Nvidia is one of the most popular artificial intelligence (AI) stocks on the market, but investors should diversify their portfolios.
In a letter to clients last year, hedge fund billionaire Dan Loeb compared artificial intelligence (AI) to the industrial revolution. The Industrial Revolution was characterized by a dramatic increase in economic output as machines replaced human workers. AI promises similar incremental increases in productivity in virtually every industry.
Loeb wrote, “We have watched the evolution of AI and believe that the technology has matured to the point that it is driving a transformational technology platform transformation of the kind seen roughly once every decade. : Personal computers in the 1980s, the Internet in the 1990s, mobile phones. The 2000s, and the cloud in the 2010s.”
This presents investors with a huge opportunity. The smartest way to leverage is to own a basket of AI stocks. Many investors will naturally gravitate towards this. Nvidia (NVDA -3.44%), the company whose chips power the most advanced AI systems. But Service Now (now -0.21%) AI is a more compelling stock at its current price.
Nvidia is a wonderful company, but the stock looks expensive
Nvidia’s graphics processing units (GPUs) are the gold standard in accelerating complex data center workloads like artificial intelligence (AI). The company consistently achieves record-breaking results on MLPerfs, objective benchmarks that measure the performance of AI hardware and software. Furthermore, The Wall Street Journal reports that “Nvidia’s chips dominate all the latest AI systems, giving the company over 80% market share.”
Nvidia delivered a surprising financial performance in the fourth quarter. Data center revenue rose 265% to $22.1 billion on triple-digit sales growth, driven by strong demand for AI solutions. Meanwhile, non-GAAP (generally accepted accounting principles) net income jumped 486 percent to $5.16 per share as gross margins expanded more than 10 percentage points, pricing power and scaling soft. Because of the ware business.
Going forward, Grandview Research estimates that AI spending will grow by 37 percent annually through 2030. Nvidia will undoubtedly benefit from this tailwind. In fact, Wall Street expects the company to grow sales at a 27 percent annual rate over the next five years. But that consensus makes its current price of 36.6 times sales look expensive.
To be clear, I’m not suggesting that investors sell Nvidia. It is an outstanding company with a history of innovative innovation and excellent prospects for future growth. But I am skeptical about its ability to deliver market-beating returns for shareholders at its current price. So investors should consider other AI stocks (such as ServiceNow) for the time being.
ServiceNow is a leader in workflow digitization and automation.
ServiceNow helps enterprises digitize and automate workflows across departments. Its platform addresses four primary use cases:
- Technology workflows such as IT service and IT operations management
- Customer workflows such as field service and customer service management
- Employee Workflow Similar to Human Resources
- Creator workflows such as software development and process automation
ServiceNow is known as a leader in IT service management, but consultancy Gartner It has also recognized its leadership in IT operations management and artificial intelligence (AI) for IT operations. Similarly, Forrester Research The company is viewed as a leader in low-code application development, customer service solutions, digital process automation, and risk management platforms. These accolades tell investors that ServiceNow is doing something right, but they also point potential customers to a compelling product.
ServiceNow posted strong financial results in the fourth quarter. Total revenue rose 26% to $2.4 billion, marking the fourth consecutive quarter in which growth continued to accelerate. This trend may continue in the future as residual performance obligation (RPO), which measures the speed in the sales pipeline, has actually grown faster than revenue. Specifically, RPO grew 29% to $18 billion in the fourth quarter.
Meanwhile, non-GAAP operating margin increased nearly 150 basis points, and adjusted net income rose 36% to $3.11 per diluted share. It reflects disciplined cost management. ServiceNow also achieved a renewal rate of 99% in the fourth quarter, up from 98% last year, indicating a high level of customer satisfaction.
ServiceNow holds the tailwinds in digital transformation and artificial intelligence.
Going forward, digital transformation (DX) should be a significant tailwind for ServiceNow. International Data Corporation estimates that DX spending will grow 16 percent annually through 2027 as businesses digitize all processes to improve efficiency. ServiceNow is ideally positioned to capitalize on this secular trend, given its leadership in several relevant markets.
Additionally, generative AI should also be a significant tailwind. ServiceNow became one of the first software companies to make generative AI available to its customers when it introduced Now Assist last September. Now Assist is a suite of tools that can automate tasks and improve productivity across IT service, customer service, human resources, and development teams. Bloomberg Intelligence estimates that creative AI software revenue will grow 58 percent annually through 2032.
ServiceNow CEO Bill McDermott commented on these tailwinds during a recent earnings call:
What we have here is a strong, sustainable market that has been supercharged by generation after generation of secular trends. ServiceNow has been investing, innovating and preparing for this wave for years, which is why we’re catching it so quickly. Artificial intelligence is adding new fuel to our already high-performance growth engine.
With that in mind, Wall Street expects ServiceNow’s sales to grow 20% annually over the next five years. In this context, its current price of 17.4 times sales is affordable. Investors with a five-year time horizon should feel comfortable buying a short position in this growth stock today.