At any given time, there is likely a hot story in the world of investing. Right now, that hot story is undoubtedly artificial intelligence (AI). Companies of all kinds are scrambling to present themselves as being in on AI, whether it's core to their business or not. That being said, because computers, automation, and technology generally drive much of modern society, it is conceivable that AI will eventually impact all or most industries in some way.
This marketwide focus on AI has also driven up the prices of the companies that have the most to gain from the rush to bring more sophisticated versions of AI to the market. The fear of missing out has put some great businesses into the valuation stratosphere. Here are three stocks that investors should keep an eye on for when there's a stock market sell-off and they become more reasonably priced.
1. Nvidia
If there's a company that kicked off the artificial intelligence boom in the stock market, it's Nvidia(NASDAQ: NVDA). It was Nvidia's string of eye-popping quarterly results that got investors to notice the opportunity to invest in all things AI. Nvidia designs the chips that have proven to be very good at helping develop AI, and as a result, demand for these chips has been robust.
Nvidia's overall revenue has seen explosive growth, but that has been driven primarily by its data center segment, which is where the demand for chips used in AI is reported. Not only has this segment's revenue grown in each of the last five quarters, but the year-over-year (YOY) growth rate has accelerated.
Q4 2023
Q1 2024
Q2 2024
Q3 2024
Q4 2024
Data Center Revenue
$3.6 billion
$4.3 billion
$10.3 billion
$14.5 billion
$18.4 billion
YOY Growth
11%
14%
171%
279%
409%
Data source: Nvidia.
Nvidia stock currently trades for 76 times earnings, which is not cheap by any means. However, considering the increasing rate of data center revenue growth and the continued demand for chips to power AI, it may surprise investors that the valuation has come down over the past year. Even so, at some point, demand will slow, and there will likely be more attractive valuations at which to accumulate shares of this great business.
2. Arista Networks
Nvidia's impressive revenue growth was driven by the sales of chips that are used in data centers. These data centers are also a driver of results for Arista Networks(NYSE: ANET), which sells the switches and routers needed to run large data centers for the world's biggest tech companies.
The growth story for Arista has been less about revenue growth and more about the bottom line. In fact, revenue growth has slowed over the last few quarters, making the rest of its results even more impressive. In the recently reported first quarter of 2024, Arista reported earnings per share of $1.99, a 44% increase over the first quarter of 2023. Arista also generated $520 million in free cash flow, compared to $369 million in the prior year.
Arista currently trades for 42 times earnings, which is less expensive than Nvidia but still quite pricey. Looking back over the last five years, Arista's average price-to-earnings (P/E) multiple is 34, and the average multiple for the S&P 500 is 25. Arista is certainly a quality business that deserves to trade at a premium, but there will likely be better buying opportunities in the future.
3. Broadcom
Broadcom(NASDAQ: AVGO) may not be a household name, but it has a long and distinguished history in the world of technological advancement. With its products in data centers, broadband modems, computers, and cellphones, there's a good chance most investors have used one of their products without even knowing it.
Broadcom reports its results in two segments: infrastructure software and semiconductor solutions. Historically, the semiconductor solutions segment has constituted 78% of Broadcom's revenue. However, the recent acquisition of cloud software company VMware has shifted the revenue mix, and infrastructure software now accounts for 38% of revenue.
The VMware acquisition resulted in a much higher year-over-year revenue growth result than is typical for Broadcom. Q1 2024 revenue growth was 34%, compared to the single-digit revenue growth seen in the previous few quarters. For the full year, the company is expecting revenue growth of $50 billion, which would be a 40% increase over 2023.
Broadcom trades for a P/E multiple of 48, which is a significant increase from one year ago when it traded for just under 20 times earnings. Broadcom's acquisition of VMware is in its early days, so investors should watch how the integration of the two businesses progresses over time. A market sell-off could present an opportunity to buy shares at a better valuation than today.
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Jeff Santoro has positions in Arista Networks, Broadcom, and Nvidia. The Motley Fool has positions in and recommends Arista Networks and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
