These two ‘Magnificent Seven’ members are significantly cheaper artificial intelligence (AI) stocks.

By | March 26, 2024

Over the past thirty years, no next major trend has changed the business landscape more than the advent of the Internet. However, the advent of the artificial intelligence (AI) revolution could give history a run for its money.

In its simplest form, AI uses software and systems to oversee tasks that would normally be delegated to humans. The integration of machine learning, which allows software and systems to “learn” over time and become more proficient at their tasks, is what ultimately makes AI useful in virtually every sector and industry.

Multiple humanoid robots type on laptops while sitting at a table in a conference room.

Image source: Getty Images.

Nvidia shares have soared thanks to the AI ​​revolution

No company has benefited more directly from the rise of AI than semiconductor stocks Nvidia (NASDAQ: NVDA). In just over a year, it has become the foundational infrastructure play in high-compute data centers. According to analysts from Citi GroupNvidia’s A100 and H100 graphics processing units (GPUs) could account for a more than 90% share of GPUs deployed in AI-accelerated data centers this year.

Keep in mind that Nvidia is still ramping up production. Chip manufacturing giant Taiwanese semiconductor manufacturing is rapidly expanding its chip-on-wafer-on-substrate capacity, which should help alleviate supply chain issues for Nvidia and allow the company to fulfill more orders from its customers.

But when things on Wall Street seem too good to be true, they usually are.

In addition to having to contend with growing external competition from, among others, Advanced micro devices And Intel, Nvidia’s four largest customers, which account for 40% of revenue, are developing their own AI GPUs to supplement or replace Nvidia’s data center infrastructure. Even if Nvidia is able to maintain some degree of advantage over these in-house GPUs from its top customers, future orders from these four companies are likely to decline.

Furthermore, Nvidia risks cannibalizing its own gross margin as it expands production. The reason data center sales more than tripled in fiscal year 2024 (ending January 28, 2024) is because of GPU scarcity. Demand for the A100 and H100 chips was so high that the company was able to dramatically increase the price of these units. As Nvidia’s GPU production, and that of its competitors, increases, industry-wide GPU scarcity and Nvidia’s pricing power should decrease.

But perhaps the most damning factor of all is Nvidia’s valuation.

A magnifying glass on top of a financial newspaper, highlighting the phrase Market Data. A magnifying glass on top of a financial newspaper, highlighting the phrase Market Data.

Image source: Getty Images.

Forget Nvidia: these two “Magnificent Seven” components are significantly cheaper

There are a number of ways to ‘value’ shares. While the traditional price-to-earnings (P/E) ratio works well for mature companies, it is not particularly good at valuing the Magnificent Seven. The Magnificent Seven are some of Wall Street’s largest and most influential companies (ranked in descending order of market capitalization):

These seven companies offer clearly defined competitive advantages, if not downright impenetrable moats in their respective industries. They are also known for reinvesting their operating cash flow in high-growth initiatives. That’s why cash flow is often the best value metric when analyzing Nvidia and its peers within the Magnificent Seven.

As of the closing bell on March 22, Nvidia was valued at just over 30 times Wall Street’s cash flow estimates for the future. That makes Nvidia the most expensive share within the Magnificent Seven.

The good news for investors is that two other components of the Magnificent Seven related to artificial intelligence are historically cheap and ripe for the opportunistic investors.

Alphabet

The first Magnificent Seven member that has a significantly better value than Nvidia is Alphabet, the parent company of internet search engine Google and streaming platform YouTube, among others.

According to Wall Street’s consensus cash flow forecasts, Alphabet is expected to generate more than $11 in cash flow per share by 2025. Based on the closing price of March 22, this gives Alphabet approximately 13.5 times its cash flow for the entire year. Not only is this less than half the number Nvidia is trading at, but it also represents a roughly 24% discount to Alphabet’s price-to-cash flow ratio over the past five years.

The operating segment that drives Alphabet is Google. According to GlobalStats, Google recorded a 91.6% share of global Internet searches in February. It has at least a 90% monthly share of global searches, going back nine years. Being the undisputed go-to for companies looking to target users with their message(s), this suggests that Google should have no trouble commanding exceptional ad prices.

But it’s Alphabet’s cloud infrastructure services platform, Google Cloud, that offers the most promise in terms of cash flow growth. Google Cloud accounted for a 10% share of global cloud infrastructure services spending in the quarter ended September, with the segment posting its first year of profit in 2023.

Google Cloud is also where Alphabet has many of its artificial intelligence tie-ins. It allows customers to use generative AI solutions to build applications in the cloud that can improve customer interactions and/or help companies better target consumers with their advertising.

Enterprise cloud spending appears to be in the early stages of an increase, suggesting double-digit revenue growth could continue for higher-margin Google Cloud.

Amazon

The other Magnificent Seven member that is a significantly cheaper AI stock than Nvidia is none other than e-commerce titan Amazon.

Despite hitting a new 52-week high last week, Amazon ended March 22 at a multiple of just 13 times Wall Street’s estimated cash flow for the coming year. This represents a 43% discount to the average price-cash flow multiple over the past five years, and is significantly lower than Nvidia’s multi-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 higher than its next largest 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 bottom line. Rather, the company’s supporting operating segments, including Amazon Web Services (AWS), subscription services, and advertising services, do most of the heavy lifting.

While Google Cloud accounts for 10% of global spending on cloud infrastructure services, AWS is at the top with a 31% share, according to estimates from technology analytics firm Canalys. Like Alphabet, Amazon uses generative AI solutions in various ways within its cloud platform so that users can build applications. On an annual basis, AWS generates nearly $97 billion in revenue and is consistently responsible for the majority of Amazon’s operating revenue.

Amazon’s other support segments are no slouch either. Attracting more than 2 billion unique users to the website each month has fueled ad sales for Amazon. Similarly, it surpassed 200 million monthly Prime subscribers worldwide in April 2021 and has likely increased that number even further since becoming the National Football League’s exclusive streaming partner for Thursday night football.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Citigroup is an advertising partner of The Ascent, a Motley Fool company. Randi Zuckerberg, former director of market development and spokeswoman for Facebook and sister of Mark Zuckerberg, CEO of Meta Platforms, is a member of The Motley Fool’s board of directors. Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Sean Williams has positions in Alphabet, Amazon, Intel and Meta Platforms. The Motley Fool holds positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, Taiwan Semiconductor Manufacturing, and Tesla. The Motley Fool recommends Intel and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, long January 2026 $395 calls on Microsoft, short January 2026 $405 calls on Microsoft , and briefly May 2024 $47 calls on Intel. The Motley Fool has a disclosure policy.

Forget Nvidia: These Two ‘Magnificent Seven’ Members Are Significantly Cheaper Stocks in Artificial Intelligence (AI) was originally published by The Motley Fool

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