The U.S. stock market indexes, such as the S&P 500 and the NASDAQ, reached all-time high levels this year due to growing hype around the technology sector. At the center of this hype, investors chose to chase stocks in the semiconductor space, with a minor in artificial intelligence, though not all stocks are created equal.
Nvidia Co. (NASDAQ: NVDA) and any other stock supporting the company’s growth received the lion’s share of market attention and price action. Today, investors wonder whether the company’s promises relative to its price may show signs of overvaluation. By not attaching a negative connotation to the importance of AI, investors can find a better – cheaper – place to expose their portfolios to this trend.
Names like Arista Networks Inc. (NYSE: ANET), Adobe Inc. (NASDAQ: ADBE), and even good old Microsoft Co. (NASDAQ: MSFT) could be better stocks for investors to enjoy the rest of the A.I. ride while filtering out some of the inevitable bumps along the way.
Arista Networks: A Profit-Churning Machine
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After falling to 80% of its 52-week high, Arista stock is the dream of every value investor today. Compared to its peers in the computer sector, Arista trades at an 82% discount on a P/E basis. A 37.2x multiple falls below the average valuation of 209.3x for the industry.
The company’s financials show a gross margin of over 60%; these are Microsoft-level margins despite Arista being a $76 billion market capitalization company, rather than counting with Microsoft’s $2.9 trillion market cap.
Profits don’t fall short for this company, which supports cloud networking and computing solutions globally through its data centers, continuously feeding its A.I. models. Returns on invested capital (ROIC) rates for this business stood at 23% over the past three years.
Since annual stock performance tends to reflect a business's ROIC long-term rates, this stock could potentially compound shareholders' wealth. Its essentially no debt on its balance sheet makes it even more attractive to Wall Street analysts.
Projecting 13.7% earnings per share (EPS) growth in the next 12 months gives those at The Goldman Sachs Group Inc. (NYSE: GS) the confidence to boost Arista’s price targets up to $356 a share, reflecting roughly 45% upside from today’s prices.
Price action compared to the Technology Select Sector SPDR Fund (NYSEARCA: XLK) shows Arista outperforming the rest of its peers. Over the past year, Arista beat the sector by 25%, which shows that bulls have dominated the price action lately.
Adobe’s a Classic, Here to Stay
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Or so do analysts think. After projecting 13% EPS jumps for this year, analysts don’t see a reason to avoid their $620 consensus price target for the stock, showing a 33% upside from where it trades today.
Those at Mizuho Financial Group Inc. (NYSE: MFG) think it could go higher to $680 instead, a much richer 46% upside. It makes sense for Adobe stock, significantly after it fell to 73% of its 52-week high prices.
Adobe leads the graphics software market by taking 42% of its share and owns roughly 59.9% of the market share in the computer sector. Yet, it trades at an 80% discount to it.
That’s right, Adobe’s 44.3x P/E valuation falls well below the sector’s 209.3x valuation today. Because of this enormous market share and brand penetration, the company’s financials show an ROIC rate of around 22%, falling into value investor territory.
Institutional investors own 81.8% of the company, and the past year alone saw $265 billion in institutional inflows. Despite being much smaller than Microsoft, at $208 billion, the company is still looking to grow its EPS at the behemoth’s rate.
Investors could see a pleasant surprise brewing from Adobe’s use of AI in graphics generation and other software-assisted features, bringing the stock’s valuation up to industry standards.
Microsoft: The People’s A.I.
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Forever in competition against Elon Musk’s OpenAI, Microsoft developed Copilot, its own version of the A.I.-backed chat. The difference here is that Copilot is available to anyone for free. At the same time, ChatGPT (OpenAI’s version) includes a paid feature to access its true potential.
The coding industry has increasingly relied on Copilot’s abilities and open access, but Microsoft’s A.I. doesn’t stop there. Carrying the company name enabled its A.I. capabilities to be accepted by Fortune 500 names like Goldman Sachs and Ford Motor (NYSE: F).
Due to its massive brand and size, this stock still offers investors a massive discount of 82% through its 36x P/E compared to the computer sector. These same advantages also allow the company to generate ROIC rates of 22%.
Because Microsoft’s business also counts on billions in recurring revenue from Office 365 products, its gross margins remain industry-leading at 68%, giving management the ample room it needs to keep ROIC higher for longer.
Knowing this, analysts at Morgan Stanley (NYSE: MS) boosted their Microsoft stock price targets up to $520, calling for a nearly 30% upside from where the stock trades today.
