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Artificial intelligence (AI) is almost like King Midas. Nearly everything it touches turns to gold. Just look at the stock charts of many of the leaders in AI chips and software.

But just as the story of the fabled king took a turn for the worse, some of the stocks that have been gold mines for investors just might be headed for a rough patch. These high-flying AI stocks could sink 20% or more over the next 12 months, according to Wall Street.

Arm Holdings: The sizzle could fizzle

Arm Holdings (NASDAQ: ARM) shares have more than doubled over the last 12 months. Most of the huge gain came in February after the chipmaker topped analysts' fiscal 2024 third-quarter revenue and earnings estimates and provided upbeat sales guidance.

There's no doubt whatsoever that AI is the primary source of Arm's good fortunes. CEO Rene Haas said in the quarterly conference call that the company is "seeing strong momentum and tailwinds from all things AI." That's great news since, as Haas wrote to shareholders, "From the most complex AI cloud applications to the smallest edge devices, AI on Arm is everywhere."

Haas wasn't exaggerating. Nvidia's GH200 Grace Hopper Superchip uses Arm technology. So does Alphabet's Google Gemini Nano large language model (LLM) that runs on Pixel 8 smartphones. Other companies, including Samsung and Vivo, have also announced new smartphones that use Arm technology to run generative AI apps.

However, many on Wall Street think that Arm's sizzle will soon fizzle. The average 12-month price target for the stock is 25% below the current share price. The most pessimistic analyst projects that Arm's shares could plunge nearly 60%.

Why such negativity? Valuation is the main culprit. Arm's shares now trade at a forward price-to-earnings ratio of 78x.

Palantir Technologies: A polarizing AI software leader

While AI chip stocks have ranked among the biggest winners, several AI software stocks have also delivered big gains. Palantir Technologies (NYSE: PLTR) is a good example, with its share price soaring nearly 50% over the last 12 months.

As was the case with Arm, much of Palantir's impressive returns have come this month after a positive quarterly update. Palantir beat the consensus revenue estimate for the fourth quarter but only matched earnings expectations. Moreover, the company's outlook for full-year 2024 projected year-over-year revenue growth of over 19% at the midpoint of the guidance range.

Palantir CEO Alex Karp wrote in his annual letter to shareholders that the company is seeing "surging demand" for AI platforms, including LLMs. The launch of Palantir's Artificial Intelligence Platform (AIP) is a major growth driver for the company.

Despite all of this great news, Wall Street isn't excited about the stock's prospects. The average price target for Palantir reflects a downside potential of roughly 20%. RBC Capital is especially pessimistic, with a price target that's nearly 80% below Palantir's current share price.

Again, valuation is a top concern for analysts. Palantir's shares trade at nearly 72 times expected earnings.

Is Wall Street right about these AI stocks?

I wouldn't bet the farm that Wall Street's less-than-rosy price targets for Arm and Palantir will be proven right over the next year. Investors' excitement about AI could remain frenzied enough to keep both stocks' momentum going.

However, I agree with analysts who think these stocks have frothy valuations. Neither is currently delivering the growth required to justify such premium prices, in my view. I think that nvestors looking for great AI stocks to buy can find better picks.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Keith Speights has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.

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