Is the AI Bubble About to Burst? Here's How to Profit Either Way

Artificial intelligence (AI) fueled investors' optimism over the past few years -- and that fueled gains in the S&P 500, leading it to its third consecutive annual increase. And in October, the bull market officially celebrated its third anniversary. Though certain headwinds weighed on stocks here and there over the past year -- from worries about President Donald Trump's import tariffs to the pace of interest rate cuts -- the market's performance overall clearly was positive.

Why such excitement about AI? Because it's showing that it may be that next great thing in technology, revamping the way things are done and generating an explosion in revenue growth for companies. All of this helped AI stocks to soar, and at the same time, the valuations of many reached vertiginous levels. And that prompted investors to start worrying about one thing in particular late last year: a potential AI bubble.

Now you may be asking yourself: Is the AI bubble about to burst? Here's how to profit either way.

Image source: Getty Images.

Strong AI earnings

The good news is, so far, corporate earnings and demand for AI products and services haven't supported the idea of a bubble. AI companies from Nvidia last quarter to Taiwan Semiconductor Manufacturing in the most recent quarter have reported climbing revenue and strong demand. Still, valuations overall remain high, with the S&P 500 Shiller CAPE ratio at a level it's only reached once before in history.

S&P 500 Shiller CAPE Ratio data by YCharts

So, what's an investor to do in such a situation? Prepare yourself to win regardless of what unfolds in the coming quarters. Here's how to do that.

First, remember to ensure that your portfolio is well diversified across stocks and industries -- so, sure, buy shares in AI chip giant Nvidia, but at the same time, in case AI stocks tumble at some point in the future, it's also important to own stocks in steady industries such as healthcare or a strong financial player like American Express.

Look for inexpensive AI players

As you invest in AI stocks, it's a fantastic idea to look for players that are involved in the space but don't depend on it for revenue and growth. Two great examples are Amazon and Apple. Also, look for AI stocks that aren't expensive -- there are some that haven't reached exorbitant valuations. Meta Platforms (NASDAQ: META), trading at 21x forward earnings estimates, fits the bill. And this company, too, doesn't rely uniquely on AI for growth as its main business is social media -- with revenue driven by advertising.

Finally, it's important to consider your comfort with risk. If you're an aggressive investor, you may more heavily weight high-growth AI stocks in your portfolio, but if you're cautious, you should limit your exposure to such players. With all of this in mind, you may set yourself up to profit -- whether the AI bubble bursts or not.

American Express is an advertising partner of Motley Fool Money. Adria Cimino has positions in Amazon and American Express. The Motley Fool has positions in and recommends Amazon, Apple, Meta Platforms, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.