The impressive rise in tech stocks recently is thanks in large part to the frenzy going on in artificial intelligence (AI) stocks. After the euphoric rise in Nvidia (NVDA, Financial) shares, it's only natural to ponder whether we're seeing another bubble inflating in the stock market. Indeed, it did not take long for Nvidia stock to hit the $1 trillion market cap milestone this year. Though shares finished the Tuesday session of trade slightly lower than the level, it's hard to tell how much room Jensen Huang's GPU juggernaut has left to run if a bubble is truly forming.
Thankfully, I don't see tech as a whole developing any sort of bubble. There's no denying that various valuation metrics have swelled for AI stocks in recent quarters. However, Wharton professor Jeremy Siegel doesn't think AI stocks are in a bubble. Things could change at the pace of their rapid rise. For now, I'm not against betting on AI stocks, even after their recent gains. That said, investors must be careful which companies they choose to place bets on at this juncture.
Growth at any price is not my style, though, not with interest rates at where they are. Should the Federal Reserve decide that it's not yet finished with the current rate-hike cycle, traders chasing names like Nvidia could find themselves at risk of substantial downside.
Not all is lost for those looking for value in the tech sector, though. There is one tech stock in particular that I believe is undervalued at the moment: Activision Blizzard (ATVI, Financial).
Activision Blizzard is a wonderful company
Nobody knows if Activision Blizzard will actually be gobbled up by the $2.5 trillion software giant that is Microsoft (MSFT, Financial). It could go either way at this point. Microsoft is determined, but regulators are pushing back. Regardless, I think Activision Blizzard has proven it can be a wonderful company on its own, even without help from the second-largest company on the planet.
The $69 billion takeover by Microsoft would certainly put quite a bit of cash into the pockets of Activision shareholders. Still, one has to wonder how high the capable video game company can rise if it were to stand on its own. I actually believe Activision Blizzard may be able to command much greater gains for investors over the next three (or even two) years that it would if it became part of Microsoft.
On June 6, Diablo IV is slated to launch. With an impressive few rounds of beta testing, I think the launch will be met with profound success. Early ratings of the game suggest the title will be a smash hit, with a solid 9 out of 10 rewarded by IGN. Diablo is one of the franchises that is very hard for other video game companies to top, in my opinion. Sure, it's an old-school hack-and-slash game with updated graphics. However, it's easy for non-gamers to overlook the impressive mechanics and the loot system. It's a refinement of the little details that make Activision Blizzard such an amazing video game company.
Similarly, Activision's Call of Duty franchise seems to have the mechanics and gameplay that have won over the hearts of gamers. Moving ahead, I expect the company's formula for quality will continue to help Activision Blizzard thrive in the video game market. After the recession passes, I'd look to $69 billion as a level to be surpassed if the Microsoft deal falls through.
What about valuation?
AS of this writing, shares of Activision Blizzard trade at a price-earnings ratio of 33.34 and a forward price-earnings ratio of 20. That may not seem like a bargain, even for a tech stock. However, given the slump the gaming industry has been in over the past few years, I'd argue the current multiples do not tell the full story.
As consumer wallets heal in a post-recession economy, I'd look for Activision Blizzard to be one of the bigger winners. In many ways, the video game company may be viewed more as a consumer discretionary than an innovative tech stock. Personally, I think it's both. As the economy tests recession territory in the second half of this year, I'd look for Activision Blizzard to keep investing heavily in titles that many gamers cherish. If the company can keep executing, it may be able to take some market share away from competitors in the gaming scene.
Final thoughts
Some traders see a merger arbitrage opportunity in the shares of Activision Blizzard today. I see a wonderful company that can do well, with or without Microsoft as an acquirer. As a long-term investor and shareholder of Activision myself, I would not be too disappointed if the Microsoft deal ends up falling through. Had Activision Blizzard not been a wonderful company, then sure, I'd really be hoping Microsoft is able to appease the regulators.
