As the deployment of artificial intelligence continues to grow across the corporate world, investors are turning to data-center infrastructure as a way to play the long-term trend. One company that has drawn the attention of investors is Nvidia Corp., whose stock has returned an impressive 189% this year, with dividends reinvested.
While Nvidia currently ranks fourth among the 16 industry players expected to increase sales at a compound annual growth rate of at least 15% through 2025, it is also an expensive stock. So, where else can investors look for exposure to the AI build-out?
A screen of 60 makers of computer chips and related hardware reveals which companies have made the most efficient use of invested capital over the past five years. This approach may be a starting point for your own research into stocks that can broaden your exposure.
Evaluating Nvidia’s Valuation
Before diving into other companies in the industry, it’s important to take a closer look at Nvidia’s valuation. As of May 25, the stock had seen a 24% pop after projecting a 50% sequential increase in sales for the current quarter, driven by the adoption of the company’s graphics processors for AI computing in data centers.
Comparing Nvidia’s valuations with those of the S&P 500 and the iShares Semiconductor ETF, which tracks the PHLX Semiconductor Index of 30 manufacturers of computer chips or related hardware, we can see how it stacks up:
Forward Price-to-Earnings Ratios
| | Nvidia (NVDA) | S&P 500 (SPX) | iShares Semiconductor ETF (SOXX) | |———–|—————|—————-|————————————-| | Current | 70.08 | 23.68 | 23.62 | | 1 Year Ago| 27.59 | 16.82 | 18.60 | | 5 Years Ago| 19.65 | 16.86 | — |
Forward Price-to-Sales Ratios
| | Nvidia (NVDA) | S&P 500 (SPX) | iShares Semiconductor ETF (SOXX) | |———–|—————|—————-|————————————-| | Current | 16.61 | 2.96 | 4.52 | | 1 Year Ago| 5.97 | 2.39 | 2.33 | | 5 Years Ago| 6.90 | 1.57 | — |
As we can see, Nvidia is currently trading at a premium to the S&P 500 and the Semiconductor ETF, with both its forward P/E and P/S ratios coming in significantly higher than those of its peers.
While Nvidia may still be attractive to investors bullish on the company’s prospects in the AI build-out, it may not be the best option for those seeking more value-oriented investments in the semiconductor industry. By analyzing other companies that have made efficient use of invested capital, investors can broaden their exposure to this long-term trend.
Nvidia Valuation versus SOXX and S&P 500
Nvidia’s forward P/E of 50.7 indicates a much higher valuation compared to the S&P 500 and SOXX which have valuations of 18.8 and 22.5 respectively. However, despite Nvidia making up 12.3% of the SOXX portfolio, its P/E is less than half of SOXX’s P/E. The highest weightings in the SOXX portfolio are held by Broadcom Inc. AVGO and Advanced Micro Devices Inc. AMD.
Nvidia’s forward P/E of 50.7 is only 2.2 times its forward price-to-sales ratio of 22.9, highlighting its high expected profitability. In comparison, the S&P 500 and SOXX have P/E ratios significantly higher than their price/sales ratios.
Investing in the AI/Semiconductor Trend
Investing in SOXX may be a wise choice to play the AI/semiconductor trend while avoiding the risks of investing solely in Nvidia.
Alternatively, investing in ETFs focused on AI has become increasingly popular. Some ETFs may take different approaches towards this trend, making it important to research and compare before investing. Robotics and Artificial Intelligence ETFs
As technology continues to advance, investors have been turning to robotics and AI ETFs as a way to capitalize on this growing industry. Below are three popular ETFs in this space:
The Global X Robotics & Artificial Intelligence ETF (BOTZ) tracks an index of companies listed in developed markets, with 43 stocks in its portfolio. The companies are expected to benefit from the utilization of robotics and artificial intelligence. The fund is weighted by market capitalization, with its largest holding being Nvidia at 12.4% of the portfolio. BOTZ is currently the largest AI ETF with $2.4 billion in assets under management and was established in September 2016.
The iShares Robotics and Artificial Intelligence Multisector ETF (IRBO) holds 116 stocks that are equal-weighted and tracks a global index of companies that derive at least 50% of their revenue from robotics or AI. This ETF has $408 million in assets and was launched in June 2018.
The First Trust Nasdaq Artificial Intelligence & Robotics ETF (ROBT) has 107 stocks in its portfolio, with a modified weighting based on how directly they are involved in AI or robotics. It was established in February 2018 and currently has $361 million in assets.
Investors looking to invest in companies involved in manufacturing equipment or providing related services for chip makers can turn to the semiconductor industry. We started with the top 30 companies in the SOXX index and added an additional 30 companies in the S&P 1500 Composite Index in the semiconductor industry. We calculated five-year averages for returns on invested capital for these companies’ past 20 reported fiscal quarters.
Analyzing a Company’s Return on Invested Capital (ROIC)
Return on Invested Capital (ROIC) is a financial metric that measures how well management teams allocate investor’s money. FactSet defines ROIC as earnings divided by the sum of the carrying value of a company’s common stock, preferred stock, long-term debt, and capitalized lease obligations. It is most useful within specific industry groups for comparing how well a company uses its investments. However, it isn’t a perfect measure, and it is imperative to conduct proper research before determining whether a company is attractive based on their ROIC number. For instance, a company’s balance sheet may show negative equity capital while still being profitable with good cash flow, and this can distort its ROIC.
Out of the 60 semiconductor companies, four have less than 20 quarters of ROIC data available. The remaining 56 companies have an average ROIC of 15% or more over the past 20 quarters. Click on the ticker symbols for more information about each company, ETF or index. To learn more about the wealth of information available about these companies, check out Tomi Kilgore’s detailed guide.
It’s noteworthy to mention that high ROIC can influence total returns. Out of these 20 companies, 16 have exceeded the S&P 500’s 72% total return over the past five years when dividends were reinvested. Meanwhile, 11 of them have surpassed the 176% five-year return for SOXX. It’s vital to conduct proper research before investing in any company solely based on its ROIC number.
Intel Corp: A Second Chance at Success?
Did you know that Intel Corp. made it on the list of companies with the highest average ROIC, standing at an impressive 16.55%? Interestingly enough, Intel is also the only company on the list that experienced a negative five-year total return.
Despite its challenges, Intel is currently in the midst of a multi-year comeback that includes the development of a sizable chip factory business located in Western countries, including the U.S. While their efforts are still ongoing, Intel’s promising ROIC serves as an excellent indicator of their potential for long-term success.
Keep in mind that ROIC is just one tool out of many used to assess a company’s efficiency at making use of investors’ money. While it may not always paint the full picture, it’s a great place to start in identifying companies that are worth further research. After all, the goal is to find businesses that show potential for sustained competitiveness and growth over the next ten years or more.
Related: If you’re already invested in stock index funds, you may be invested in AI. But there are other strategies you can explore to capitalize on this growing industry.