- Some of the big winners from the AI boom will be some under-the-radar stocks.
- These include less-than-stellar companies providing power and data center services.
- These “boring” stocks are already doing well as Nvidia gains attention and followers.
Imagine a stuffy, windowless room with servers lined up back to back, with thousands of computers running at once, and it's hot. Huge industrial fans are spinning to keep them cool.
Across the road, work has begun on another data center, and an entire industrial park is springing up, with the construction company barely able to keep up with demand.
The scene symbolizes the massive amount of computing power needed to fuel the artificial intelligence boom. And while it's far from the glitz and glamour of the tech giants that make the headlines, the biggest winners from this movement will be the companies working on the back end.
This specifically means data centers, which will become increasingly important in storing information as AI goes mainstream. Analysts increasingly say that data centers are one of the most overlooked beneficiaries of the AI shift.
“This new generation AI architecture essentially requires about $1 trillion in infrastructure upgrades,” said Ted Mortenson, managing director and technology strategist at Baird, “and we're still in the very early stages. In baseball terms, we're probably not even at the beginning of the game yet.”
Goldman Sachs predicts that data center electricity demand will increase by 160% in 10 years' time, and points out that a search powered by ChatGPT uses up to 10 times more electricity than a basic Google search.
“The United States has not seen a surge in electricity demand since the beginning of this century,” Goldman analysts said in the report. “This surge in demand will be driven not only by electrification and reshoring of industry, but also by AI.”
Going further from there, the AI revolution could be a boon for the many construction, utility, and electric companies that make up the data center industry. Typically considered the most boring and defensive sector of the market, these companies could offer some of the most exciting investment opportunities.
The winners who went unnoticed
Companies are already pouring billions of dollars into building data centers, sending stocks tied to building and powering them soaring.
First, utilities have been the third-best performing sector out of 11 sectors in the S&P 500 over the past six months, trailing only the information technology and communications services sector, which is home to AI-focused giants like Meta, Nvidia, and Alphabet. Typically, when growth stocks are leading the way, more defensive sectors like utilities perform the worst. But that hasn't been the case this time.
On an individual basis, Digital Realty Trust, the only data-center real estate investment trust listed on the NYSE, is up 38% over the past year, while the Global X Data Center & Digital Infrastructure ETF is up 12%, far outpacing the 4% gain of the iShares Core US REIT ETF over the same period.
Stocks that underpin big electricity consumption are also poised to do well in 2024. Supermicro, whose liquid cooling technology is essential for AI hardware, is up 200% so far this year. Nvidia may be the king of AI, but it's still only up 150% in 2024.
meanwhile, Vertive Shares of NVIDIA, which also makes power and cooling equipment for data centers, have risen 80% this year. A 435% increase since NVIDIA's strong first quarter 13 months ago represents 130 percentage points of outperformance. The company's dominance recently earned it the title “a true AI darling” from Bank of America.
Globally, power grid and utility stocks in the U.S., South Korea, India and Europe have risen as much as 140% since the start of the year, JPMorgan analysts said in a recent survey.
Investors aren't used to viewing energy-utilities stocks as a gold mine, given the sector's lackluster earnings over the past decade, says Travis Miller, energy-utilities strategist at Morningstar. But strong growth is coming: The firm sees the sector growing 10% annually for the next decade.
“I don't think investors fully understand the impact of data center growth,” Miller told Business Insider.
Software left behind
While traditional hardware companies and their data center and real estate affiliates have boomed, software stocks have been left far behind.
Hardware technology stocks have outperformed their software peers by 30 percentage points this year as demand for graphics processing units, data centers and other physical computing equipment soars. That's a reversal from the past decade, when software companies, valued for their high profit margins and asset-light business models, outperformed hardware stocks by more than 250 percentage points.
Why is this change happening? Mortenson said it's hard for software companies to build around AI.
“This generational AI cycle is about infrastructure, everything is about infrastructure,” Mortenson told BI in a previous interview, adding that cloud companies plan to spend more than $200 billion on data centers this year. “That's the horsepower, or the engine, of generational AI,” he said.
Moreover, on a comparative valuation basis, traditional software tech stocks look expensive relative to their energy and data-center peers, while utilities appear to be about 5% undervalued, Miller said.
Still, despite the recent strong performance, the data center boom may take years to fully mature — Miller estimates it won't be until 2028 at the earliest before data centers have a significant impact on corporate earnings, meaning investors may have to wait a while to realize the full potential of deals.
There's also a risk that the US won't build as many data centres as expected due to concerns about whether it has the energy capacity to support them, he added.
Despite that outlook, he still expects significant expansion.
“It was only a generation ago that utilities had the kind of significant growth potential we expect over the next decade,” Miller said.
