2 AI Stocks to Avoid Buying on the Dip

Three years after OpenAI launched ChatGPT, the initial excitement surrounding generative AI is starting to fade. Investors have become increasingly frustrated due to the lack of significant value generated within the software segment of the industry.

Two prominent AI-related technology companies currently facing challenges are Tesla and Palantir Technologies. Both companies are struggling to validate their previous optimistic stock valuations and face a changing political environment that previously bolstered their stock prices.

Palantir Technologies

Palantir's positive outlook is diminishing as its stock has decreased by 36% from its all-time high of $125, achieved in mid-February. The share prices surged following the integration of AI large language models into its data analytics platforms, along with a boost from the hype generated after Donald Trump’s election victory. However, these once-promising indicators are now turning into sources of disappointment.

Palantir's co-founder Peter Thiel has connections to Trump and his vice president, JD Vance. However, the real benefits for Palantir from this connection remain uncertain. In fact, some of the new administration's political objectives, such as proposed budget cuts to the Pentagon by 8% per year, could reduce the demand for Palantir’s services, particularly since government clients account for about 42% of their revenue for the full year of 2024.

Furthermore, the expected transformational impact of Palantir's shift towards AI has not materialized as hoped. While the company saw impressive sales growth of 47% in 2020, that rate has declined to 29% for 2024. While this rate is still positive, it struggles to justify a staggering price-to-earnings (P/E) ratio of 419.

Additionally, Palantir's profitability is under significant pressure due to substantial expenses from stock-based compensation, which amounted to $281.8 million in the fourth quarter alone. This figure represents 74% of the adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

Tesla

Similarly, Tesla's stock has soared due to the excitement around generative AI and the political circumstances following Trump's election. However, the ongoing political influence on Tesla from CEO Elon Musk may be detrimental to the company’s image.

Analysts at JPMorgan have pointed out that Tesla is currently facing severe reputational harm, which is having an adverse effect on sales. For instance, in Germany, sales plummeted by 76% compared to the same period last year, with only 1,429 vehicles sold in February.

On the positive side, certain European markets may not significantly impact Tesla's overall business. Musk’s political connections might assist in alleviating tensions in China, which is currently the world’s largest electric vehicle (EV) market. In 2024, Tesla sold over 657,000 units in China, making it crucial for Musk to fortify this aspect of the business, particularly with intensifying competition from local manufacturers.

With a P/E ratio of 118, Tesla's valuation appears excessively inflated given the slowing sales, damage to its reputation, and various challenges in international markets. While the company is exploring advancements in AI and self-driving technology, which could provide alternative revenue streams outside the automotive sector, investors should refrain from purchasing Tesla stock at this juncture.

Which stock has a better chance of recovery?

Both Palantir and Tesla seem overvalued and susceptible to further declines. However, Palantir is at a higher risk of taking a larger hit due to its more extreme valuation challenges.

On the other hand, Tesla, while facing immediate obstacles, has the potential for long-term growth through its self-driving tech, which could generate new software and service revenues. Investors should avoid Tesla for now, but it may be wise to monitor the company for future developments regarding these promising growth drivers.

AI, Stocks, Valuation