Over the last 30 years, no next-big-thing trend has changed the corporate landscape more than the advent of the internet. However, the arrival of the artificial intelligence (AI) revolution may give history a run for its money.
In its simplest form, AI utilizes software and systems to oversee tasks that would normally be delegated to humans. The incorporation of machine learning, which allows software and systems to "learn" over time and become more proficient at their tasks, is what ultimately gives AI utility in practically every sector and industry.
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Nvidia's stock has soared thanks to the AI revolution
No company has more directly benefited from the rise of AI than semiconductor stock Nvidia (NVDA 6.18%). In the span of a little over one year, it's become the foundational-infrastructure play in high-compute data centers. According to analysts at Citigroup, Nvidia's A100 and H100 graphics processing units (GPUs) could account for a greater-than 90% share of GPUs deployed in AI-accelerated data centers this year.
Keep in mind that Nvidia is still in the process of ramping its production. Chip fabrication giant Taiwan Semiconductor Manufacturing is rapidly increasing its chip-on-wafer-on-substrate capacity, which should help ease supply chain issues for Nvidia and allow the company to meet more of its customers' orders.
But when things seem too good to be true on Wall Street, they usually are.
In addition to contending with growing external competition from the likes of Advanced Micro Devices and Intel, Nvidia's four largest customers, which account for 40% of its sales, are developing AI-GPUs of their own to either complement or replace Nvidia's data-center infrastructure. Even if Nvidia is able to maintain some degree of advantage(s) over these in-house GPUs from its top customers, future orders from these four businesses are liable to taper.
Furthermore, Nvidia finds itself at risk of cannibalizing its own gross margin as it expands production. The reason data-center sales more than tripled in fiscal 2024 (ended Jan. 28, 2024) is because of GPU scarcity. Demand was so strong for its A100 and H100 chips that the company was able to dramatically increase the price of these units. As Nvidia's GPU production, and that of its competition, increases, industrywide GPU scarcity and Nvidia's pricing power should wane.
But the most damning factor of all might be Nvidia's valuation.
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Forget Nvidia: These two "Magnificent Seven" components are considerably cheaper
There are a number of ways to "value" stocks. While the traditional price-to-earnings (P/E) ratio works well for mature businesses, it doesn't do a particularly good job of valuing the "Magnificent Seven." The Magnificent Seven are some of Wall Street's largest and most influential businesses (listed in order of descending market cap):
- Microsoft (NASDAQ: MSFT)
- Apple (NASDAQ: AAPL)
- Nvidia
- Alphabet (GOOGL 10.22%) (GOOG 9.96%)
- Amazon (AMZN 3.43%)
- Meta Platforms (NASDAQ: META)
- Tesla (NASDAQ: TSLA)
These seven businesses offer well-defined competitive advantages, if not outright impenetrable moats in their respective industries. They're also well known for reinvesting their operating cash flow into high-growth initiatives. That's why cash flow tends to be the best measure of value when analyzing Nvidia and its peers within the Magnificent Seven.
As of the closing bell on March 22, Nvidia was valued at just north of 30 times Wall Street's forward-year cash-flow estimates. That makes Nvidia the priciest stock within the Magnificent Seven.
The good news for investors is that two other Magnificent Seven components with artificial intelligence ties are historically inexpensive and ripe for the picking by opportunistic investors.
Alphabet
The first Magnificent Seven member that's a considerably better value than Nvidia is Alphabet, the parent company of internet search engine Google and streaming platform YouTube, among other ventures.
According to Wall Street's consensus cash-flow forecasts, Alphabet is expected to generate more than $11 in cash flow per share in 2025. Based on its closing price for March 22, this places Alphabet at roughly 13.5 times forward-year cash flow. Not only is this less than half the multiple Nvidia trades at, but it represents a roughly 24% discount to Alphabet's price-to-cash-flow multiple over the trailing-five-year period.
The operating segment that makes Alphabet tick is Google. In February, Google registered a 91.6% share of worldwide internet search, according to GlobalStats. It's sustained at least a 90% monthly share of global search dating back nine years. Being the undisputed go-to for businesses wanting to target users with their message(s), it suggests Google should have no trouble commanding exceptional ad-pricing power.
But it's Alphabet's cloud-infrastructure service platform, Google Cloud, which offers the most promise in terms of cash-flow growth. Google Cloud accounted for a 10% share of global cloud-infrastructure service spend during the September-ended quarter, and this segment delivered its first year of profits in 2023.
Google Cloud is also where Alphabet has many of its artificial intelligence tie-ins. It's allowing customers to use generative AI solutions to build applications within the cloud that can improve customer interactions and/or help businesses better target consumers with their advertising.
Enterprise cloud spending looks to be in its early stages of ramping up, which suggests double-digit sales growth can continue for the higher-margin Google Cloud.
Amazon
The other Magnificent Seven member that's a considerably cheaper AI stock than Nvidia is none other than e-commerce titan Amazon.
Despite hitting a fresh 52-week high last week, Amazon ended March 22 at a multiple of only 13 times Wall Street's estimated forward-year cash flow. This represents a 43% discount to its average price-to-cash-flow multiple over the trailing-five-year period, and it's markedly lower then Nvidia's multiple-to-forward-year cash flow.
Most consumers are familiar with Amazon because of its leading online retail platform. The company's e-commerce marketplace accounted for nearly 38% of U.S. online retail sales last year, which was more than 31 percentage points above its next-closest competitor.
But dig beneath the surface and you'll find that online retail sales generate low margins and don't contribute much to Amazon's cash flow or operating income. Rather, the company's ancillary operating segments, which include Amazon Web Services (AWS), subscription services, and advertising services do most of the heavy lifting.
Whereas Google Cloud accounts for 10% of global cloud-infrastructure service spending, AWS sits at the top of the pecking order with a 31% share, according to estimates from tech-analysis firm Canalys. Similar to Alphabet, Amazon is deploying generative AI solutions in a multitude of ways within its cloud platform to allow users to build applications. On an annualized run-rate basis, AWS is generating nearly $97 billion in sales and is consistently responsible for most of Amazon's operating income.
Amazon's other ancillary segments aren't slouches, either. Luring more than 2 billion unique users to its website each month has fueled ad sales for Amazon. Likewise, it crossed above 200 million monthly worldwide Prime subscribers in April 2021 and has likely added to this total since becoming the exclusive streaming partner of the National Football League for Thursday Night Football.
