Without question, the market has developed an insatiable appetite for artificial intelligence (AI) technology and the companies steering this new frontier. Viewed as a promising future, the profit potential is staggering, with the generative AI market currently experiencing a 42% growth rate and the potential to reach $1.3 trillion by 2032, according to Bloomberg Intelligence estimates.
A significant portion of this revenue is expected to come from the demand for infrastructure required to train AI models, estimated at $247 billion by 2032. As the competition to dominate AI technology intensifies, it's not hard to spot the clear winners. Investor have flocked to Microsoft (MSFT) (up 57%) and Nvidia (NVDA) (up 227%), which have both skyrocketed in 2023, driven by the release of consumer-focused AI tools, such as ChatGPT and Google's Bard, among others.
But if you’ve missed the gains in megacap tech companies Microsoft and Nvidia, buying “picks and shovels” could be a worthwhile strategy for the long term. In a note to clients last Wednesday, analyst Timm Schulze-Melander of investment firm Redburn Atlantic initiated coverage on several semiconductor stocks, suggesting that the AI "gold rush" holds opportunities beyond the aforementioned tech behemoths. Among those Schulze-Melander believes are poised for massive gains are Applied Materials (AMAT) and Lam Research (LRCX), which he rates at Buy. AMAT's price target was set at $149, while Lam Research was set at $700.
"Cyclically, most chipmakers will see improvement before wafer fabrication equipment (WFE) does. Recent data points in DRAM coincide with the first green shoots in several end markets," Schulze-Melander wrote. The analyst emphasized that companies will adopt what he calls “vertical scaling.” When combined with gate-all-around transistors and backside power delivery chip architectures, chip stocks are well-positioned for outsized growth in the next three to five years.
AI enables computers to learn and problem-solve like humans, employing advanced forms of computer processing, including machine learning and neural networks. with AI-assisted digital ads projected to generate $192 billion in annual revenue by 2032, and AI servers potentially reaching $134 billion. He did, however, point out that several chip stocks that he’s positive on, including KLA Corporation (KLAC), are dealing with with 30% excess capacity.
That said, Schulze-Melander foresees that the industry, known for its cyclical nature, is likely to emerge from its trough in 2024. He cited, among other things, the recovery of the PC and smartphone markets as well as the rebound in dynamic random access memory (DRAM) and NAND prices supports this market resurgence. He also pointed to, relative to Nvidia, there are under-owned companies such as Intel (INTC) and Advanced Micro Devices (AMD) that have potential positive gains in CPU demand.
What’s more, there are other chip stocks, particularly those which are powered by Arm Holdings (ARM) architecture that are expected to experience "very strong" growth rates over the next two years. Estimates suggests that the AI-assisted digital ads business could reach $192 billion in annual revenue by 2032, while revenue from AI servers could hit $134 billion. This is where certain chips such as Applied Materials and Lam Research that are designed to support these markets will experience immense growth.
Overall, when assessing this burgeoning AI frontier, competition is fierce, while clear winners Microsoft and Nvidia have emerged, but just like other market trendy buzzwords that have captivated the investor community, not every company that puts out an AI press release will thrive. However, the attractive risk-reward opportunity in the realm of picks and shovels offers attractive growth opportunities in 2024 and beyond.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.