Last week, news circulated that Sam Altman's OpenAI had assigned itself a valuation of $830 billion.
However, that nosebleed valuation was challenged by analysts who pointed to competition from rivals like Anthropic and Alphabet's Google and asked whether the current breakneck pace of artificial intelligence (AI) spending is sustainable.
Given the challenges of trying to pick a winner in this space, investors might be better off looking at pick-and-shovel plays in the AI space. Surprisingly, many of them seem to be faring even better than the marquee AI companies right now. Is the real money in AI in the power cooling and connectivity space?
Image source: Getty Images.
Where the revenue is growing
If you look at revenue growth for some of the biggest AI-focused companies -- those developing AI-powered software and solutions -- you'll see some impressive numbers.
Alphabet, maker of Gemini and a heavy investor in AI features, has increased its trailing-12-month (TTM) revenue by 37.3% over the last three years. And Microsoft (MSFT 0.73%), which has been integrating AI applications like Copilot into its products, has grown TTM revenue by 44% during that same period.
Those are stellar growth numbers, particularly from such massive companies. Yet they pale in comparison to the revenue growth being experienced by some of the AI industry's pick-and-shovel plays.
Vertiv Holdings (VRT 1.07%), a maker of industrial cooling and electrical systems, including those used by data centers, has seen its TTM revenue grow by 70.4% over the last three years. TTM revenue at Arista Networks (ANET 3.18%), which manufactures electrical switches and networking infrastructure that are also critical for data centers, has grown by 92.8% over that period.
The AI infrastructure plays seem to be smoking the more traditional AI companies when it comes to revenue growth.
Profits are growing even faster
It would be one thing if the companies were growing their revenue but not their profits, indicating that most of the revenue growth was being eaten up in increased expenses. However, the opposite appears to be happening. All of these companies have grown their net income much faster than their revenue over the last three years.
Microsoft's net income has grown by 55.5% since December 2022, while Alphabet's has more than doubled, with three-year growth of 107.2%. But once again, that pales in comparison to Arista Networks' 148.2% net income growth and Vertiv's jaw-dropping 1,250% growth in net income over the same time period.
To be fair, both Vertiv and Arista have much smaller net incomes -- of $1 billion and $3.4 billion, respectively -- than the $100 billion-plus net incomes of the tech giants, but the point is that not only are Vertiv and Arista growing revenue faster than Alphabet and Microsoft, they're also growing their profits more quickly.
NYSE: VRT
Key Data Points
Premium valuations
If power cooling and connectivity are where the money is, the market seems to have already caught on. Arista and Vertiv may be growing faster than their AI-wielding counterparts, but that faster growth is also baked into their share prices.
Looking at the forward price-to-earnings ratio -- which accounts for near-term growth -- we find that Microsoft and Alphabet are practically identically valued at 30 times forward earnings and 29.7 times forward earnings, respectively. Compare them to Vertiv, which is trading at 40.6 times forward earnings, and Arista, which is trading at 45.8 times forward earnings. The difference is even more stark if we look at trailing earnings, with Vertiv's 63.2 and Arista's 50.2 sharply higher than Microsoft's 34.7 and Alphabet's 30.9.
Of course, the fact that the market is assigning a higher valuation to makers of network switches, power connectors, and integrated cooling equipment than it is to the makers of AI tools like Gemini and Copilot says a lot about where investors see the best odds for growth.
While you should expect to pay a premium for these kinds of companies as the AI buildout continues, smart investors will put together a watchlist of pick-and-shovel AI companies and keep an eye out for potential short-term dips in share price that might offer more attractive buying opportunities.
