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Artificial intelligence (AI) has emerged as one of the most compelling investing themes of 2023. Optimism about AI helped propel many U.S. tech stocks higher, with Nvidia (NVDA) joining the $1 trillion market cap club this year.
The tech rally was broad-based, and the Nasdaq Composite ($NASX) had its best first-half performance in four decades. The index rose almost 32% over the period, and in absolute terms, the constituents added over $4 trillion in market cap.
In fairness, there were multiple factors – including the 2022 crash that made tech valuations appealing, as well as better-than-expected economic data – that helped propel tech stocks higher. However, it's impossible to overlook the AI factor, as investors overwhelmingly looked to tech stocks to play the emerging AI story.
Analysts Mixed on Artificial Intelligence
The market’s opinion on AI is somewhat mixed. On one hand, we have brokerages like Citi, which see a “euphoria” - while on the other hand, Wedbush analysts term the current climate as an “AI revolution.”
Investors have reason to be apprehensive amid the rally in AI stocks. After all, we have seen several boom-and-bust cycles in “emerging industries” – including green energy, metaverse, and blockchain – over the last five years. While all of these “revolutionary” industries are still interesting long-term stories, all have undergone a shakeup as multiple players are now fighting for relevance, while others have gone out of business entirely.
However, AI is not exactly a new technology, and companies have used it alongside Machine Learning (ML) for years. This is certainly a pivotal year for AI, though, thanks to the popular reception for generative AI apps like ChatGPT.
Of course, like any other emerging industry, there will be winners and losers in AI, as well. That said, I believe Amazon (AMZN) and Nvidia look like two good plays on AI.
Nvidia: One of the Best Ways to Play AI
While a lot of tech giants, including Alphabet (GOOG) and Microsoft (MSFT), are working on generative AI, they have yet to fully monetize their investments. Revenue realization will be staggered, at best, for many of the companies that are working on AI.
It’s a different story for Nvidia, which designs and sells the GPUs underpinning some of the most widely used AI technology. Unlike most other tech companies, Nvidia has been an immediate beneficiary of the AI pivot, as demand for its chips has already skyrocketed.
This was best highlighted in its fiscal Q1 2024 earnings release in May, where revenues of $7.19 billion easily exceeded the $6.52 billion analysts were expecting. Even more impressive, Nvidia's revenue guidance of $11 billion for the fiscal second quarter was over 50% higher than what analysts expected.
Wall Street analysts expect the company’s revenues to rise 61.2% and 29.2%, respectively, in the current and next fiscal years. Earnings are projected to rise 162% and 44% during each of these two years.
NVDA's Not That Expensive Post-Rally
NVDA stock has tripled this year, so there are bound to be questions over its valuation. However, its forward 12-month price-to-earnings multiple of 47.8x is actually similar to its average over the last three years.
Also, apart from generative AI, Nvidia is also benefiting from the shift towards autonomous cars, and sees that business as a $300 billion opportunity.
To sum it up, I believe Nvidia is among the best ways to play the AI story, and the Santa Clara-based company could continue to reward investors over the long term.
Amazon: An Underappreciated AI Story
Amazon hasn’t seen the kind of rerating that some other AI plays have seen over the last six months. While the stock has rallied this year and is outperforming the markets, I believe there are still legs in the rally as markets start appreciating its AI business.
The company uses AI in several business functions, including its enterprise-focused Amazon Web Services (AWS), Alexa, logistics, as well as grocery stores.
During the company’s Q2 2023 earnings call – where it posted better-than-expected earnings and provided upbeat guidance for Q3 – Amazon also extensively talked about its AI initiatives.
CEO Andy Jassy said that data is the “core” of AI while adding, “AWS not only has the broadest array of storage, database, analytics, and data management services for customers, it also has more customers and data store than anybody else.”
He added separately, “every single one of our businesses inside of Amazon, every single one has multiple generative AI initiatives going right now.”
Responding to an analyst question on the monetization of AI, Jassy said, “We're a few steps into a marathon in my opinion. I think it's going to be transformative, and I think it's going to transform virtually every customer experience that we know.”
AMZN's a Reasonably Valued AI Play
Amazon is a play on multiple high-growth and secular themes, including e-commerce, cloud, streaming, digital advertising, and AI.
The company’s Q2 earnings beat and strong Q3 guidance corroborate my view that Wall Street was a bit too pessimistic about Amazon’s revenue, as well as its profitability outlook.
I believe as the company starts integrating AI across its business functions, an initiative highlighted during the Q2 earnings call, it will not only be able to cut costs even further, but also improve the customer experience - which could eventually lead to higher revenues and profits in the coming quarters.
While Amazon might not be a pure-play AI stock in a strict sense, it's nonetheless among the best ways to play the AI story - and with a forward 12-month price-to-sales multiple of 2.24x running below the five-year average of nearly 3x, I find it reasonably valued at these levels.
On the date of publication, Mohit Oberoi had a position in: AMZN , NVDA , MSFT , GOOG . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
