Artificial intelligence (AI) stocks have yielded fantastic results for investors in recent years. Since the start of 2023, the Global X Artificial Intelligence & Technology ETF has risen by around 150%. During that stretch, the S&P 500 has climbed by a more modest rate of 78% (returns as of Dec. 15).
But when stocks rise so quickly in a relatively short time frame, there are inevitable concerns about valuations and whether stocks have become too expensive. Many analysts and investors have also become worried about a possible bubble in the markets, with the potential for a massive sell-off looming, not unlike the one that tech stocks suffered in 2022.
One leading tech company, Oracle (NYSE: ORCL), recently posted earnings that appear to have sent some shockwaves throughout the AI world. Investors were taken aback by its latest results, and they could be a problem for AI stocks as a whole. Here’s why.
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Oracle posted its latest earnings numbers on Dec. 10. While the tech company’s adjusted earnings per share totaled $2.26 and came in better than estimates of $1.64, its revenue fell short — $16.06 billion compared with forecasts of $16.21 billion for the period ending Nov. 30. These metrics were mixed, but not really a cause for concern.
The bigger problem for Oracle was its reported big jump in AI-related spending. The company’s capital expenditures for the period totaled $12 billion, which were significantly higher than the $4 billion that it reported in the prior-year period. It also raised its guidance for capital expenditures for the full fiscal year (which ends in May), from $35 billion to $50 billion.
The heavy spending has investors concerned about whether all the AI-related investments will be worthwhile, especially as Oracle’s debt load rises. The company’s debt as of the end of the quarter totaled $108.1 billion, which includes notes payable and other borrowings. By comparison, the company has just $34.4 billion in current assets on its books. As of the end of May, its debt load was $92.6 billion. It’s a significant increase in a relatively short time frame, and it occurs as investors are paying greater attention to signs of excessive spending on AI among companies. It’s perhaps not a surprise that Oracle’s stock has tumbled more than 17% since releasing its earnings.
Another problem for Oracle these days is that its close relationship with OpenAI may prove to be a vulnerability. Earlier this year, the two companies agreed to a five-year deal that will see OpenAI purchase a staggering $300 billion in compute power from Oracle, beginning in 2027.
OpenAI has been investing heavily in advancing its popular chatbot, ChatGPT, to ensure it stays ahead of rivals. Recently, CEO Sam Altman declared a “code red,” signifying the urgency for the company to not fall behind rival chatbots, including Alphabet‘s Gemini, which has been experiencing a substantial rise in users, proving to be a viable alternative to ChatGPT.
For OpenAI, its expenditures could grow significantly as it invests more money in the development of its chatbot. And given that the company doesn’t expect to be profitable anytime soon, this may put Oracle in a tough situation if one of its key customers struggles to generate sufficient cash flow. With many tech giants partnering with one another, the risk is that if one struggles and experiences trouble, they all will.
Tech stocks have been declining in recent days, and Oracle’s sharp decline should serve as a reminder to investors of just how vulnerable these top tech companies may be, given their exposure and dependence on one another, and the need for AI spending to remain robust.
There could be a lot of room for AI stocks to fall, especially those that are trading at inflated valuations. Now may be a good time for investors to consider reevaluating their portfolios and potentially pivoting out of highly valued tech stocks and into safer investments that trade at more modest valuations. At 36 times its trailing earnings, Oracle may not be the most expensive AI stock out there, but it’s not the cheapest one, either. It’s still far more expensive than the average S&P 500 stock that trades at a price-to-earnings multiple of 26.
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David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Oracle. The Motley Fool has a disclosure policy.
