- AI stocks are declining as market volatility increases and investor caution grows.
- The good news is that some of these formerly expensive companies are now in fair-value territory.
- Names like Microsoft, Adobe, and ServiceNow are solid names and well-priced.
It’s hard to believe that AI stocks are now in a bear market since many have fallen by more than 20% from their highs. It comes after a multi-year run that lifted the S&P 500 by about 24% in 2023 and 23% in 2024.
The script has flipped, and the index is being held up by the broader market instead of the Magnificent 7. As of Thursday, the two largest stocks, Nvidia and Apple, were down by almost 14% and 12%, respectively this year.
Other well-known AI plays followed closely behind. As of Thursday, Broadcom was down by over 17%, Arista Networks by 25%, and Marvell Technology by over 37% this year.
DeepSeek’s debut, which introduced a software-efficient solution to investors in late January, marked a peak reversal for this sector. A new reality has kicked in: Big Tech isn’t immune to market competition, which is causing investors to sober up from their valuation-induced highs.
“We’ve essentially seen the AI stocks on a downward trend ever since then, said Dave Sekera, Morningstar’s chief US market strategist. “Most of those stocks have sold off anywhere between 15% to 20%. So pretty close to what would be considered a bear market in AI stocks.”
Risk-off moves followed the reversal as economic fears mounted from trade wars and slowing GDP growth.
The bad news is, if you have heavy exposure to AI, you’re portfolio is likely down. The good news is that some of these formerly expensive companies are now in fair-value territory, according to Morningstar’s five-star valuation system, which considers a company’s fundamentals relative to its trading price.
This year, Sekera expects investor attention to move away from Big Tech and toward companies integrating AI into their products and services to drive additional revenue growth, improve customer retention, and boost productivity and efficiency.
So, at this point, investors have three options. The first is to chase the crowd into a later phase of the AI trade, where bets are being made on which companies will successfully integrate AI for wider profit margins. Or, stay behind and look for sales on AI’s picks and shovel stocks. Finally, they can choose to seek out more speculative opportunities in leading-edge sectors like robotics.
Either way, the market could remain choppy, and volatility must be an accepted part of the trade.
Stock picks
The software sector is a great place to look for AI bargains. Stocks in this corner were dumped in a flight to risk-off trades, including those with solid business models and recurring revenue growth, which brings us to the main point: if you’re screening for names here, you’ll want to focus on revenue growth above all else because the industry’s perk is that it can grow fast, said Dan Romanoff, a senior equity research analyst for technology at Morningstar.
“You can just draw a chart that compares software multiples versus revenue growth. And the higher the revenue growth, the higher the multiples will be, even if the company is losing money,” Romanoff said. “If you’re looking at your portfolio holistically, tech is usually providing the most growth within your portfolio, and so you want to lean into the growth where you can get it.”
The key is to find the best growth story, he added. And the answer may not always be the company making the widest strides but rather the one that has shown sustainability in its revenue growth. In other words, a bump in revenue could be temporary due to a product release, which could fizzle out in the next quarter, he said. Knowing the difference is key to deciphering between a short-term trade and a long-term investment opportunity.
Within software, stocks that are now well-priced include Microsoft. As of Thursday, it was down by almost 7% this year. But it’s still a harbor in a storm because of its blue-chip name, he noted. It has a monopoly in desktop operating systems with Windows. It has a near monopoly in productivity software in the office suites. Then, it piled on GenAI tools, which has catapulted it into a leadership spot in the AI race, Romanoff said. Its Azure is also a cloud provider in a three-horse race with Amazon Web Services and Google Cloud Platform. Romanoff believes cloud providers will be the real winners in GenAI because inference happens on these servers.
Adobe is another software firm to bet on. It’s not a pure AI play, which is positive because it means the company has a solid, long-running business. The stock is down by over 10% this year. It’s being dumped because investors fear GenAI will take over. After all, GenAI is improving at creating images and could circumvent the need for Adobe’s platform. But Romanoff believes Adobe’s FireFly, which provides AI-based text-to-image and text-to-video options, will remain necessary.
“You’re still going to need tools to edit the content that is created by a generative AI model,” Romanoff said. “If you’re in advertising and creating a campaign, the images you create need to be very specifically edited to create, inform, and define the brand image you want.”
Finally, there’s ServiceNow. It’s a company that has successfully provided customer service and IT platforms. Its Q4 revenue was up by 21.34% from last year. But the stock is down almost 22% this year. They have a solid, long-running business with only a small part of their revenue coming from GenAI offerings, Romanoff noted. Their annual recurring revenue, which is a key metric for software providers, has been on a solid growth trajectory, he added.
If you’re curious about where the rest of the Magnificent 7 are trading, some are now well-priced, too. According to Morningstar’s five-star rating system, which factors in volatility and uncertainty, these three names are now rated at four-stars: Amazon (AMZN), Alphabet (GOOGL), Meta (META).
Additional picks and shovel names that are now well priced and thus four-stars are ASML (ASML), Advanced Micro Devices (AMD), and Marvell International (MRVL).
For investors who want to make a more leading-edge bet, cheap or not, robotics is set to take off as automation integrates with AI. The two sectors combined now make up 1% of global GDP. And that’s expected to increase to a whopping 35% by 2040, according to VettaFi. Demand will come from manufacturing, healthcare, logistics, and agriculture end users. And that runway creates a trillion-dollar opportunity for investors.
However, betting in this sector can be trickier since a company’s past fundamentals won’t be the best measure of its future success. Here, Zeno Mercer, an investor and researcher in Deep Tech at VettaFi, says companies must be evaluated based on their contribution to relevant AI or robotics subsectors. They also need to be assessed on their technological leadership, their position within the market, such as who they are partnered with, and whether they’re making strategic investments that will grow their presence.
VettaFi’s ROBO Global Robotics and Automation Index is one place to look for leading global companies in this arena. The Index’s top holdings include names like Harmonic Drive Systems, which makes precision control equipment for robots; Fanuc Corp, a robotics manufacturer; and GEA Group AG, an industrial, pharmaceutical, and chemical equipment manufacturer.
