2 Top Artificial Intelligence (AI) Stocks to Watch in October

The launch of OpenAI's ChatGPT in late 2022 boosted interest in companies that could support or monetize generative AI. Nvidia (NASDAQ: NVDA) and Palantir Technologies (NYSE: PLTR) are two great examples. Let's explore the pros and cons of both stocks to decide if they have a place in your portfolio in October and beyond.

1. Nvidia: the hardware leader

With shares up a solid 160% over the last 12 months, Nvidia remains one of the top beneficiaries of the AI hype cycle. And unlike some alternatives, its rally is backed by equally impressive operational results.

To say business is booming might be an understatement. Second-quarter (ended July 28) revenue soared 122% year over year to $30 billion based on massive demand for its high-end graphics processing units (GPUs) used to run and train AI algorithms. The company's technological moat allows it to sell its hardware at a huge markup (with gross margins of 75%), helping its operating income jump 174% to $17.6 billion.

But despite the strong results, the company leads a speculative and unproven industry. Large language models (LLMs), like ChatGPT and Google Gemini from Alphabet are riddled with mistakes. And they will be difficult to monetize because of open-source competition. If tech giants stop investing in their often unprofitable AI projects, Nvidia's operational momentum could vanish as quickly as it appeared.

That said, with a forward price-to-earnings multiple (P/E) of just 31, Nvidia's stock is relatively cheap considering its epic growth. The market seems to be waiting for the software side of AI to show more results before unlocking the company's next bull run.

2. Palantir: a software contender

While Nvidia focuses on the hardware side of the AI opportunity, Palantir focuses on software -- combining the LLMs behind platforms like ChatGPT with proprietary data analytics and machine learning.

The company has a relatively strong moat because of its focus on sensitive government contracts. And a relatively fast-growing private-sector business could offer much-needed growth and diversification.

For tech companies, working with the government can be risky for their brand image. This challenge might have led Google to abandon a military AI project called Maven amid employee backlash in 2019.

Image source: Getty Images.

On the other hand, Palantir made its name through government contracting -- even helping with high-profile missions like finding Osama Bin Laden in 2011. This niche makes it resistant to this type of pressure.

And in September, the company won a $100 million contract for the U.S. Army's Maven Smart System project that Google abandoned. Palantir also works with the governments of Israel and Ukraine for military targeting.

However, while contracting is Palantir's bread and butter, it also attracts commercial clients interested in its data analytics services.

Second-quarter (ended June 30) revenue grew 27% year over year to $678 million, helped by a 33% jump in commercial revenue to $307 million, a little under half of the total. However, Palantir's forward price-to-earnings multiple (P/E) of 87 is substantially higher than the S&P 500 estimate of 24. And growth would have to accelerate substantially for this price tag to make sense.

Which stock is better for you?

Nvidia and Palantir are two top AI stocks that belong on your investment radar. However, uncertainty about the future of AI means it probably isn't the right time to bet on either company.

With a forward P/E of just 31, Nvidia's valuation seems to price in most of the risk. However, Palantir's forward P/E of 87 looks too high. And that could mean significant downside if the company doesn't meet lofty expectations.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.