Nvidia stock drops 6.5%, dragging artificial intelligence stocks lower

Is the AI bubble bursting?

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The artificial intelligence (AI) trade took a turn for the worse on Monday as Nvidia (NASDAQ: NVDA) shares dropped as much as 6.5%, dragging the entire AI market with it.

Super Micro Computer (NASDAQ: SMCI) fell as much as 8.5%, and Taiwan Semiconductor Manufacturing (NYSE: TSM) was down 3.8% at its low today. The three AI stocks were down 4.9%, 7%, and 3.2%, respectively, at 11:30 a.m. ET. There isn't any specific news about AI, but investors have a lot on their minds about the future demand for the chips driving AI today.

Nvidia insiders are selling in droves

On Friday, Nvidia insiders, including CEO Jensen Huang, announced massive stock sales beyond just tax sales related to stock options and warrants. Huang reported he sold 240,000 shares on the open market on Thursday and Friday, totaling $31.6 million for just those two days.

In June alone, Huang has already sold nearly $95 million of stock as he's been touting the growth potential for AI long term. Numerous other executives have also reported large stock sales on the open market.

Insider sales can be an indication they are less bullish on a stock, which is why this is notable.

Is the bubble popping?

As impressive as AI demand has been, the valuations of Nvidia and Super Micro Computer in particular have hit crazy levels. You can see below that Nvidia's price-to-earnings (P/E) multiple is still over 70 and its price-to-sales (P/S) multiple is 37.6. Super Micro Computer isn't quite as expensive, but it's still priced for perfection.

NVDA PE Ratio Chart

NVDA PE ratio data by YCharts.

Investors must consider how much growth is priced into AI stocks right now and what the likelihood is that they will live up to that potential. Very few AI companies make money, so the money flowing to chips could slow down if those that are developing AI models and tools don't create business plans that make them sustainable in the long term.

Earnings come into focus

Investors are suddenly thinking about demand because we're only a few weeks away from the start of earnings season for the second quarter of 2024. That's when we'll hear about end demand and margins for tech companies building AI products, including those buying the most Nvidia chips.

If demand is strong, stocks could go up, but investors are taking money off the table for fear there could be some disappointing signs. And with stocks priced to perfection, even the smallest crack in the AI growth story could send them tumbling.

It's all up to Nvidia

Nvidia is the biggest name in AI, and its fortunes will drive Super Micro Computer and TSMC, which are suppliers to the company and beneficiaries from the overall growth in AI demand. If the market for Nvidia chips continues to grow, the other companies will have plenty of demand.

What I think the focus over the next month will be is the demand for AI products that companies have introduced and whether or not that will lead to more capital spending. If not, there could be a pullback in orders in the future, and that could put both revenue and margin projections into question.

These high valuations and lack of AI business models are why I'm avoiding AI stocks today. The risk is simply too high for the observable reward right now.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Nvidia and Taiwan Semiconductor Manufacturing. Travis Hoium has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Nvidia. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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