If we want a more sober look at the AI landscape, a good place to start is to step back from the hype-driven stock market frenzy and understand how the technology fits into the larger context.
The S-curve of adoption is a theory that describes how new technologies enter the market over time. It is a five-stage process that begins with the innovator stage, then moves to early adopters, early majority, and finally to late majority and laggards.
Investors can use this model as part of their thought exercise to help determine where a company and its stock fall on the AI adoption curve, which can help investors decide whether to bet on a short-term, early-stage growth stock or a longer-term story.
Shares within the adoption framework
There are a few angles to look at when determining where a company sits in the evolution of AI, but Goldman Sachs has created its own AI adoption stages: In a June 17 note, a team led by chief U.S. equity strategist David Kostin outlined four stages of AI trading.
Phase one is an area most investors are familiar with: the Nvidia deal (NVDA).
AI's early winners included the big tech stocks that saw exponential revenue growth and attracted many investors. Over the past two years, it was the Magnificent Seven that drove the S&P 500 higher. More recently, much of the rally has been driven by five stocks directly related to AI developments. Those five stocks include Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOGL), Meta (META) and Amazon (AMZN).
Investors who rode this wave have reaped handsome profits: Through 2023, there was a 53% difference in annual earnings growth between the top five AI companies and the rest of the S&P 500. This difference is expected to continue in 2024 at a 31% difference. But going into 2025, Goldman predicts the earnings growth gap between the top five AI companies and the rest of the index will narrow.
The chart below shows Goldman's forecast for slowing earnings growth in concentrated stocks and a more modest recovery for the broader market.
Goldman Sachs Global Investment Research
But investors hoping to find AI-related gains elsewhere may have a hard time sifting through all the companies trying to jump on the frenzy. Executives are increasingly saying the word “AI,” as evidenced by the percentage of S&P 500 companies using the term on earnings calls jumping from 10% in early 2023 to 40% by the first quarter of 2024, according to the Goldman memo. This trend creates a daunting task for investors trying to discern where each company is in its development stage and whether exposure to AI will translate into meaningful cash flows in the near term.
That's not to say the top five stocks won't continue to lead AI trades, but if you're worried about crowded positions, you have options.
Investors who want to bet on early winners can consider Goldman's second phase of stocks. These are companies directly involved in developing the infrastructure for AI. They provide the hardware, software, land, and power needed to run and maintain large-scale language models. Examples include semiconductor manufacturers, data centers, server and network providers, cloud and security providers, and the utility sector.
Goldman's third and fourth phases focus on how companies are integrating AI tools to improve business outcomes. Phase three is companies leveraging AI in their operations to drive revenue growth. Sectors included in phase four include companies that are expected to benefit from the cost savings of AI by moving towards automation to reduce labor costs.
Below is the list of infrastructure players Goldman is positioning in phase two, split across 10 sectors.
10 sectors in the second phase
- design: These companies own internet protocols and electronic design automation software used to design and analyze integrated circuits and printed circuit boards. Stocks in this sector include Arm Holdings (ARM), Synopsys (SNPS), and Cadence Design Systems (CDNS).
- Fabless Designer: Like Nvidia, these companies design semiconductor chips but don't manufacture them. Stocks in this sector include Broadcom (AVGO), AMD (AMD), Qualcomm (QCOM), Marvell Technology (MRVL), Monolithic Power Systems (MPWR), Lattice Semiconductor (LSCC), and Credo Technology Group (CRDO).
- Foundries and Integrated Device Manufacturers: These are semiconductor chip makers. Stocks in this sector include Taiwan Semiconductor (2330 TW), Intel (INTC), and GlobalFoundries (GFS).
- memoryThese companies manufacture memory units. Stocks in this sector include Micron Technology (MU) and Western Digital (WDC).
- production equipmentThese companies supply semiconductor manufacturing equipment. Stocks in this sector include ASML (ASML-NL), Applied Materials (AMAT), Lam Research (LRCX), KLA (KLAC), Teradyne (TER), Onto Innovation (ONTO), MKS Instruments (MKSI), Advanced Energy Industries (AEIS), Axcelis Technologies (ACLS), FormFactor (FORM), Kulicke and Soffa Industries (KLIC), Ultra Clean Holdings (UCTT), and Veeco Instruments (VECO).
- Data CentresThese are real estate-based companies that own and operate data centers that hold the servers that train and run AI models. Stocks in this sector include American Tower (AMT), Equinix (EQIX), Digital Realty Trust (DLR), and DigitalBridge Group (DBRG).
- Servers and NetworkingThese companies build and operate the hardware inside data centers. Stocks in this sector include Cisco Systems (CSCO), Arista Networks (ANET), Amphenol (APH), Supermicro Computer (SMCI), Corning (GLW), Vertiv (VRT), Keysight Technologies (KEYS), Hewlett Packard Enterprise (HPE), NetApp (NTAP), Jabil (JBL), Pure Storage (PSTG), nVent Electric (NVT), Coherent (COHR), TD Synnex (SNX), FabriNet (FN), Littelfuse (LFUS), Sanmina (SANM), Belden (BDC), Lumentum (LITE), Viavi Solutions (VIAV), and ePlus (PLUS).
- utilityThese utilities will be responsible for supplying electricity to meet the growing demands of data centers. Stocks in this sector include NextEra Energy (NEE), Southern Co (SO), Duke Energy (DUK), Constellation Energy (CEG), Sempra (SRE), American Electric Power (AEP), Dominion Energy (D), Exelon (EXC), PG&E (PCG), Public Service Enterprise (PEG), Xcel Energy (XEL), WEC Energy Group (WEC), Entergy (ETR), FirstEnergy (FE), Vistra (VST), PPL (PPL), Ameren (AEE), CMS Energy (CMS), Avangrid (AGR), NRG Energy (NRG), Evergy (EVRG), AES (AES), Brookfield Renewable (BEPC), Pinnacle West Capital (PNW), OGE Energy (OGE), IDA (IDA), Portland General Electric (POR), and Black Hills (BKH).
- Cloud ProvidersThese companies provide the remote computing and data storage space to run AI models. Stocks in this sector include Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOGL), and Oracle (ORCL).
- Security company: These are software providers with a focus on security. Stocks in this sector include: Palo Alto Networks (PANW), Crowdstrike (CRWD), Palantir (PLTR), SentinelOne (S).
