Artificial Intelligence (AI) Stocks Are Red Hot, but Here's Why I'm Not Touching Them

Many tech stocks have been surging in recent years due to strong results stemming from investments in artificial intelligence (AI). Palantir Technologies (NASDAQ: PLTR), Nvidia, and Broadcom have all rallied more than 500% in just the past three years.

Companies involved with AI have been benefiting from robust demand for their products and services, which has led to investors also being extremely bullish on these types of stocks. But as hot as the AI trade has been of late, I've stayed away from it, as the valuations have gotten out of control. And that can be vital to ensure you don't violate Warren Buffett's first rule when it comes to investing: "never lose money."

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Ignoring valuations can make you vulnerable to losses

Many AI stocks are incredibly overvalued today, and one of the best examples of that is Palantir Technologies. Strong growth and ties to the U.S. government have made this a bit of a safe haven stock for tech investors in recent years. The company is involved in data analytics, and its AI platform has provided companies with significant opportunities for enhancing their businesses and improving efficiency.

The problem with Palantir is that although its shares are down 23% this year, the stock still isn't cheap; it trades at a price-to-earnings (P/E) multiple of more than 150. Buying a stock at that kind of valuation, regardless of how promising its growth prospects are, can open you up to some considerable downside risk. While not all AI stocks are as expensive as Palantir, many are, and they're priced on rosy expectations ahead, which is why I've avoided them.

Following Buffett's advice can help protect your portfolio

Taking a cautious approach may result in you missing out on gains and sitting on the sidelines while others profit from the excitement around AI stocks. But investing is about the long term, and investing in quality stocks and hanging on for years is where the most significant gains can come from. By considering Buffett's advice and his rule of not trying to lose money when investing, you can make more sound, safe investing decisions. While that may not be all that exciting, particularly with growth stocks taking off in value, it can help ensure you focus on a balanced investing strategy.

Tech stocks have a volatile history, and when sentiment sours on them, they can quickly go into a free fall. Regardless of how many investing years you have left, I think it's important not to overlook valuations, as doing so could leave your portfolio vulnerable to significant risk later on.

David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Broadcom, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.