Artificial intelligence and related technology giving machines and systems the ability to make decisions is a fast-growing industry. Global spending on AI grew by a double-digit percentage in 2020, and the pace of expansion is only expected to continue in the years to come.
But rather than picking some smaller up-and-coming names like I did last month, I'm focusing my attention on larger companies like Alphabet (GOOGL +0.66%) (GOOG +0.41%), IBM (IBM +0.06%), and Fortinet (FTNT +5.60%) to kick off 2021. Here's why.
Alphabet: The dog of FAANG
2020 was a big year for tech -- even big tech. But among the FAANG stocks (Facebook (FB 1.18%), Apple (AAPL +2.08%), Amazon (AMZN +0.55%), Netflix (NFLX 0.91%), and Google), Google parent Alphabet fared the worst. It was up "only" 30% on the year, dragged down, along with Facebook, by its reliance on advertising revenue and plagued with regulatory and antitrust scrutiny.
Data by YCharts.
But I think the dog of the FAANG stocks will do well in 2021 and beyond. For one thing, the antitrust lawsuit recently brought against the internet search leader in the U.S. isn't expected to begin until the autumn of 2023. Advertising has also come roaring back since the economic lockdown early in the pandemic, making for an easy lap time to beat during the first half of the new year (since Google ads took a hit during the spring of 2020). Thus, I think Google is something of an economic recovery stock.
Google is also a top user of AI. Everything from its search to advertising to cloud computing businesses has a healthy dose of AI injected into it. It's also a top researcher, using its highly profitable core businesses to fund currently loss-generating but promising upstarts like autonomous vehicle outfit Waymo and life sciences technologist Verily. Even if Google's core business continues to face pressure from regulators around the globe in the next few years, there are still ample opportunities for this company to grow as AI becomes an increasingly important factor in the business world.
There's also a 12-figure reason I wouldn't bet against Google. The company reported nearly $133 billion in cash and short-term marketable securities on the books at the end of September 2020 -- making this by far the most cash-rich of all the FAANG stocks and one of the wealthiest organizations on the planet. Imperfections aside, there are ample reasons to still want a piece of this internet and computing leader for the long term.
Image source: Getty Images.
IBM: Slimming down to beef up on the cloud and AI
Speaking of dogs, IBM was another stock that underperformed in 2020. Shares of the old tech bellwether fell 7%, compared to a 16% return for the S&P 500 index. Revenue has been stuck in gradual decline for years, and the story was no different in 2020, because many of IBM's customers put IT spending on hold during the pandemic.
But underneath the surface is a thriving cloud computing business, thanks in no small part to IBM's acquisition of Red Hat a couple of years ago. In fact, through the trailing 12-month period ended Sept. 30, 2020, the company said its cloud revenues increased 22% to $24.4 billion from the comparable period a year prior. And under the guidance of new CEO Arvind Krishna, IBM will be offloading much of the problematic legacy business in 2021 in order to narrow its focus to more modern computing and technology needs -- including AI.
This could be a truly transformational move for IBM. Parting ways with some of its historical business (specifically, its managed IT infrastructure segment) won't be an easy process for this old firm, but it's a decision I believe needed to be made a long time ago. Krishna, who's been involved with IBM's cloud, AI, and computing research division for years, may be just the leader the company needs to head up the monumental task. If IBM pulls this off, what remains will be a leaner and growing computing services leader focused on expanding areas of importance to the future economy like AI.
IBM stock currently trades for a lowly 8.8 times trailing 12-months free cash flow (revenue minus cash operating expenses and capital expenditures). The new IBM will likely command a much higher premium than that, one reflecting a growth company rather than a steadily declining tech firm of yesteryear. I think investors may be overlooking an opportunity here, so I'm going on the hunt for a purchase ahead of the planned divestiture of its legacy business.
Fortinet: A long-term cybersecurity winner poised to keep winning
With the pandemic came remote work, and with a dispersed workforce came myriad new cybersecurity challenges for organizations to worry about. Cloud and endpoint (think laptops and smartphones accessing company data outside of an office) security stocks skyrocketed in 2020 as a result and will remain prominent, because an increasingly remote global workforce is likely to be part of the new normal.
However, Fortinet is an oft-overlooked name in this space. It's a provider of best-in-class security hardware for data centers (the basic staples that enable remote work in the first place). It also has a growing services segment focused on securing assets like a company's cloud computing network. And because this is a highly profitable business, Fortinet has the resources to invest in emerging technologies like AI to help thwart the efforts of criminals.
The cybersecurity world is in dire need of improvements, as made evident by the shocking SolarWinds (SWI +0.00%) supply chain hack, in which malicious code was inserted into the systems of U.S. government agencies and businesses. For one thing, more organizations need to build more security redundancy into their operations. Zero-trust architecture (in which the identity of users is constantly questioned and has to be proved before users are allowed data access) will also help. Building security directly into applications themselves is another solution.
Put another way, cybersecurity investors should spread their bets across several leading security stocks, not just one -- just as businesses need multiple layers of security service. Fortinet deserves to be part of that investing conversation. Its revenue grew 19% year over year in the third quarter of 2020, continuing its long-term double-digit-percentage growth story. It operated at a very healthy 34% free cash flow profit margin over the last year. And it had $1.66 billion in cash and equivalents and no debt at the end of September. This cybersecurity leader putting next-gen services like AI to work in keeping the world safe remains one of my top buys.
