Investing in the tailwinds behind technological innovation can produce wealth-building returns in the stock market. But just because a stock is soaring in value doesn’t mean it’s worth buying. It’s always important to consider a company’s valuation relative to business fundamentals.
To aid you in your search, here are two stocks I would buy today with my money, and one I would avoid.
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Spending on data center infrastructure is booming. Companies are upgrading hardware and components to support artificial intelligence (AI) workloads. Broadcom(NASDAQ: AVGO) benefits from this trend as a leading supplier of semiconductors, networking hardware, and software solutions for data centers. The stock nearly doubled over the last 12 months but still trades at a reasonable valuation that can support excellent returns over the next several years.
Broadcom’s components are a staple in smartphones. Apple signed a new long-term deal with the chip company last year to supply 5G radio frequency components for the iPhone maker. But Broadcom is seeing monstrous growth for its custom AI accelerators, with sales up 3.5 times year over year in the last quarter.
Revenue from other markets, including wireless and broadband, are not performing as well, but these markets are expected to turn around. Management noted stabilizing performance in non-AI semiconductor products, which could turn into a catalyst in 2025, as more AI-enabled devices become available. Wall Street analysts expect Broadcom’s earnings to be up 28% next year and grow at an annualized rate of 20% in the coming years.
That’s enough growth to support the share price that currently trades at a forward price-to-earnings (P/E) ratio of 27. Broadcom is one of the strongest tech companies in the world. It delivered steady growth in revenue and profits for many years, which has funded a growing dividend to shareholders. The stock’s current dividend yield is 1.2%.
The most in-demand components for working with AI technology are graphics processing units (GPUs). Nvidia(NASDAQ: NVDA) has been the dominant supplier of these chips for many years. It is growing revenue at triple-digit rates, fueling excellent returns for investors.
Analysts currently expect Nvidia’s revenue to increase by 42% next year to reach $179 billion. The company makes GPUs for gaming and general-purpose computing, but its data center segment is generating over 80% of its revenue right now. These advanced AI chips command high margins, which generated an impressive $16 billion in profit in fiscal Q2 alone.
Demand from cloud service providers is driving close to half of its data center revenue, but Nvidia is also seeing growth coming from foreign countries investing to build their sovereign AI infrastructure. Management also sees healthcare emerging as a large and growing market for the company, with AI bringing major changes in medical imaging and patient care.
GPUs are absolutely essential components for how businesses are operating today. Nvidia is helping most of the Fortune 100 companies with AI opportunities. Generative AI-powered software is growing rapidly across the enterprise space, which is fueling a lot demand for Nvidia.
Nvidia stock has had an incredible run, but the stock’s forward P/E of 33 on next year’s earnings estimate still looks attractive relative to earnings growth estimates. Analysts expect Nvidia’s earnings to grow at an annualized rate of 57% in the coming years. Investors should expect market-beating returns over the next 12 months and beyond.
MicroStrategy(NASDAQ: MSTR) shares have climbed 406% over the last year. The enterprise software analytics company adopted a new policy in 2020 that allowed management to hold Bitcoin in place of cash as its primary treasury reserve asset, which basically turned the company’s shares into a tracking stock for the value of Bitcoin.
MicroStrategy held 252,220 Bitcoins at the end of the third quarter. While this is benefiting the share price as the value of Bitcoin soars, the shares look overvalued relative to the company’s financials.
The problem is that MicroStrategy’s core business is not performing well. While subscription service revenue was up 32% year over year, this revenue stream is still too small to make an impact on the company’s growth. Total revenue was down 10% year over year in Q3, and more importantly, the business isn’t turning a profit. MicroStrategy has struggled to keep its profit margin above water in recent years, and it reported a net loss of $340 million last quarter.
If the company were profitable and reinvesting profits in Bitcoin, that would be a sound strategy from a risk perspective. But given the company’s losses, MicroStrategy is issuing debt to help finance its Bitcoin purchases. Through the third quarter, its total debt outstanding stood at $4.3 billion and has been increasing over the last few years.
Moreover, investors are paying a big premium for the company’s $18 billion worth of Bitcoin at the end of Q3. This is too low to support MicroStrategy’s current market cap (share price times shares outstanding) of $48 billion. Investors are paying 2.6 times the value of the company’s Bitcoin holdings to buy shares. What’s most alarming about that premium is that even with the assistance of borrowing to finance its investments, the company’s Bitcoin holdings are not growing fast enough to support the value of the share price at these levels.
MicroStrategy shares look overvalued. Investing in a spot Bitcoin exchange-traded fund (ETF) seems like a safer option for investors interested in the cryptocurrency, considering the company’s willingness to issue debt to fund its Bitcoin investment on top of weak performance from its core business.
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John Ballard has positions in Nvidia. The Motley Fool has positions in and recommends Apple, Bitcoin, and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
