Surging demand for high-powered chips made Nvidia the king of AI stocks. But as the generative AI craze rages on, Wall Street's focus is expanding to companies like MongoDB, Confluent and Elastic that are poised to ride a gigantic spending wave in data software.
Data has become even more valuable for enterprises as they scramble to build AI-powered tools like customer-service chatbots and workplace assistants. The trend opens up opportunities for data-focused software firms, even as they grapple with a Wall Street slump and worries that payoff from AI investments will take longer than expected. But they won't be the only competitors in the ring. Faceoffs loom with software behemoths like Microsoft and Oracle — and with Nvidia itself as the chip powerhouse makes moves into software.
"In the long run, this is going to be very, very significant for us," said Elastic Chief Executive Ash Kulkarni, in an interview shortly after the company's stock fell on its Feb. 29 earnings report. "We can see how it's improving and increasing the total addressable market. But it's not going to happen overnight."
AI Stocks: Bumpy Ride For Data Software
The recent market slump underscores this. The long list of hot AI stocks of 2023 that have struggled this year include Adobe, MongoDB and Snowflake.
The iShares Expanded Tech-Software ETF, which holds shares of more than 100 enterprise software players, gained just 5% in the first quarter of 2024, compared with a 19% gain in the last three months of 2023. The Nasdaq composite index, meanwhile, advanced 9% in the first three months of 2024.
"Across every stock or company associated with generative AI, expectations got there very quickly," William Blair analyst Sebastien Naji told Investor's Business Daily. "And these things take time."
Research firm Gartner expects global IT spending to rise 8% in 2024, to more than $5.06 trillion. Software spending is expected to grow 13.9% year-over-year, compared to 12.6% growth last year. Meanwhile, Gartner expects spending on data center systems to jump 10% in 2024, compared to 4% growth last year. And spending on devices will swing from a 9% decline last year to 3.6% growth this year, according to Gartner.
"In 2023, enterprises were telling the story of GenAI and in 2024 we are seeing most of them planning for eventual execution in 2025," Gartner analyst John-David Lovelock wrote in the report.
Broader Macro Concerns
In the meantime, Brent Thill, a software analyst with Jefferies, noted in a March report to clients that 50% of companies in his coverage issued 2024 sales guidance below consensus expectations in the most recent round of earnings.
There are also broader economic concerns. Many software firms are still recovering from a spending slowdown that began in 2022.
"Rates remain high, (and) the macro narrative is dictating the mood of the market," Tejas Dessai, a research analyst at financial firm Global X, told IBD. "But at the same time, you have this enthusiasm for AI. It is a tug of war between these realities."
Business Software Spending Outlook
But as in other emerging tech trends, software's time will come, executives and analysts say.
Elastic's Kulkarni points to the first web boom of the 1990s. At that point, "the first things that were just flying off the shelves were routers, networking devices and servers," Kulkarni told IBD.
With time and a few headaches along the way, it was internet software that "just completely exploded," Kulkarni said. "And now nearly everything you do is online."
The AI ROI
Similarly, the early days of the AI boom have been mostly about tech infrastructure spending.
Cloud computing giants Microsoft, Amazon and Alphabet's Google are investing billions to build AI-capable data centers. So is social media giant Meta Platforms. Chips made mostly by Nvidia are at the heart of those data centers. That computing capacity is then used to train powerful large language models like OpenAI's ChatGPT.
But software companies, particularly companies focused on data storage and management, hope to grab a big piece of the AI pie.
Wedbush analyst Daniel Ives estimates that "AI and related purchases will comprise 8% to 10% of IT budgets in 2024 vs. less than 1% in 2023."
"This will be a massive growth catalyst for the likes of Microsoft, Salesforce, Palantir Technologies, MongoDB, Oracle, Snowflake, Elastic and others in this 'initial wave of AI software growth,'" Ives told clients in an April 14 note.
In previous reports, Ives estimated that every $1 spent on Nvidia chips could eventually drive an additional $10 to $12 in broader software and IT services spending.
AI Stocks: Focus On Data
The rapid rise of generative AI turned the spotlight on the importance of data.
Massive amounts of data and powerful computing enable AI tools like ChatGPT to spit out humanlike responses, including generally high-quality text, images and video.
But large language models pose challenges to enterprises, which must grapple with issues of privacy and security. Gaps in the data used to train an AI model can lead to strange answers, which the industry calls hallucinations.
"When you apply a very powerful technology on data that is not reliable, you do not get anything good," Shaun Clowes, chief product officer at Confluent, told IBD.
RAGs To AI Riches
MongoDB, Elastic and Confluent are banking on the power of their technology to help manage the massive amounts of data needed to help their clients use AI.
Elastic, which has a market cap near $10 billion, saw its shares double in value in 2023, helped by AI excitement. The company provides the leading search software for enterprises, along with a broader suite of data software tools that run on cloud providers such as Microsoft Azure, AWS and Google Cloud.
Last year, Elastic expanded its tools dedicated to AI. One point of focus is called retrieval augmented generation, or RAG, which lets companies retrieve and insert their data into an AI model. The company sees its search capabilities as being crucial to finding the right information to supply to AI models, Kulkarni told IBD.
MongoDB, meanwhile, has expanded its offerings as well. The company, with $25 billion in market cap, provides advanced database software. Its main product is the subscription-based Atlas, which integrates with the major cloud providers. Last year, it launched vector search to help power RAG. Vector is a type of flexible database that has become a go-to for developers using generative AI.
Ittycheria told IBD he sees MongoDB's broader data platform helping unify different data sets, addressing one of the "hardest problems" for developers while adopting AI.
AI Stocks: The Role of RAG
Confluent, which describes its software as a central nervous system for an enterprise's data, has a market cap near $9 billion. The company sees an opportunity to use its software to deliver "great information into the RAG stack," said Clowes, the company's chief product officer.
The RAG concept is straightforward, he said: "What you really have is a foundational model that meets your enterprise data to power a feature."
But for most organizations, getting access to the right data at the right time is very difficult, he said. Companies are constantly collecting new data on top of decades of existing information. That's where Confluent steps in.
Last fall, Confluent launched Data Streaming for AI, which Clowes described as a "RAG stack in a box." It partnered on the initiative with a list of database providers that includes MongoDB and the vector-focused startup Pinecone.
Performance Of AI Stocks
But it's been a rocky period on Wall Street for the three companies.
Elastic shares hit a two-year peak of 136.06 on Feb. 29, building on a big jump in the final months of 2023. But the stock fell fast following its January-quarter earnings report that same day.
The firm topped estimates with adjusted earnings of 36 cents a share on sales of $328 million, up 18%. But growth for its Elastic Cloud business came in slower than expected, analysts noted.
Elastic stock is down 10% this year and nearly 30% off its February high.
MongoDB, which also saw its share price double in 2023, fell after its earnings report in March. Sales grew a better-than-expected 27% to $458 million for the January quarter.
But MongoDB's revenue outlook for the rest of the fiscal year came in lighter than expected. The stock is down 10% to start the year and more than 30% off a 2024 high of 509.62 on Feb. 12.
Confluent stock, on the other hand, is up more than 20% this year. Confluent stock jumped on Feb. 7, when it reported that sales increased 26% to $213.2 million for its December quarter. But its shares are still working back from a 40% slide that followed its third-quarter results in November.
In the most recent round of earnings, leaders from each company had a similar message for analysts: Customers are excited about AI, but it is still early in development.
AI Stocks: Cautious Enterprises
AI remains a strong trend, but many companies are proceeding with caution.
A recent survey by Morgan Stanley analysts of 100 chief information officers found that about 89% of CIOs expect to deploy some sort of generative AI project in the "near future." But for the majority of respondents, that means either the second half of this year or in 2025 and beyond.
Companies are balancing a range of concerns.
A survey of 2,800 executives by Deloitte in January found that only about a quarter of leaders believe their companies are "highly prepared" to address governance and risk issues related to generative AI.
About 79% of companies expect Gen AI to drive "substantial organizational transformation" in fewer than three years, according to Deloitte.
"We're seeing more and more conversations asking 'How do we go from exploration to scaling?'" Nitin Mittal, Deloitte's Global AI and Emerging Markets leader, told IBD.
AI Stocks: A Fast-Evolving Trend
For MongoDB, Elastic and Confluent, the challenge will be navigating a fast-evolving trend featuring big and small players jockeying for position.
The cloud giants — Amazon, Microsoft and Google — are racing to beef up their AI capabilities. Oracle, the legacy database giant, is banking on AI-powered growth to expand the reach of its own cloud business. These tech giants also offer software to enable clients to launch AI tools.
Meanwhile, Nvidia is moving quickly to defend its AI lead, including expanded software capabilities. The chip giant offers the Nvidia AI Enterprise, a cloud-native software platform it says provides "end-to-end AI solutions."
The chipmaker has "aggressively moved up the stack," Global X's Dessai told IBD. He said Nvidia essentially is declaring, "Not only will we sell chips, but we will also sell you the software and infrastructure that allows you to gain maximum efficiency from our chips."
Then there are the startups led by OpenAI, whose ChatGPT launch in 2022 triggered the AI frenzy, that are targeting the enterprise market. Another AI challenger is Databricks, a rising data management startup which has been valued at $43 billion.
AI Stocks: Technical Scores For Data Players
MongoDB, Confluent and Elastic remain highly rated stocks. Together with Oracle, the four are among 22 stocks in the IBD Computer Software-Database group. The group has been among the top- ranked industry groups, based on six-month price performance, for the past several months.
But technical ratings for some of its top firms have declined in recent weeks. According to IBD Stock Checkup, MongoDB stock is ranked No. 11 in the industry group. It has a Composite Rating of 79, an EPS Rating of 80 and a Relative Strength Rating of 39, each out of a best-possible 99.
With its stronger recent run, Confluent ranks second in the Software-Database group. It has a Composite Rating of 95, an EPS Rating of 81 and a Relative Strength Rating of 61.
Elastic stock, meanwhile, ranks fourth in the industry group. It has a Composite Rating of 92, an EPS Rating of 81 and a Relative Strength Rating of 79.
Commvault Systems, which provides data security tools, leads the Computer Software-Database group. Commvault, Elastic and Confluent are on the IBD Tech Leaders list, which ranks the top technology stocks based on standard stock metrics and IBD's proprietary rating system.
AI Stocks: The Focus On Software
The AI spotlight on software is expected to grow stronger. That's good news for companies like MongoDB, Elastic and Confluent. BofA Securities analyst Alkesh Shah expects generative AI "to drive the next leg of software investment, revenue growth and margin expansion."
"But investors frequently overestimate the magnitude of tech disruption in the near term and underestimate it over the longer term," he told clients in a note.
The consensus is that AI is a long-term trend. And it will take time to figure out which players are in a position to play the long game.
"Who is doing better comes back to: Where are their customers in the adoption life cycle?" William Blair's Naji told IBD. "Are they still in the experimentation and training phase? Or have their customers crossed the chasm, and are running these in production?"
