there's no direct correlation. Investors have showcased an excessive enthusiasm for stocks related to AI, setting unrealistic expectations for the AI adoption timeframe.

• Nvidia supplies the graphics processing units (GPUs) that play a vital role in training and operating AI systems. These GPUs have driven the adoption of AI and experienced extraordinary demand.
• Arm Holdings designs the architecture for numerous widely-used semiconductors. The company garners royalties and licensing fees from companies utilizing its chip designs.
• Micron Technology manufactures flash memory and storage processors, essential components for the GPUs employed for AI processing. Consequently, it too is impacted by the pace at which AI technology is evolving.

Of these three, Micron was the only company to announce any stock-specific news - and the news was positive. Today, Micron announced that it was the "first to ship essential memory," required for AI processing. The company has successfully validated and shipped its 128GB DDR5 RDIMM memory, a vital component in high-performance CPUs used for generative AI and machine learning in cloud computing and data centers. This development is undeniably positive; however, it doesn't provide an explanation for the stock's lackluster performance.

In terms of valuation, what constitutes a fair price varies among individuals.

Micron, Arm Holdings, and Nvidia are currently selling for 160 times, 64 times, and 33 times forward earnings respectively - demonstrating that Nvidia is the most affordably priced. On a price-to-sales basis, Arm, Nvidia, and Micron are evaluated at 21 times, 15 times, and 3 times forward sales respectively, making Micron the most cost-effective option. Yet, neither metric accounts for the underlying growth potential.

In the context of a forward price/earnings-to-growth (PEG) ratio, which considers a company's current growth rate, Nvidia, Arm Holdings, and Micron all exhibit a multiple less than 1 - a standard indicator of an undervalued stock.

Although the early stages of AI adoption are captivating, investing in AI requires fortitude and anticipation of the high volatility.

Despite the promising potential of AI in finance and investing, some companies in the sector, like Supermicro, have experienced stock price decreases even after reporting impressive financial results, due to investor expectations exceeding actual performance. In the pursuit of quick returns, some investors are focusing on AI stock performance rather than long-term growth prospects, leading to fluctuating stock prices and unrealistic expectations.

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