Has the AI Hype Already Peaked? 'Valuation Guru' Warns: The Real Danger Isn't the Magnificent Seven, But 'These' AI Stocks

Aswath Damodaran, a finance professor at New York University's Stern School of Business and known as the 'Dean of Valuation,' has once again issued a warning to investors in AI-related stocks, suggesting that the market may have already reached its 'AI peak' several months ago, with particular concern over the future trajectory of 'certain' stocks.

According to a report by Business Insider, some AI-related stocks have recently seen significant sell-offs, with capital shifting toward other sectors.

Throughout July, investors pulled substantial funds out of memory and semiconductor stocks. The Roundhill DRAM ETF (DRAM-US) has fallen 36% from its recent high, while the iShares Semiconductor ETF (SOXX-US) has declined 22% from its peak.

Damodaran stated, 'I think the AI hype peaked several months ago, and we'll see more consolidation and correction in the coming months.'

He further pointed out that when the AI industry undergoes a shakeout, the real danger lies not with the 'Magnificent Seven' U.S. tech giants, but with smaller AI companies.

Damodaran explained that smaller and mid-sized firms within the AI investment theme lack sufficient financial buffers. If the AI investment frenzy cools further, they will find it harder to withstand the ensuing market correction and will face greater pressure.

Recently, as investors have begun rebalancing by repurchasing previously sold tech stocks, AI-related stocks have started to rebound. Fueled by rising risk appetite, capital has flowed back into tech shares, pushing both the Dow Jones Industrial Average and the S&P 500 to record highs this week.

However, Damodaran believes this rally is primarily driven by 'fear of missing out' (FOMO) rather than improvements in corporate fundamentals.

He said, 'The investor mindset is, 'Finally, I have a chance to buy AI companies.' I wouldn't interpret this any more complexly.'

Regarding the hyperscale cloud service providers investing the most in AI capital expenditures, Damodaran described them as the 'most defensive' group within the AI sector, thanks to their robust cash flows and ability to take on significant debt.

Nonetheless, he still cautions about the outlook for large AI firms, noting that they are taking on increasing debt while the return on investment for massive AI capital spending remains low.

Damodaran noted, 'Unless these companies start delivering profits commensurate with their tens of billions of dollars in capital spending, they will evolve into fundamentally different companies in the future.'

He added, 'There's nothing inherently wrong with that, but I think investors aren't yet accustomed to the risks of investing in a more capital-intensive business model.'

Damodaran has previously warned multiple times that valuations for some AI stocks may be too high. As early as 2023, he pointed out that NVIDIA's (NVDA-US) stock price was already severely overvalued from a valuation standpoint and estimated its fair value at roughly half the market price at the time.