AI Hardware Stocks Take a Hit Following DeepSeek Model Reveal

Shares of companies linked to AI hardware fell sharply on Monday, including Taiwan Semiconductor Manufacturing (NYSE: TSM), Marvell Technology (NASDAQ: MRVL), and Arista Networks (NYSE: ANET). By 1:11 PM EDT, the stocks had declined 14.4%, 18%, and 21.9%, respectively.

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The sell-off’s trigger was last week’s introduction of the AI reasoning model, DeepSeek V3 R1. Over the weekend, it became clear that DeepSeek, a lesser-known Chinese AI lab, had developed a leading AI model that required far less computing power than previously believed.

DeepSeek Shakes Up AI Expectations

Founded in 2023, DeepSeek emerged from a quantitative hedge fund named High-Flyer, which Liang Wenfeng started in 2015. The organization released its large language model, V3, in December, followed by the reasoning model R1 on January 20. Surprisingly, R1 matches or outperforms the latest OpenAI reasoning model, o1.

Notably, DeepSeek could achieve this at a fraction of o1’s costs, using technology limited by U.S. trade restrictions on advanced AI GPUs from 2022 and 2023. In terms of expenses, DeepSeek claims costs were one-tenth to one-thirtieth of those incurred by OpenAI and other leading firms. Their research paper elaborates on how strategic hacks were used to optimize limited hardware, passing scrutiny from industry experts.

As a result of this breakthrough, many AI hardware stocks faced significant sell-offs. The prevailing thought is that companies may now have to allocate less funding towards AI infrastructure to develop advanced models, impacting previously inflated valuations negatively.

This situation poses potential challenges for Taiwan Semiconductor, which currently dominates the market for leading-edge AI processors. Recently, the company reported outstanding earnings and anticipated increased capital investment for the coming year, pushing its valuation above 30 times its earnings before the downturn.

Marvell Technology, known for manufacturing various chips for AI infrastructure, including custom designs for major cloud providers, saw its stock surge by 83% in 2024. Heading into today, its valuation stood at 46 times expected earnings.

Similarly, Arista Networks, a top player in data center networking producing high-performance switches, had a robust 2024 with an 88% rise in stock value, trading at 62 times earnings based on projections of extensive future AI data center expansions.

With such high valuations, the uncertainty introduced by the DeepSeek model understandably caused a sharp decline in these stocks.

Image source: Getty Images.

Are Investors Overreacting?

Some analysts on Wall Street view the recent decline as a potential buying opportunity for AI hardware stocks, citing two primary reasons. First, they speculate that DeepSeek’s reported costs may underestimate the true operational costs. Second, there are concerns that DeepSeek may possess unauthorized access to Nvidia (NASDAQ: NVDA) H100 chips.

Yet, many industry experts trust the figures provided by DeepSeek and believe the cost to train and run AI models will decrease significantly. If the costs drop, it could lead to increased AI usage, which may ultimately boost profits for AI hardware companies.

However, a shift in demand could favor inferencing hardware—used for real-world applications of AI models—over training hardware, which has previously seen the bulk of investment. Thus, investors might need to reconsider their approach moving forward.

Additionally, as always, high valuations carry increased risks. These market changes underscore the importance of valuation, even among strong-performing firms.

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Billy Duberstein and/or his clients hold positions in Taiwan Semiconductor Manufacturing. The Motley Fool has interests in and recommends Arista Networks, Nvidia, and Taiwan Semiconductor Manufacturing, and recommends Marvell Technology. The Motley Fool maintains a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.