The S&P 500 index has rebounded sharply from its bear market lows as easing inflation, better-than-expected earnings, and enthusiasm surrounding artificial intelligence (AI) elevated investor sentiment in 2023. The benchmark index is now just 6% below its all-time high, putting it on the brink of a new bull market.
Ed Yardeni of Yardeni Research expects the S&P 500 to reach a new record high between 4,800 and 5,400 in the next 18 months, implying a 6% to 19% upside from its current level. Those gains would push the index into bull market territory, an important milestone given that the S&P 500 returned an average of 151% during the last 11 bull markets.
Here are two AI growth stocks to buy now and take advantage of the projected market upturn.
1. Microsoft: The leader in enterprise software
Microsoft (MSFT -0.70%) offers a broad range of subscription software and cloud services that have become the backbone of many modern organizations. Its best-known product is Microsoft 365, the most popular enterprise application of any kind, but the company also has a strong presence in other software verticals like cybersecurity, communications, and enterprise resource planning (ERP). In fact, Microsoft accounted for 16.4% of all software-as-a-service spending last year, nearly double the market share of its closest competitor.
Microsoft Azure is also gaining ground on its cloud computing competitors. It accounted for 23% of cloud infrastructure and platform services in the first quarter, up from 17% three years ago. Those share gains reflect strength in several verticals, including hybrid cloud and artificial intelligence (AI) infrastructure. Indeed, CEO Satya Nadella says Azure has the "most powerful AI supercomputing infrastructure in the cloud."
Microsoft reported reasonably strong financial results in the third quarter of fiscal 2023 (ended March 31). Revenue increased 7% to $52.9 billion, and earnings based on generally accepted accounting principles (GAAP) climbed 10% to $2.45 per diluted share. But the company should be able to accelerate growth in the future, especially under more favorable economic conditions.
Microsoft is leaning into generative AI to enhance its portfolio of enterprise software products and cloud computing services. For instance, Microsoft 365 leans on AI to draft emails in Outlook, analyze data in Excel, and create presentations in PowerPoint; and its ERP software Dynamics 365 leans on AI to automate workflows in sales, marketing, and supply chain management. Additionally, consultancy Gartner recently recognized Microsoft Azure as a leader in cloud AI developer services, citing its exclusive access to prebuilt generative AI models from ChatGPT creator OpenAI as a key strength.
So what? Grand View Research expects the AI software and services market to grow at 37% annually through 2030, and Morgan Stanley analyst Keith Weiss believes Microsoft is the software company best positioned to monetize generative AI.
With that in mind, Microsoft shares presently trade at 12.5 times sales, a premium to the three-year average of 11.3 times sales, but still a reasonable price given the AI tailwind. Investors should consider buying a small position in this AI growth stock today.
Arista Networks: The leader in high-speed data center switches
Arista Networks (ANET -1.20%) specializes in high-performance networking solutions for cloud and enterprise data centers. The company offers switching and routing platforms that bring industry-leading speed and power efficiency to IT infrastructure, and it provides adjacent software for network workflow automation, monitoring, and security.
Arista says its core innovation is the Extensible Operating System (EOS). A single version of EOS runs across every piece of Arista hardware, allowing clients to integrate public clouds, private data centers, and hybrid cloud environments into a seamless network. That strategy differs from legacy vendors like Cisco Systems that use multiple operating systems, a strategy that complicates network management for IT workers.
However, the most important thing investors should know about Arista is that it leads the market for high-speed data center switches, a product that is essential to AI networking and other demanding data center workloads. In fact, the company holds 42% market share in 100G, 200G, and 400G switches, twice as much as its closest competitor Cisco.
Arista reported phenomenal financial results in the first quarter. Revenue jumped 54% year over year to $1.3 billion, and GAAP net income soared 62% to $1.38 per diluted share. As a caveat, growth may slow in the coming quarters due to the cyclical nature of the industry, but there is still plenty of upside for patient investors.
Arista currently values its total addressable market at $31 billion, but management says that figure will reach $51 billion by 2027 as data centers require faster networking solutions to keep pace with technologies like the Internet of Things, 5G networks, and AI software. In fact, Morgan Stanley analyst Meta Marshall says AI networking alone will be an $8 billion market by 2028, and that Arista will be "one of the biggest beneficiaries" of that tailwind.
On that note, Arista shares currently trade at 11.1 times sales, a slight premium to their three-year average of 10.7 times sales, but a reasonable price given the potential upside. Investors should consider buying a small position in this growth stock today.
