While global economic growth has slowed in 2022 due to inflation and other macroeconomic factors, one area of the economy in particular is firing on all cylinders: Data centers. These complex pieces of real estate act as the computing units for the internet itself. But as daily use of the world wide web evolves and expands, massive amounts of new data are being created. All of that information needs to be computed, moved around, and stored, and a data center upgrade cycle is underway to facilitate this boom in digital activity.
To that end, three Fool.com contributors plan on buying shares of Alphabet (GOOGL -0.95%) (GOOG -1.22%), Super Micro Computer (SMCI 4.54%), and Digital Realty Trust (DLR 2.58%). Here's why they think these three are top data center stocks to buy right now.
The ubiquitous internet business goes hardware shopping
Nicholas Rossolillo (Alphabet): Google parent Alphabet is one of the world's top data center operators. Google owns a few dozen of these massive computing units to run its myriad services, and Google Cloud and other Alphabet companies rent space for its hardware in other data centers located around the globe. Like other internet businesses, Google is in the midst of a big spending uptick on its infrastructure to accommodate more data and more advanced uses of the web.
Upgrades to these incredibly complex pieces of tech real estate cost substantial sums of money. Alphabet revealed in its second-quarter earnings update that it has spent $16.6 billion on property and equipment through the first half of 2022, up sharply from $11.4 billion in the same period last year. Paired with slowing growth in its online advertising empire, this has weighed on the bottom line for Alphabet. As a result, free cash flow generated is essentially flat over the last reported 12-month stretch, even as revenue has climbed 16%.
Alphabet's data center and computing hardware spending spree will pay off in time, though, as it works to continuously improve its services. And as it goes through an infrastructure upgrade cycle, this is still an incredibly profitable business. Operating profit margin was just shy of 30% over the last year. Alphabet is using that profitability to buy back stock in a return of excess cash to shareholders.
That being said, this stock has been clobbered by the bear market of 2022 (shares are down 24% this year as of this writing), and now trades for just 20 times enterprise value to free cash flow. Google's growth has indeed slowed, but this is a rock-solid business that continues to expand steadily with use of the internet over time. I'm still scooping up shares amid the downturn and holding for the long haul.
This stock is up 40% in 2022 and still looks cheap
Billy Duberstein (Super Micro Computer): With so many technology stocks down for the year, you may be surprised that I'm recommending a stock that has defied the odds and is actually up a staggering 40% in 2022.
Super Micro Computer makes server and storage systems for data centers, cloud companies, and Internet of Things/telco applications. In general, as a "server assembler," it tends to have relatively low margins in a competitive field. So how has the company managed to defy the odds this year?
Under founder and owner-operator Charles Liang, Super Micro is headquartered in Silicon Valley, very close to the leading CPU and GPU chip designers that the company puts into its servers. From these close relationships, Super Micro has strategized methods for big data center operators to achieve better total costs of ownership in two important ways.
First, Super Micro builds its servers with a modular "building block" design. So instead of customizing a new server from scratch every time there is a new chip architecture, Super Micro can just insert a new "block" into its designs. This speeds up time to market and also helps customers save money, due to their ability to swap out "blocks" over time, instead of whole servers.
Second, Super Micro fashions itself as a "green computing" provider, with an eye toward making its products as energy-efficient and heat-efficient as possible. Large data centers require a huge amount of electricity, as well as cooling systems, to run. And given what soaring natural gas prices and heatwaves have done to electricity costs this year, more and more customers are now turning to Super Micro's solutions.
In the last earnings call, Liang noted Super Micro Computer's power usage effectiveness (PUE), which essentially measures the total amount of energy used in a data center divided by the amount of energy that is used for computing functions. The closer to one the PUE is, the more efficient the data center is.
Super Micro's latest solutions are pushing 1.05 PUE, which is incredible considering the industry average is 1.57. That's a nearly 50% improvement! Liang claims that if the entire industry used Super Micro's solutions, it would save $10 billion per year and eliminate the need for 30 fossil fuel power plants.
In the past fiscal year ended in June, Super Micro grew revenue a stunning 46%, with earnings per share (EPS) up 143%. Not only that, but management forecast continued revenue growth of 27% at the midpoint of its range for 2023, and earnings per share of "at least" $7.27, which would amount to 37% growth over 2022. Liang has outlined some ambitious growth plans to reach $10 billion in revenue in the intermediate term and $20 billion over the long term, up from just $5.2 billion last year.
Considering today's proven growth and Liang's outlook, Super Micro stock still looks like a steal at just 8.7 times its 2023 EPS guidance, despite its rise year to date.
The data center giant you never knew you needed
Anders Bylund (Digital Realty Trust): The cloud computing titans don't stand alone. When Alphabet or Amazon want to expand their gigantic cloud services to a new location, they will pick a company that provides data center space and connectivity in the right location, for the right price, with the right features. Digital Realty Trust often comes up in those discussions, and the company wins many of these hyperscale data center deals from networks like Google Cloud and Amazon Web Services.
The company manages more than 300 data centers across 25 countries and six continents. With a flexible and consistent architecture from one data center to the next, Digital Realty offers a reliable platform that clients can learn once and then deploy over and over with predictable results.
And the business is booming. Digital Realty recently reported strong demand in key markets such as Japan, Europe, and North America, especially from hyperscale customers like the cloud giants mentioned above. In the second quarter of 2022, core funds from operations (FFO) rose 12% year over year, with a 4% increase in total operating revenue.
The company also pays out a generous dividend, with an unbroken string of annual payout increases stretching all the way back to Digital Realty's initial public offering in 2004. The dividend yield stands at 3.9% today, partly due to a falling stock price. Digital Realty shares have lost more than 30% of their value in 2022. I'm sorely tempted to lock in those bountiful dividend yields by picking up some Digital Realty shares while the stock is cheap.