Some investing trends come and go, resulting in a few winners and lots of potential losers. But other trends take hold and don't let go, making plenty of investors wealthy. One recent example of an investing trend with staying power that has yielded incredible results is the migration to cloud computing. Amazon's Amazon Web Services (AWS), Microsoft's Azure, and Alphabet's Google Cloud brought in a combined revenue of $64 billion for these three companies in just the last reported quarter.
Before the advent of the cloud, it was the internet that provided an enduring trend. An enduring trend that dominated much of the 20th century was the automobile. What all three of these trends have in common is their emphasis on efficiency and practicality. Cars have become more efficient and practical than most other forms of transportation. Making data and communications easily accessible online anywhere all the time topped things like encyclopedias, sending a letter, using a phone operator, buying a newspaper, etc. Connecting to the office remotely, eliminating on-premises servers, and analyzing reams of data carries on the neverending need to be more efficient and effective.
Artificial intelligence (AI) shares these characteristics and offers the latest example of an enduring trend and investors are obviously excited. But that doesn't mean that all AI stocks are good buys. Many won't generate the success that translates into life-changing wealth for investors. To increase your chances of success, diversified investing that focuses on quality companies is critical. Famed investor Peter Lynch summed it up well: "Know what you own and why you own it."
1. UiPath
I own UiPath (PATH 1.54%) because it exemplifies the efficiency trend referenced above. For example, a large company managing hundreds of incoming invoices daily through email might use workers spending long hours downloading the invoices and manually entering the data into their accounts payable software. Alternatively, it could use UiPath's robotic process automation (RPA) to perform these functions, freeing employees to focus on other more value-added tasks.
Recent earnings reports suggest UiPath is the more popular of the two options for more and more companies. UiPath reported record sales of $1.3 billion last year (24% growth) from 10,800 customers. Its sales and cash flow have risen steadily since it went public in 2021 (see chart below).
PATH Revenue (TTM) data by YCharts
This growth has allowed UiPath to build a fortress balance sheet with $1.9 billion in cash and investments against zero long-term debt. The company isn't profitable yet on a generally accepted accounting principles (GAAP) basis because, like many growing tech companies, it is investing back into the company to grow further.
That makes UiPath stock difficult to value. It trades with a price-to-sales (P/S) ratio under 10, which is much lower than highfliers like Palantir Technologies (PLTR 1.38%) and SoundHound AI (P/S ratios of 24 and 29, respectively). The valuation, terrific capital position, and potential make UiPath a desirable stock to keep in the AI basket.
2. Palantir Technologies
Speaking of Palantir, it is doing incredible things with AI. Yes, its stock is on the expensive side, but it is proving many critics wrong. The knock against Palantir was that it couldn't be profitable. Well, it just reported its fifth straight GAAP-profitable quarter. Growing its commercial business was also a struggle at times. Palantir's early focus was on government work, but this market is limited (albeit coveted). The private sector is a much larger potential market. As you can see below, commercial growth is booming.
Image source: Palantir.
At its heart, Palantir's software supports businesses and governments by helping them centralize, visualize, analyze, and use their data to make better decisions. The company's newest product, aptly named Artificial Intelligence Platform (AIP), takes it to another level. As companies realize they must leverage AI to keep up with competitors, it will drive demand.
Palantir reported $2.2 billion in sales in fiscal 2023 (up 17%) and $731 million in free cash flow. The company is long-term debt-free and has $3.7 billion in cash and investments. As mentioned, Palantir stock trades at 24 times sales, which is not cheap. So it's wise to dollar-cost average, diversify, and watch for dips to make your buys.
3. Arm Holdings
There is a good reason that Nvidia tried to buy Arm Holdings (ARM 1.26%) for $40 billion in 2020 (regulators eventually blocked the merger). Arm is critical to the semiconductor market, which powers AI. Advanced chips are needed to process immense amounts of data at high speeds with efficient power usage. Arm doesn't manufacture the chips; it designs them (developing what it calls the chip's architecture) and receives royalties and license fees when others use its model. To date, $280 billion worth of chips using Arm architecture have been shipped.
Arm's customers include tech giants like Apple, Nvidia, Amazon, Samsung, and many others. You likely use Arm's technology daily without knowing it -- 99% of smartphones use CPUs with Arm designs. Arm's revenue was $824 million last quarter with 14% year-over-year growth. This growth is alright, but the big scoop was the massive increase in remaining performance obligations (similar to backlog), which rose 38% to $2.4 billion. This shows that the AI race is increasing demand fast.
The business model is also desirable. Arm doesn't have significant manufacturing overhead and equipment costs compared to chip manufacturers, which means that a higher percentage of revenue is converted to bottom-line profits. Arm posted a 30% free cash flow margin last quarter.
Similar to UiPath and Palantir, Arm stock is difficult to value. It has few true peers and has been a public company for less than a year (It was also publicly traded in the 1990s and 2000s before being bought by SoftBank in 2016). Its market cap is $128 billion, which is pretty high for a company expected to report $3.2 billion in sales when it reports its fiscal 2024 fourth-quarter results (for the quarter ending March 31) sometime in early May. But Arm is a must-have stock for the long term. What works for me is buying a little at a time and then pouncing when the stock dips.
AI is a fascinating field that covers a wide area. Not all companies will succeed, and not all stocks will be tremendous investments, but many will. These are three to consider for the long haul.
