The start of 2024 will be remembered for the significant developments and investments in artificial intelligence.

Billions of dollars have poured into high-growth areas like data centers, which are critical infrastructure powering the AI ecosystem.

Many technology stocks surged thanks to strong demand from the AI industry. For example, Nvidia’s (NVDA) stock price has almost doubled since the start of the year.

Nvidia has been a major beneficiary of expanding AI workloads in areas like machine learning and deep learning.

Hyperscalers and cloud providers like Amazon (AMZN), Microsoft (MSFT), and Google (GOOGL) have all significantly increased their purchases of Nvidia’s GPUs and other AI hardware to support these workloads.

However, high valuations also bring risks, especially if growth doesn’t meet expectations.

A recent example is SoundHound (SOUN), which is up over 200% year-to-date. Despite this, its stock dropped by 17% in one day after its latest earnings report.

The company has shown impressive growth, posting record Q3 results and raising its full-year revenue outlook.

However, these numbers didn’t satisfy the market. When investors have high expectations, even strong growth can disappoint if it falls short of what the market anticipated.

In this case, despite SoundHound’s revenue increase, the stock’s steep drop shows that valuations matter.

The company’s recent acquisition of AI-driven software firm Amelia played a big part in its revenue.

Amelia has added significant revenue, but SoundHound’s core business has actually seen a decline in organic growth. When factoring in acquisitions, SoundHound’s organic growth rate fell by 15% in Q3.

The high valuation of the stock puts pressure on the company to keep growing at a fast rate.

For SoundHound to justify its current price, it must shift to profitability and maintain strong growth at the same time.

Furthermore, the company’s cash burn rate averages around $20 million per quarter, and while it has enough cash to cover short-term needs, it may need further funding, which could dilute shareholders’ stakes.

AI has a lot of potential, but as with any investment, caution is crucial.

Investors should carefully evaluate high-growth stocks to ensure that valuations are grounded in realistic growth prospects, not just market hype.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research

This portfolio analysis highlights the same insights we share with our FA Alpha Members. To find out more, visit our website.