Nvidia’s just the start: Goldman says the AI boom will have four phases

Goldman has separated the AI revolution into four phases, looking to identify the stocks and sectors set to benefit most after Nvidia.

Despite Nvidia’s massive share price rally, its forward price-to-earnings ratio remains virtually unchanged over the past two years – and that’s because its earnings outlook has managed to keep pace with its stellar stock rise.

Goldman sees semiconductor-related firms, and software and services companies getting a huge boost from AI, and says the potential improvement in productivity across most sectors bodes well for the economy as a whole.

Sure, Nvidia’s been the poster child for the AI investing boom. But there’s a lot more to AI than this popular, green-logo chipmaker. Goldman Sachs, in a recent report, says the AI trade will unfold in four separate phases – and this stock is just chapter one. So let’s take a look at those phases, then, and the companies that are likely to win big in each.

Phase 1: Nvidia

This part kicked off less than a year and a half ago, with the release of OpenAI’s ChatGPT. The generative AI bot took the world by storm, sparking a surge in demand for shares of Nvidia, whose AI-powering computer chips made it the market’s clearest near-term AI beneficiary.

What’s the opportunity?

Despite Nvidia’s massive share price surge, its current valuation – judging by its forward-looking price-to-earnings ratio – is almost unchanged. And that’s because its estimated earnings per share have been shooting rapidly higher too.

This all looks great right now, but Goldman notes that as companies get bigger, they usually have a harder time achieving rapid growth and maintaining high margins. For now, it seems right to just enjoy the investing ride, knowing that, eventually, even Nvidia will see its growth slow.

Phase 2: AI infrastructure

You can think of AI as its own little world, with a ton of firms involved in its infrastructure. These include semiconductor companies whose chips are the critical components needed to train and use AI. And there are subsectors within semiconductors, including design companies such as ARM, and fabless designers (who design but don’t manufacture) like Broadcom and Advanced Micro Devices. There are also memory companies like Micron, and semiconductor manufacturing equipment companies like Applied Materials and ASML.

Plus, there are data centre companies, such as Equinix, which own and operate physical places that contain the servers needed to train and run AI models. And there are hardware and equipment companies, like Vertiv, supplying the things needed to build and operate the data centres.

Utility companies, like Duke Energy, meanwhile, deliver vast amounts of electricity to power the data centres. Cloud providers, like Microsoft, Amazon, and Alphabet help train, run, and maintain AI models through their computing and data storage solutions. And security companies like CrowdStrike work to keep data safe.

What’s the opportunity?

Goldman looked closely at these companies’ EPS estimates and P/E ratios three years into the future – and then accounted for various unforeseen factors. After all, lots of things can impact valuations and stock prices. And this is how the investment bank sees things panning out.

The companies that fall below the “best fit” are potentially more attractive to investors because they have higher expected profit growth relative to their P/E valuations.

For example, “foundry and integrated device manufacturers” look to have a relatively good-looking setup of strong expected EPS growth with modest valuations. The companies in that subsector are TSMC, Intel, and Global Foundries.

Meanwhile, security stocks have strong earnings expectations but could struggle to perform, since they already trade at very high valuations, with their prices above 50x their earnings (that’s more than double the average for companies in the S&P 500).

Utilities could represent an interesting opportunity because they look cheap in valuation terms. But since they operate in a highly regulated industry, they could continue to struggle to make meaningful gains.

Overall, it’s worth noting that semiconductors are still a big component of Phase 2 companies, and so semiconductor companies could be a good place to look for some broad-based AI exposure.

Phase 3: AI-enabled sales

The companies that will benefit at this stage are the ones that can add AI into their product offerings to boost what they sell. Many of them are software and IT services companies, like Meta, MongoDB, Intuit, Nutanix, ServiceNow and Uber.

What’s the opportunity?

Loads of software and IT services firms have already described how they’ll take advantage of AI. So Goldman had a look across the industry, scouting for companies whose share prices have high beta (or volatility), and have been rising with Nvidia’s. Then they zeroed in on the ones whose executives specifically mentioned AI in their latest quarterly earnings calls with investors. That left the bank with a long list of companies. 

Phase 4: AI productivity.

Eventually, the AI trade will focus on companies that are using AI to improve productivity – across a wide range of industries – with the biggest potential likely to be in more labour-intensive industries.

Goldman crunched the data and estimated that profits at software and IT services, and commercial and professional service companies could benefit the most. After all, a hefty segment of their well-paid workers are in jobs that could be replaced by AI automation, which could dramatically reduce those firms’ labour costs. Goldman’s report highlighted Match Group and News Corp as a couple of prime examples.

What’s the opportunity?

Phase four is about the grand promise of the technology: the way things shift when AI is adopted by a wide range of companies. Goldman sees software and IT services firms, and commercial and professional services firms affected the most, as AI adoption improves their labor productivity and dramatically shrinks their wage costs. 

And, last, a look at the big picture

The important thing to remember is that we’re still in the early stages of AI. Phase one star Nvidia has been the standout performer, by far, but there have been gains in stocks from across each of the tech’s phases.

Taking on more risk can potentially bring bigger returns. And picking stocks and sectors is generally riskier than choosing the broader market index. If AI is set to improve productivity across a huge number of sectors and the wider economy, as suggested in phase four, owning the S&P 500 through the SPDR S&P 500 ETF Trust or the Invesco S&P 500 Equal Weight ETF could well prove to be a good long-term bet.

Disclaimer

This publication has been produced with Finimize. As with all investing, your capital is at risk. Forecasts are never a perfect predictor of future performance, and are intended as an aid to decision- making, not as a guarantee. This publication does not contain and should not be taken as containing, investment advice, personal recommendation, or an offer of or solicitation to buy or sell any financial instruments. Prospective investors should seek independent financial, tax, legal and other advice before making an investment decision.