Should You Forget Palantir and Buy These 2 AI Stocks Instead?

Source The Motley Fool

Palantir's (NYSE: PLTR) stock hit a record high of $51.13 on Nov. 5. Its 223% year-to-date rally was driven by its accelerating revenue growth, soaring profits, and its inclusion in the S&P 500. The buying frenzy in AI stocks, expectations for lower rates, and the market's post-election rally amplified its gains.

It's easy to see why the bulls love Palantir. The analytics software company, which helps its government and commercial clients aggregate data from disparate sources to make smarter decisions, expects revenue to rise 26% this year -- accelerating from its 17% growth in 2023 -- as it stays profitable. Most of that growth will be driven by new government contracts, the robust growth of its U.S. commercial business, and the expansion of its generative AI services.

A person gazes at digital projections on a screen.

Image source: Getty Images.

From 2023 to 2026, analysts expect Palantir's revenue and earnings per share (EPS) to grow at compound annual growth rates (CAGR) of 23% and 59%, respectively. But at 186 times forward earnings and 33 times next year's sales, the company's frothy valuations might limit its upside potential.

Instead of chasing Palantir's high-flying stock, should investors buy Nvidia (NASDAQ: NVDA) and TSMC (NYSE: TSM) as their long-term AI plays instead?

Nvidia still looks cheaper than Palantir

Nvidia is the linchpin and bellwether of the AI market because it's the dominant producer of high-end data center GPUs for processing AI tasks. The world's leading AI companies -- including OpenAI, Microsoft, Alphabet's Google, and Meta Platforms -- all run their AI applications on Nvidia's GPUs.

The soaring popularity of OpenAI's ChatGPT and other generative AI applications drove many companies to upgrade their data centers with Nvidia's GPUs. As a result, the market's demand quickly outstripped the company's available supply, its prices and gross margins soared, and revenue skyrocketed. In fiscal 2024 (which ended this January), Nvidia's revenue soared 126% as its adjusted EPS jumped 288%.

Nvidia faces some long-term challenges. Many of its top customers are developing first-party AI accelerator chips, its rival AMD is ramping up its production of cheaper data center GPUs, and its sales to China are being throttled by tighter export restrictions. Its major customer Super Micro Computer also faces some tough questions amid its delayed 10-K filing, its auditor's departure, and a potential regulatory probe.

But assuming Nvidia weathers those challenges, analysts expect revenue and EPS to grow at a CAGR of 51% and 56%, respectively, from fiscal 2024 to fiscal 2027, as the AI market expands. Based on those estimates, Nvidia trades at 39 times forward earnings and 20 times next year's sales, so it still looks like a cheaper and faster-growing play on the AI market than Palantir.

TSMC: A more balanced and diversified choice

TSMC is the world's largest and most advanced contract chipmaker. It manufactures chips for "fabless" chipmakers -- including Nvidia, AMD, and Apple -- which outsource their production to third-party foundries.

Over the past decade, TSMC pulled ahead of its two closest competitors, Samsung and Intel, in the "process race" to manufacture smaller and denser chips. It gained that lead by adopting ASML's top-tier lithography systems (used to etch circuit patterns onto silicon wafers) before its competitors.

From 1997 to 2022, TSMC reduced the size of its chipmaking nodes from 300 nanometers (nm) to 3nm. It plans to start mass producing its first 2nm chips next year.

That's why TSMC is often considered the linchpin of the semiconductor market. It suffered a cyclical slowdown in 2023 as the PC and smartphone markets cooled, but it expects revenue to grow "nearly 30%" this year as it books big AI-driven orders from Nvidia, AMD, and other chipmakers.

From 2023 to 2026, analysts expect TSMC's revenue and EPS to grow at a CAGR of 25% and 28%, respectively, as it manufactures even smaller and more powerful chips. Those are high growth rates for a stock that trades at just 18 times forward earnings and 8 times next year's sales. Like Nvidia, TSMC might be a good alternative to Palantir for AI-oriented investors who want a more balanced growth stock.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Leo Sun has positions in ASML, Apple, and Meta Platforms. The Motley Fool has positions in and recommends ASML, Advanced Micro Devices, Alphabet, Apple, Intel, Meta Platforms, Microsoft, Nvidia, Palantir Technologies, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft, short January 2026 $405 calls on Microsoft, and short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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