2 AI Stocks to Avoid Buying on the Dip

Three years have passed since OpenAI launched ChatGPT, and the excitement surrounding generative AI has begun to wane. Investors are becoming increasingly frustrated with the declining value offered by the software side of the industry.

Companies involved in artificial intelligence (AI), such as Tesla and Palantir Technologies, are struggling to support their high valuations. The political buzz that initially propelled their stock prices following former President Trump's election win is also fading away. Here are some reasons why these stocks should be avoided, even after dips in prices.

1. Palantir Technologies

Palantir's bullish outlook is becoming less convincing, with stock values down by 36% from their peak of $125 in mid-February. The surge in share prices happened when the company incorporated AI large language models (LLMs) into its data analytics platforms. The hype from political sources has also now turned sour.

While co-founder Peter Thiel supports Trump's administration, it is uncertain how his political ties will benefit Palantir in a meaningful way. Interestingly, some of the administration's objectives, like proposing to cut the Pentagon budget annually by 8%, could actually reduce the demand for Palantir's offerings. A significant portion of their revenue, around 42% in 2024, comes from government contracts.

Moreover, the anticipated impact of Palantir's AI strategy is underwhelming. In 2020, the company enjoyed a sales growth of 47%. However, this growth has decreased to 29% in 2024. Although this is still a respectable number, it is insufficient to validate the hefty price-to-earnings (P/E) ratio of 419 that Palantir currently holds.

The profitability of Palantir is also being affected by high stock-based compensation expenses, which were $281.8 million in the fourth quarter and represented 74% of adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

2. Tesla

Similar to Palantir, Tesla witnessed its stock rise on the back of interest in generative AI and Trump's election result. However, while CEO Elon Musk is connected to the current political environment, investors may be underestimating the negative consequences this has for Tesla.

According to analysts at JPMorgan, Tesla is facing significant reputational harm which is starting to reflect on its sales performance. For instance, in February, vehicle sales in Germany plummeted by 76% compared to the previous year, totaling just 1,429 cars sold.

A silver lining here is that the impact of this decline may be mitigated as individual European countries do not substantially contribute to Tesla's overall business performance. Furthermore, Musk might leverage his political connections to improve relations in China, which is crucial as anti-U.S. sentiment could hit Tesla's operations hard. In 2024, Tesla managed to sell over 657,000 vehicles in China, and competition from local brands is on the rise.

Currently, Tesla’s P/E ratio of 118 appears excessive, especially with sales slowing down, growing reputational issues, and other challenges in its global market. While a shift towards AI and self-driving technology could potentially diversify Tesla's offerings beyond actual vehicle sales, until those advancements materialize, investors should refrain from purchasing the stock.

Which Stock Might Recover?

Both Tesla and Palantir carry high valuations and face downward pressure. However, Palantir seems more susceptible to further declines due to its extreme overvaluation compared to Tesla.

Despite the serious immediate hurdles Tesla encounters, its self-driving technology might create new avenues for revenue in software and services in the future. Investors are advised to avoid buying Tesla shares now, but it would be wise to keep an eye on the company as more information about its potential growth emerges.

AI, Stocks, Valuation