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3 Top Artificial Intelligence Stocks to Buy in October

By Nicholas Rossolillo – Updated Oct 5, 2020 at 11:56AM

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Google, a chip designer, and an emerging leader in enterprise software top the list.

Artificial intelligence (AI) is a fast-growing segment of technology. According to researcher IDC, global spending on AI (hardware, software, and services built on them) is expected to exceed $150 billion this year. By 2024, IDC expects the total to exceed $300 billion.  

However, as big as it's getting, there are few viable AI pure-play stocks, and investors won't see a line item on tech companies' income statements labeled "AI revenue." Rather, these intuitive systems are being built into existing operations to help organizations increase efficiency. Nevertheless, it's still possible to invest in the growth of AI. Marvell Technology Group (MRVL 0.56%), Google parent Alphabet (GOOGL -0.90%) (GOOG -0.84%), and salesforce.com (CRM -1.31%) top my buy list for October. Let's take a closer look at these three companies.

someone in a business suit holding a tablet. A brain illustrated with electrical connections hovers above the screen.

Image source: Getty Images.

1. Marvell: An emerging leader in modern networking infrastructure

As with all software and digital services technologies, AI starts with some basic building blocks: semiconductors. High-end and complex computing processes like AI are demanding chips that can deliver a combination of fast processing speed, the massive movement of data at speed, and power efficiency. 

Marvell does just that and is picking up some new business as its customers' needs evolve. The company designs a diverse mix of chips for data centers, 5G wireless network equipment, auto manufacturers, and other industrial equipment. Among other related hardware, the company is a leader in developing data processing units (DPUs) for cloud computing based on designs from Softbank-owned Arm Holdings -- the company NVIDIA (NVDA -1.19%) is attempting to acquire for $40 billion.

In fact, NVIDIA CEO Jensen Huang has indicated the importance of the DPU for the future of computing. According to Huang's vision, the old CPU standard will continue as a general-purpose processor, the GPU (NVIDIA's specialty) as a computing accelerator, and the DPU as a mover and manager of massive amounts of data. And it's this latter type of chip that is helping Marvell find new business among cloud service providers, autonomous vehicle and advanced driver assist system designers, and new mobile network infrastructure builders.  

As for how an NVIDIA/Arm tie-up would affect Marvell, that remains to be seen. Any closing of the deal, if it happens, is likely to take quite some time as it will need to clear numerous regulatory hurdles around the globe. But in the meantime, Marvell is registering robust growth. Revenue grew 8% during the first half of 2020, and another 13% increase is expected during the third quarter. The stock trades for 65 times trailing 12-month free cash flow (revenue less cash operating and capital expenses) -- a figure that includes the $600 million takeover of Avera in late 2019 -- or 19 times trailing 12-month earnings. This growing AI hardware technologist looks like a value.

2. Alphabet: A ubiquitous internet essential gets smarter

On to the more familiar. AI lies at the core of most services delivered by Google and its sprawling empire housed under the Alphabet parent organization. Advertising remains the primary income generator here, comprising 78% of revenue during the second quarter of 2020. Built into the various internet search-based services (all paid for by advertising) is AI -- both to bring relevant information to the user and to deliver insights for the organizations paying for the ads themselves.  

Moving beyond the ad empire, Google's fastest-growing segment Google Cloud (which grew 43% in the second quarter) has a myriad of AI-enhanced services available for customers, from simple productivity tools like docs and spreadsheets to more complex services like software development and data analytics tools. And then there's the hardware side of the equation, including Pixel phones and tablets, smart speakers and displays, and Nest smart home equipment -- all of which come packaged with Google Assistant.

Google uses these profitable businesses to invest in AI research and new services built on it. These projects span everything from quantum computing to start-ups like self-driving car outfit Waymo. This research racks up substantial losses right now, with the company's "other bets" segments generating operating losses of $1.12 billion on revenue of just $148 million during Q2 alone. But even the profit-draining experiments combined with a difficult period during the height of the COVID-19 lockdown did little to hurt the internet search leader. Total operating profit was $7.57 billion, good for an operating margin of 20%.

Additionally, Google has some of the deepest pockets around with net cash of $117 billion. Shares trade for 35 times trailing 12-month free cash flow, a premium I think is well worth the money for investors wanting to bet on the long-term growth of AI and related tech.  

3. Salesforce: The new standard in enterprise software?

Customer relationship management and general digital transformation software company Salesforce is another platform that has AI embedded throughout its services. Billed as "Einstein," Salesforce's AI can help its users predict customer needs, map out a marketing strategy, and integrate with an organization's digital data to build new apps and services.

The massive enterprise software platform has been adding some especially timely new tricks to its arsenal as of late. Recently, Salesforce expanded the use of its new Work.com (a suite of software designed to help organizations return to work safely during the pandemic) to help manufacture, distribute, and administer vaccines. New cloud products for communications, media, energy and utilities, and public sector organizations were also unveiled. And a company report discussing the looming holiday shopping season highlighted a surge in e-commerce and order fulfillment bottlenecks. Salesforce has a solution for managing orders and logistics too.

All of this builds on what has thus far been the company's relentless advance, averaging well over 20% revenue growth each year over the last decade. The expectation is that its 20%-plus growth streak will continue this year as well, with management predicting at least 21% year-over-year revenue growth to $20.7 billion. Salesforce is quickly becoming a new staple software service for enterprises, much like productivity tools built by Microsoft became staples in decades past.  

Shares have recently pulled back just over 10% from all-time highs. This is a pricey stock (price to trailing 12-month free cash flow of 65, reflecting Salesforce's heavy spending during COVID-19), but it carries a high premium for good reason. I remain a buyer of this AI-enabled software leader after the stock's recent breather.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Nicholas Rossolillo owns shares of Alphabet (C shares), NVIDIA, and Salesforce.com. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), NVIDIA, and Salesforce.com. The Motley Fool recommends Softbank Group. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Alphabet (A shares) Stock Quote
Alphabet (A shares)
GOOGL
$95.19 (-0.90%) $0.86
Marvell Technology Group Stock Quote
Marvell Technology Group
MRVL
$42.91 (0.56%) $0.24
Salesforce, Inc. Stock Quote
Salesforce, Inc.
CRM
$151.68 (-1.31%) $-2.01
Alphabet (C shares) Stock Quote
Alphabet (C shares)
GOOG
$95.44 (-0.84%) $0.81
Nvidia Stock Quote
Nvidia
NVDA
$156.39 (-1.19%) $-1.88

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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