These pick-and-shovel AI plays are moving faster than some people expect.
However, that fragile valuation was challenged by analysts who pointed to competition from rivals such as Anthropic and alphabetGoogle was asked whether the current breakneck pace of artificial intelligence (AI) spending is sustainable.
Given the challenges of picking a winner in this area, investors may be better off looking at pick-and-shovel plays in the AI sector. Surprisingly, many of them are currently outperforming even the leading AI companies. Is the real money in AI in the power cooling and connectivity areas?
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where revenue is increasing
If you look at the revenue growth of some of the largest AI-focused companies – those developing AI-powered software and solutions – you’ll see some impressive numbers.
Alphabet, maker of Gemini and a heavy investor in AI features, has grown its trailing-12-month (TTM) revenue by 37.3% over the past three years. And Microsoft (MSFT 0.79%,which is integrating AI applications like Copilot into its products, has increased TTM revenue by 44% during the same period.
These are fantastic growth numbers, especially from such large companies. Yet they pale in comparison to the revenue growth being experienced by some of the AI industry’s pick-and-shovel plays.
Vertiv holdings (VRT 1.42%,The company, which makes industrial cooling and electrical systems, including systems used by data centers, has seen its TTM revenue grow 70.4% over the past three years. on ttm revenue Arista Networks (a net 1.06%,which manufactures electrical switches and networking infrastructure that are also vital to data centers, grew 92.8% in that period.
AI infrastructure appears to be outshining more traditional AI companies when it comes to revenue growth.
Profits are increasing even faster
It would be one thing if companies were growing their revenues but not their profits, which would indicate that much of the revenue growth was being lost to increased expenses. However, the opposite seems to be happening. All of these companies have grown their net income much faster than their revenue over the last three years.
Microsoft’s net income has increased 55.5% through December 2022, while Alphabet’s has more than doubled with a three-year increase of 107.2%. But once again, this pales in comparison to Arista Networks’ 148.2% net income growth and Vertiv’s astonishing 1,250% net income increase over the same time period.
To be fair, the net income of both Vertiv and Arista is very small – of $1 billion and $3.4 billion, respectively – compared to the tech giants’ net income of more than $100 billion, but the point is that Vertiv and Arista are not only growing revenue faster than Alphabet and Microsoft, but they are also growing their profits faster.
,-1.42,-2.33
current price
,162.01
key data points
$62b
day limit
,161.91 ,165.76
52wk range
,53.60 ,202.45
volume
17K
average volume
7.3M
gross margin
33.73,
dividend yield
0.11,
premium valuation
If there is money in power cooling and connectivity, it seems the market has already caught on. Arista and Vertiv are growing faster than their AI-enabled counterparts, but that faster growth is also reflected in their share prices.
Looking at the forward price-to-earnings ratio – which accounts for near-term growth – we find that Microsoft and Alphabet are practically similarly valued at 30 times forward earnings and 29.7 times forward earnings, respectively. Compare them to Vertiv, which is trading at 40.6 times forward earnings, and Arista, which is trading at 45.8 times forward earnings. If we look at past earnings the difference is even more stark, with Vertiv’s 63.2 and Arista’s 50.2 significantly higher than Microsoft’s 34.7 and Alphabet’s 30.9.
Of course, the fact that the market is assigning higher valuations to makers of network switches, power connectors and integrated cooling equipment than to makers of AI tools like Gemini and Copilot says a lot about where investors see the best prospects for growth.
While you should expect to pay a premium for these types of companies as the AI buildout continues, smart investors will keep a watchlist of pick-and-shovel AI companies and keep an eye out for potential short-term dips in share price that could provide more attractive buying opportunities.
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