Investing in the tailwinds behind technological innovation can deliver wealth-building returns in the stock market. But just because a stock is rising in value doesn’t mean it’s worth buying. It is always important to compare a company’s valuation with its business fundamentals.
To help you in your search, here are two stocks I would buy with my money today, and one I would avoid.
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Spending on data center infrastructure is increasing explosively. 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 has almost doubled in the last twelve months, but is still trading at a reasonable valuation that could deliver excellent returns in the coming years.
Broadcom’s components are an important part of smartphones. Apple signed a new long-term agreement 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 revenue up 3.5x year over year in the latest quarter.
Revenues from other markets, including wireless and broadband, are not performing as well, but these markets are expected to recover. Management noted that performance in non-AI semiconductor products is stabilizing, which could become a catalyst in 2025 as more AI-enabled devices become available. Wall Street analysts expect Broadcom’s profits to rise 28% next year and grow 20% annually in the coming years.
That’s enough growth to support the share price, which currently trades at a price-to-earnings (P/E) ratio of 27. Broadcom is one of the strongest technology companies in the world. It delivered steady sales and profit growth for 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 years. Revenues are growing at triple digits, delivering excellent returns for investors.
Analysts currently expect Nvidia’s revenue to rise 42% to $179 billion next year. The company makes GPUs for gaming and general computing, but the data center segment currently generates more than 80% of its revenue. These advanced AI chips have high margins, generating an impressive $16 billion in profits in the second fiscal year alone.
Demand from cloud service providers drives nearly half of its data center revenue, but Nvidia also sees growth coming from foreign countries investing in building their sovereign AI infrastructure. Management also sees healthcare emerging as a large and growing market for the company, with AI bringing major changes to medical imaging and patient care.
GPUs are absolutely essential components for the way businesses operate today. Nvidia helps most Fortune 100 companies with AI capabilities. Generative AI-powered software is growing rapidly in the enterprise space, driving a lot of demand for Nvidia.
Nvidia stock has had an incredible run, but its forward price-to-earnings ratio of 33 on next year’s earnings forecast still looks attractive compared to earnings growth expectations. Analysts expect Nvidia’s profits to grow 57% annually in the coming years. Investors can expect market-based returns over the next twelve months and beyond.
MicroStrategy (NASDAQ:MSTR) Shares are up 406% in the past year. The enterprise software analytics company adopted a new policy in 2020 that allowed management to hold its ground Bitcoin instead of cash as the main treasury reserve, effectively converting the company’s stock into a tracking stock for the value of Bitcoin.
MicroStrategy held 252,220 Bitcoins at the end of the third quarter. While this helps the stock price as Bitcoin’s value rises, the shares appear overvalued relative to the company’s financials.
The problem is that MicroStrategy’s core businesses are not performing well. Although subscription services revenue increased 32% year-over-year, this revenue stream is still too small to have an impact on the company’s growth. Total revenue fell 10% year over year in the third quarter, and more importantly, the company isn’t making a profit. MicroStrategy has struggled to keep its profit margin above water in recent years, reporting a net loss of $340 million last quarter.
If the company were profitable and reinvested the profits in Bitcoin, that would be a good strategy from a risk perspective. But given the company’s losses, MicroStrategy is issuing debt to help finance its Bitcoin purchases. During the third quarter, total outstanding debt was $4.3 billion and has been increasing in recent years.
Furthermore, investors will pay a large premium for the company’s $18 billion worth of Bitcoin at the end of the third quarter. This is too low to support MicroStrategy’s current market capitalization (share price times outstanding shares) of $48 billion. Investors pay 2.6 times the value of the company’s Bitcoin holdings to buy shares. What’s most alarming about this premium is that even with the help of loans to fund its investments, the company’s Bitcoin holdings are not growing fast enough to support the share price value at this level.
MicroStrategy stock appears overvalued. Investing in a Bitcoin Exchange Traded Fund (ETF) seems like a safer option for investors interested in the cryptocurrency, given the company’s willingness to issue debt to finance its Bitcoin investment, on top of the weak performance of its core businesses.
Consider the following before buying shares in Broadcom:
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John Ballard has positions at 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.
2 Supercharged Stocks to Buy in November, and 1 to Avoid was originally published by The Motley Fool
