Editor’s Note: Recently, AI stocks have been swinging between rallies and sell-offs, as market scrutiny intensifies over whether massive capital expenditures will translate into revenue and profits. On October 29, Alphabet’s earnings report triggered a new round of adjustments, with its stock dropping 12.6%, the Nasdaq falling about 1.4%, and the semiconductor sector ending a four-day winning streak. Financing costs, cash flow, and return on investment are now key variables influencing the AI market.
Increased volatility has also left investors facing a recurring question: Is the current decline offering a better buying opportunity, or is it revealing deeper risks?
The key judgment must rest with the company itself. Finimize analyst Theodora Lee Joseph proposes a four-step framework: identify the true catalyst for the sell-off, assess whether the profit outlook has changed, evaluate whether the valuation adequately reflects the risks, and then decide whether to buy, reduce, or wait.
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Every few months, AI stocks seem to go through a similar cycle: negative news triggers a sell-off, reigniting debates about a bubble; then, strong earnings reports ease concerns, prompting capital to flow back into familiar companies—until the next round of volatility emerges.
For investors, the challenge lies in determining whether the current decline offers a better buying opportunity or signals deeper underlying issues.
It’s difficult to answer this question by following market sentiment alone, as markets may overreact or underestimate risks. Finimize analyst Theodora Lee Joseph proposes a four-step analytical framework: identify the true catalyst for the sell-off, assess whether the company’s prospects have changed, evaluate whether the price fully reflects the risk, and then decide whether to buy, reduce exposure, or wait.
Step 1: Identify the true cause of the decline
When a stock begins to decline, various explanations often emerge quickly. However, before accepting a seemingly plausible story, it’s more useful to revisit the timing of the price movement and confirm what actually triggered the selling.
Catalysts could include an inflation report higher than expected, rising Treasury yields, disappointing earnings reports, or a company cutting its AI spending plans. Company announcements, earnings reports, and direct statements from management are typically more valuable than market speculation about traders' psychology.
Next, observe which companies are affected by the decline.
If the Nasdaq as a whole declines while U.S. Treasury yields rise, the pressure may primarily stem from interest rates. Higher yields reduce the present value of future profits, which is particularly detrimental to technology stocks whose valuations rely on long-term growth.
If chip companies experience a concentrated decline while other sectors remain relatively stable, investigate whether there have been changes in chip demand, supply, or competitive dynamics. If data center operators with high debt levels show the largest declines, financing costs and debt repayment capacity may be the core issues.
The most important thing to avoid here is treating a triggering event as the final conclusion. A company’s earnings miss can easily be overstated as evidence of a collapse in demand across the entire AI industry. However, a stock price decline alone does not prove this. The first step is to confirm what actually happened and which companies were truly affected.
Step 2: Verify whether the original investment logic still holds.
After identifying the trigger, further evaluation is needed: Has the news altered the company’s ability to generate profits over the next few years?
First, examine growth expectations. Are customer demands stable, is revenue expanding as expected, is management maintaining its guidance, and have analysts lowered their profit forecasts for the next one to two years?
A strong quarterly performance that exceeds expectations does not mean there are no underlying issues. If revenue and profit forecasts for the coming year continue to decline, even an impressive quarterly report may not be enough to support the stock price.
Second, examine business quality. Can the company consistently generate cash flow? Is its market share stable, and is its competitive advantage being eroded?
For AI chip companies, a temporary slowdown in industry orders and customers shifting to competitors offering lower prices and better performance are two distinct types of risks. The former may recover with industry cycles, while the latter could indicate long-term damage to profitability.
Finally, examine the balance sheet. Companies with ample cash and manageable debt are better positioned to weather difficult periods. Companies that rely on borrowing or continuous financing to sustain expansion have less room for error when funding costs rise.
If the message does not fundamentally alter future profitability, the decline may reflect more emotional sentiment or valuation adjustments. If the profit outlook has already deteriorated, continue assessing whether the current decline sufficiently reflects these losses.
Step 3: Determine whether the stock price has fully reflected the risk.
Even if a company does encounter issues, the market may overreact. But a 30% drop in a stock could signal an opportunity—or it could be just the beginning of a larger decline.
The key determinant is valuation, not the previous stock price.
For profitable companies, begin by examining the forward price-to-earnings ratio (Forward P/E), which indicates how much investors are paying for each yuan of expected future earnings per share. When comparing valuations before and after a price decline, account for changes in earnings forecasts.
For example, if a stock's price falls by 20% but its expected earnings per share decline by 30%, its forward P/E ratio may actually rise by approximately 14%. Although the stock price has decreased, the cost to investors for each dollar of expected earnings has increased.
The macroeconomic environment can also alter fair valuation. Even if a company’s profit forecasts remain stable, rising interest rates may reduce the present value of future earnings. Therefore, “fundamentals haven’t changed” does not automatically mean the stock price should return to its previous high.
For companies that have not yet turned a profit, evaluation should consider the price-to-sales ratio, potential future profit margins, and the time required to generate cash flow.
A more prudent approach is to establish three scenarios—optimistic, neutral, and pessimistic—and estimate the company’s potential profits and the valuation the market might assign under each. While this won’t yield an exact price, it helps assess how much growth expectation and operational risk are currently embedded in the stock price.
"More expensive in the past" is merely a price record and cannot alone serve as a reason to buy.
Step 4: Turn the judgment into action and set correction criteria
After completing the first three steps, investors should be better able to determine: what is driving the decline, whether the company’s prospects have changed, and how much bad news is already reflected in the current price.
If the business remains solid and the valuation is below a reasonable range, selling may present an opportunity. However, there’s no need to chase the absolute bottom. Dollar-cost averaging can help reduce the risk of timing the market, provided the underlying investment thesis remains intact.
If the company’s prospects continue to deteriorate while its valuation remains high, consider reducing your exposure. When evidence is insufficient, waiting is also a valid strategy.
Investment decisions should also be evaluated within the context of the entire portfolio. Holding five different AI stocks may appear diversified, but if they all rely on the same wave of data center construction and capital expenditure expansion, the actual risk remains highly concentrated.
Finally, write down in advance what changes would prompt you to adjust your judgment, such as downward revisions to profit forecasts, increased debt, significant customers reducing purchases, or valuation clearly deviating from a reasonable range.
Investment confidence requires evidence to support it—and room for correction. The cost of clinging to an outdated judgment may far exceed the cost of acknowledging it is no longer valid.
Use this framework to understand this round of AI sell-off
Applying the above framework to the October AI stock adjustment requires distinguishing between funding risk and demand risk.
According to Finimize’s analysis, this round of pressure stems from concerns triggered by reports on OpenAI’s revenue, as well as financing worries driven by inflation and rising U.S. Treasury yields. Companies like CoreWeave, which rely on external funding for expansion, are more vulnerable to the impact of higher borrowing costs.
However, difficulty in financing does not directly prove that customers have reduced their use of AI. As of the original article’s publication, Finimize analysts noted that there is still no sufficient evidence to indicate a broad slowdown in demand, and large tech companies continue to invest in infrastructure.
Differences in the reported revenues of OpenAI also require verification of the accounting standards. According to Finimize, some of the higher figures include sales from cloud partners, while OpenAI itself has only confirmed revenue attributable to the company. To determine whether demand has deteriorated, these accounting methods must be further verified; conclusions cannot be drawn solely based on the discrepancy between two figures.
Tighter financing may also lead to industry consolidation. If smaller operators cannot secure funding, new computing power supply will be constrained, while demand continues to grow—large tech companies with ample cash reserves and the ability to sustain construction may gain a more favorable competitive position.
The impact of this logic varies across different companies. Microsoft can leverage its strong financial position to continue expanding; NVIDIA, while potentially benefiting from purchases by major cloud providers, faces risks such as financing difficulties and order reductions from clients like CoreWeave. Whether large customers can make up for this gap is an unverified variable.
Therefore, future earnings reports should focus on three key areas: whether large tech companies maintain their AI capital expenditures, whether demand for cloud computing remains stable, and whether future profit forecasts are revised downward. If major vendors begin broadly cutting budgets, the outlook for demand and orders will need to be reassessed.
True buying opportunities require alignment among business fundamentals, valuation, and financial resilience; true warning signs emerge when financing pressures begin to affect projects, orders, and profits, yet the stock price has not yet fully reflected these changes.