Imagine a claustrophobic, windowless room occupied by rows of servers. Thousands of computers are running at once, and it’s hot. Huge industrial fans are spinning to try and bring the temperature down. Another data facility across the street has broken ground. There’s a whole new industrial complex emerging. The responsible building companies are barely able to meet demand.
The image shows the enormous processing power needed to drive the growth of artificial intelligence. Even while the megacap tech corporations that make headlines are distant from this movement’s glitz and glamour, some of the back end enterprises will stand to gain the most.
This refers specifically to data centers, which will become more and more important for information storage as AI becomes more widely used. A rising number of analysts claim that they are among the AI shift’s most underappreciated benefits.
Ted Mortonson, a managing director and tech strategist at Baird, stated that in order to implement this new architecture for gen AI, you essentially need to modernize infrastructure worth roughly a trillion dollars. It’s also quite early. Applying the baseball analogy, we’re probably not even close to the beginning of the game.
Taking into account that Goldman Sachs estimates that by the end of the decade, data center power demand will rise by 160%, and the bank notes that a search enabled by ChatGPT consumes up to 10 times the electricity of a standard Google search.
According to an analysis by Goldman analysts, the US hasn’t witnessed a jump in power demand like that since the early years of this century. AI will fuel it in addition to electrification and industrial reshoring.
From there, the AI revolution may benefit many electrical, utility, and construction firms that contribute to the data center industry. Thought to be the most defensive and dull sectors of the market, they may actually present some of the most interesting investing opportunities.
The unsung heroes of the moment
Businesses are already investing billions of dollars in building data centers, and stocks associated with their design and power supply are soaring.
First off, out of 11 sectors in the S&P 500 during the last six months, utilities has performed the third best. The only industries in which the group lags are information technology and communication services, which are home to pure-play AI giants like Meta, Nvidia, and Alphabet. Generally speaking, more defensive industries like utilities perform the worst when growth equities are leading the way. That hasn’t actually happened.
The sole data-center real estate investment trust listed on the New York Stock Exchange, Digital Realty Trust, has increased 38% on a single-stock basis over the last year, while the Global X Data Center & Digital Infrastructure ETF has increased 12%. Over the same period, the returns on both those stocks outpace the 4% gain realized by the iShares Core US REIT ETF.
Large electricity users’ stocks have also performed well in 2024. Super Micro Computer has increased its sales by 200% year to date. Its liquid-cooling technology has been dubbed a must for AI hardware. Even though Nvidia is the leader in AI, its growth is “only” 150% by 2024.
Vertiv, which also produces cooling and electrical equipment for data centers, has seen an 80% increase in value this year. It has increased by 435% from Nvidia’s first blockbuster quarter, which was 13 months ago, representing a 130 percentage point outperformance. The company was recently dubbed “the real AI darling” by Bank of America because to its dominance.
According to recent study by JPMorgan analysts, the global market capitalization of grid and power equipment equities in the US, South Korea, India, and Europe has increased by up to 140% since the beginning of the year.
Given the industry’s lackluster returns during the previous ten years, investors certainly aren’t used to viewing energy and utility stocks as a gold mine, according to Morningstar’s Travis Miller, an energy and utilities strategist. However, significant development is on the horizon: during the next ten years, the company projects 10% annual growth in the utility industry. Miller stated that he believes investors are unaware of the entire impact that data center growth has.
Software being left behind
Software equities have usually lagged behind while traditional hardware companies and their counterparts in the data center and real estate sectors have had tremendous growth.
The soaring demand for graphics processing units, data centers, and other physical computing devices has resulted in a 30 percentage point return advantage for hardware-tech equities this year over their software peers. The last ten years have seen a complete 180-degree turnabout, with software companies—praised for their robust profit margins and asset-light business models—beating their hardware counterparts by margins exceeding 250 percentage points.
What caused the change? Software firms find it challenging to develop around AI, according to Mortonson. According to Mortonson, who previously spoke in an interview, cloud businesses are expected to invest over $200 billion on data centers this year. This gen-AI cycle is all about infrastructure. He said, “That’s the engine, or horsepower, of Gen AI.
Not only that, but typical tech stocks linked to software appear pricey when compared to names in energy and data centers. According to Miller, utilities appear to be undervalued by roughly 5%.
Even still, years may pass before the data center growth reaches its full potential, notwithstanding recent outperformance. According to Miller, 2028 is the earliest year that data centers could have a major impact on business profits. This implies that investors might need to wait a bit to get the full benefit of the trade.
He said that there’s also a chance that worries about our ability to supply enough electricity may prevent the US from developing as many data centers as planned. He still anticipates significant growth in spite of that possibility. Miller stated that the growth potential for utilities that we will witness over the next ten years has not been seen in a generation.
