Artificial intelligence (AI) applications will likely be a key determinant of economic growth for the next decade and beyond. However, the burgeoning AI industry is anything but static. Just last month, China’s DeepSeek R1 model was a watershed moment, which showed that a top-performing large language model could be built at very low cost.
The exact effect of DeepSeek on the industry is still not known today, but it does appear that AI is on its way to becoming cheaper, but also more pervasive. In that light, here are two companies that look to be in good position right now as the industry moves forward.
1. Microsoft
Microsoft (MSFT) has been a huge long-term winner, but has actually dramatically underperformed the Nasdaq Composite (^IXIC) over the past year, up just 1.5% versus the Nasdaq’s 23%-plus gain. Still, there’s nothing fundamentally wrong with Microsoft. The past year’s underperformance merely appears to be a consolidation period after a couple of years of strong gains. Likely, there will be another period of outperformance in the future, perhaps the near future.
It may seem odd to recommend Microsoft now. After all, in late 2022 and early 2023, Microsoft was perceived as an early leader in AI thanks to its investment in OpenAI, the company behind ChatGPT.
However, over the past year, Microsoft’s cloud computing competitors appear to have caught up in the AI races, either through building their own competitive large language models or investing in other strong AI start-ups.
Furthermore, OpenAI appears to be distancing itself from Microsoft. According to a recent report by The Information, OpenAI now plans to get three-quarters of its compute from Stargate by 2030, rather than Microsoft. Stargate is a massive data center project unveiled last month by OpenAI and SoftBank.
But this doesn’t appear to be an indictment of Microsoft’s technical capabilities. Rather, it’s merely that Microsoft CEO Satya Nadella isn’t willing to spend tens of billions of dollars without a high probability of getting returns on those investments. Nadella has also previously noted Microsoft’s massive AI investments have better corresponding demand signals than others’. This is because Microsoft’s Azure cloud tends to serve large enterprises that will likely use AI at scale, rather than riskier start-ups.
In fact, in a recent interview, Nadella predicted that by 2027 to 2028, there will likely be an AI “overbuild.” But that doesn’t particularly bother Nadella, as he says Microsoft will be able to then lease computing capacity at low rates. Nadella also said he doesn’t give much credit to terms like “artificial general intelligence,” or other nontangible milestones, but rather views AI success in terms of tangible financial improvements, such as increased efficiency and faster economic growth.
This is all really encouraging to Microsoft investors. The last thing investors would want is for the company to spend huge amounts of money without a tangible payoff. Moreover, Nadella understands Microsoft’s position as a cash-rich company with the ability to take advantage of other’s mistakes.
While Microsoft’s stock hasn’t really moved over the past year, it should still be a long-term AI winner and a safe tech stock to own through this transition.
2. Applied Materials
Another longtime tech winner that has underperformed recently is Applied Materials (AMAT). In fact, Applied’s stock is down over 9% over the past year. This is despite Applied beating revenue and earnings expectations every quarter over that time period.
So, like Microsoft, Applied’s recent stock performance merely seems like the business growing into its valuation after a couple of very strong years. But at just 22.5 times trailing earnings, this is a pretty solid value today for this long-term compounder.
Applied is the largest, most diversified semiconductor equipment maker, with a big concentration in etch and deposition. Etch and deposition intensity is only going up for leading-edge chips, as innovations such as gate-all-around transistors and backside power delivery are just beginning to be implemented by leading-edge chipmakers. As AI logic chips incorporate these new innovations, Applied should outgrow the overall semiconductor industry, which itself should outgrow the overall economy.
In addition, Applied has a strong position in lagging-edge chip equipment as well. Those segments are currently going into a downturn after a strong past of couple years. Moreover, Applied noted that about $400 million of its China sales will go away in the year ahead, due to newer restrictions that just came out in December. The combination may have caused Applied to sell off after its recent earnings report.
But these headwinds are really a drop in the bucket; Applied has made over $27.6 billion in revenue over the past year. Management also guided to 6.8% year-over-year revenue growth in the current second fiscal quarter. That’s not bad at all, considering the China headwind.
Meanwhile, Applied’s strong margins enable it to shower cash on shareholders via share repurchases and dividend increases. All in all, the recent pullback offers an excellent opportunity for long-term investors to add to their stakes.
— Billy Duberstein
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Source: The Motley Fool
