Palantir Technologies has been one of the best-performing artificial intelligence (AI) stocks in recent years. Shares have advanced 1,000% since January 2024, but many analysts worry about its valuation. That may explain why Palantir did not appear on Morningstar's recent list detailing the best AI stocks to buy now.
Instead, Nvidia (NVDA 1.53%) and Microsoft (MSFT 0.73%) took the top two spots, followed by Amazon, Broadcom, and Meta Platforms. But optimism concerning Nvidia and Microsoft is not limited to Morningstar. Most Wall Street analysts believe the stocks are undervalued.
- Among 69 analysts, Nvidia has a median target price of $250 per share. That implies 31% upside from its current share price of $190.
- Among 63 analysts, Microsoft has a median target price of $631 per share. That implies 29% upside from its current share price of $488.
Here's what investors should know about Nvidia and Microsoft.
Image source: Getty Images.
1. Nvidia
Morningstar analyst Brian Colello writes:
"Nvidia has a wide economic moat, thanks to its leadership in graphics processing units, or GPUs, hardware, software, and networking tools needed to enable the exponentially growing market around artificial intelligence. In the long run, we expect tech titans to strive to find second sources or in-house solutions to diversify away from Nvidia in AI, but these efforts will, at best, only chip away at Nvidia's AI dominance."
To summarize, Nvidia has an important competitive advantage in its full-stack strategy. The company is best known for its GPUs, chips that accelerate demanding data center workloads like AI training and AI inference. But Nvidia is truly formidable because it pairs best-in-class GPUs with CPUs, high-speed interconnects, and networking platforms, such that the company essentially builds entire data centers.
Additionally, Nvidia has spent the better part of two decades creating its CUDA software platform, which comprises an unparalleled number of code libraries, pretrained models, and application frameworks that assist developers. While custom AI chips developed by Broadcom may be cheaper, the total cost of ownership is often higher because they lack pre-built software tools.
Nvidia has over 90% market share in data center GPUs, a market where sales are projected to grow at 36% annually through 2033, and the company is likely to maintain its dominant position due to its full-stack strategy. Wall Street estimates Nvidia's adjusted earnings will increase at 48% annually through the fiscal year ending in January 2028. That makes the current valuation of 47 times earnings look cheap.
NASDAQ: NVDA
Key Data Points
2. Microsoft
Microsoft is the largest enterprise software company in the world. While best known for Microsoft 365 (a suite that includes office applications like Excel, PowerPoint, and Word), the company also has a strong position in other software verticals, including business intelligence, cybersecurity, and enterprise resource planning.
Microsoft has added generative AI copilots to several software products and monthly active users surpassed 150 million in the September quarter, up from 100 million in the June quarter. And CEO Satya Nadella told analysts, "Customers continue to adopt Microsoft 365 Copilot faster than any other Microsoft 365 suite. All up, more than 90% of the Fortune 500 now use Microsoft 365 Copilot."
Meanwhile, Microsoft Azure is the second-largest public cloud in terms of infrastructure and platform services sales. "Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud," according to Morningstar analyst Dan Romanoff. "Based on its investment in OpenAI, the company has also emerged as a leader in AI."
Microsoft owns a 27% equity stake in OpenAI and it has exclusive rights to the AI start-up's most advanced models (e.g., GPT-4 and GPT-5). Also, The Information reports that OpenAI shares 20% of its revenue with Microsoft under the agreement. Those payments will top $1 billion this year, up from about $500 million last year, according to TechCrunch.
Wall Street estimates Microsoft's adjusted earnings will increase at 16% annually through the fiscal year ending in June 2027. That makes the current valuation of 34 times earnings look somewhat expensive. But Microsoft topped the consensus earnings estimate by an average of 8% during the last four quarters, which makes the current valuation look more reasonable. Nvidia is still the more attractive option, but I think patient investors should consider buying a small position in both stocks.
