Wall Street has found its next-big-thing investment, and artificial intelligence (AI) be thy name.
AI describes the use of software and systems to oversee/handle tasks that would normally be assigned to humans. What gives AI such intrigue is the incorporation of machine learning, which is what allows AI-driven systems to learn and evolve over time in order to become more efficient at their tasks.
While AI has logical applications in the tech space, its usage extends to virtually all sectors and industries. According to PwC, AI can provide a lift to global gross domestic product (GDP) of $15.7 trillion by 2030.
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But as we've witnessed from an abundance of previous next-big-thing trends, not every company is poised to be a winner. As we move headlong into September, two AI stocks stand out for all the right reasons, while another widely owned AI stock is contending with a growing number of headwinds.
Artificial intelligence stock No. 1 to buy hand over fist in September: Alphabet
The top AI stock that looks like nothing short of a screaming buy for patient investors is Alphabet (GOOGL 10.22%) (GOOG 9.96%), the parent company of leading internet search engine Google and streaming platform YouTube,
Alphabet is deploying AI, to some varied degree, in most of its products and services. AI is bolstering Google's search engine, helping to remove noncompliant material from YouTube, and is imperative to the success of Waymo, Alphabet's autonomous-vehicle subsidiary. While it's tough to put a dollar figure on what AI solutions have done for Alphabet, there's little doubt AI has had a positive impact on the company's sales and profits.
But just like any next-big-thing trend, AI is going to take time to mature and evolve. Though Alphabet's AI ambitions have the ability to eventually take its products and services to the next level, there are even more tangible reasons to buy Alphabet stock right now.
For example, Google holds a veritable monopoly in internet-search share, which is leading to exceptionally predictable growth in Alphabet's cash flow. You have to go back to March 2015 to find the last time Alphabet didn't account for at least 90% of global internet-search share, based on data from GlobalStats. Having a roughly 90 percentage-point lead over the next closest competitor squarely puts ad-pricing power in Alphabet's corner.
Google Cloud also looks to be hitting its stride. Alphabet's cloud-infrastructure service has reported two consecutive quarterly profits after years of losses. Furthermore, enterprise cloud spending still looks to be in the very early innings of expansion. Generative AI with Google Cloud will allow businesses to completely transform how they reach consumers.
And did I mention that Alphabet is still historically cheap? Alphabet stock has averaged a little over 18 times its year-end cash flow over the previous five years. However, it's currently trading at less than 15 times estimated cash flow for 2024.
Artificial intelligence stock No. 2 to buy hand over fist in September: Baidu
A second AI stock that looks like a no-brainer buy in September is China-based Baidu (BIDU 0.62%).
To clear the air, there are certainly added risks that come with buying China stocks. There are additional regulatory concerns on both ends (from Chinese officials and the U.S. government), as well as growth concerns following China's move away from its strict COVID-19 mitigation measures this past December. Nevertheless, Baidu has the puzzle pieces firmly in place to be a winner in the AI space and well beyond.
Baidu is somewhat of a mirror image of Alphabet's operating model but within the world's No. 2 economy by GDP. The two indications where AI is particularly prominent is the company's AI-driven enterprise cloud, as well as Apollo Go. The latter is China's most successful autonomous ride-hailing company (3.3 million rides since inception). Baidu's non-online marketing revenue has pretty consistently grown by a double-digit percentage for years, with the company's AI Cloud and Intelligent Driving segments leading the charge.
Like Alphabet, Baidu also has a clear edge in internet search. As of August, GlobalStats pegged Baidu's share of China's internet-search market at roughly 61.5%. That's about 44% percentage points higher than the next closest competitor, and it makes Baidu's search engine the clear go-to for merchants in the world's No. 2 economy.
Admittedly, it's going to take time for China's economy to right the ship following three years of stringent COVID-19 mitigation measures. But once that happens, Baidu's various operating segments will be well positioned to deliver double-digit sales growth. Don't be surprised if Baidu manages to nearly double its earnings per share over the next four or five years.
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The artificial intelligence stock to avoid like the plague in September: Nvidia
However, not every AI stock is necessarily worth buying in September. Despite its blazing-hot performance through the first eight months and change of 2023, Nvidia (NVDA 6.18%) is the clear AI stock to shy away from.
Nvidia is viewed as the infrastructure backbone of the artificial intelligence movement. The company's AI-driven graphics processing units (GPUs) are being used in high-compute data centers to accelerate processing speeds, which is a necessity for AI software and systems that often require split-second decision-making. Nvidia likely controls around 90% of all GPUs in use in AI-accelerated data centers.
Although Nvidia has been crushing it from an operating perspective, three very clear headwinds stand out.
The first issue is that Nvidia is staring down plenty of AI-GPU competition in the quarters and years that lie ahead. Advanced Micro Devices is launching its MI300X GPU for AI-accelerated data centers to a handful of customers this year but plans to ramp up production and deliveries in 2024. Meanwhile, Intel plans to bring its Falcon Shores GPU to market by 2025. In short, Nvidia's proverbial land grab in the AI-GPU space is likely to be short-lived.
The second concern is that Nvidia's second-quarter operating results show that pricing power, not volume, is driving the company's massive gains. Though it's great to have strong pricing power in the interim, this pricing power is going to evaporate quickly once Taiwan Semiconductor Manufacturing Company can reduce supply chain constraints on Nvidia's A100 and H100 GPUs. Effectively, Nvidia increasing output could be its own demise on the margin front.
Lastly, it's a struggle to make sense of Nvidia's valuation. While Wall Street's exceptionally strong growth forecast for the company may make its nosebleed valuation a bit more palatable, history has not been kind to valuation expansion to the degree that Nvidia has experienced this year. Since every next-big-thing investment tends to go through an initial bubble, history would suggest that Nvidia could retrace quite a bit.
