Artificial intelligence (AI) is the hottest topic on Wall Street right now. Some headline names are unavoidable in this space, and for good reason. There are also many companies doing everything they can to demonstrate their AI credentials, regardless of how legitimate their claims might be.
However, some companies have flown a bit under the radar while posting impressive results and have legitimate tailwinds from the AI boom currently taking place. Here are two companies that might be the top AI stocks to buy right now.
1. Arista Networks
When you hear about AI, it's often about companies rushing to buy the semiconductor chips necessary to train the large language models (LLMs) that power consumer-facing products like ChatGPT. However, it's important to remember that many of these chips end up in the data centers of the largest tech companies in the world. Inside these companies' data centers, the servers are connected by routers and switches, and a large percentage of those routers and switches are supplied by Arista Networks (ANET 1.90%).
As tech giants like Meta Platforms and Microsoft grow their data center footprints, Arista is a critical partner. The financial results demonstrate just how important this relationship has been for Arista. Thirty-nine percent of Arista's total revenue comes from Meta and Microsoft.
In the first quarter of 2024, Arista posted year-over-year revenue growth of 16%. While this was a deceleration from previous quarters, profitability remained strong. Net income grew by 46% compared to the year-ago quarter. This impressive increase in net income was driven by an improvement in gross margin, which jumped more than 4 percentage points over Q1 2023, as well as a reduction in operating expenses as a percentage of revenue.
2. Broadcom
Broadcom (AVGO 2.89%) is a supplier of semiconductor hardware and software in a variety of products such as wireless routers and cellphones. Much like Arista, Broadcom has relied on relationships with large tech companies with AI aspirations. For example, Apple represents approximately 20% of Broadcom's total revenue.
Broadcom recently reported its earnings results for its fiscal second quarter of 2024, ended May 5, and the results were impressive. Revenue increased by 43% year over year to $12.5 billion. Revenue from AI products grew by 280% and represented approximately 25% of the total, demonstrating that Broadcom is benefiting from the rush to build out AI capacity by the largest tech companies in the world.
There is one caveat to Broadcom's revenue growth that investors should be aware of. The company recently acquired infrastructure software company VMWare, and that contributed meaningfully to the revenue results. Excluding revenue from VMWare, revenue growth would have been 12%.
For the full year, Broadcom expects revenue from AI products to be approximately $11 billion, which management intimated was a conservative estimate, suggesting there's a possibility for further upside as the year progresses.
The bottom line for investors
Neither Arista Networks nor Broadcom seem to be breaking through the headline AI news, but investors certainly have noticed their strong results. Both stocks trade for steep valuations compared to their historical results.
ANET PE Ratio data by YCharts
These companies are certainly in the right place at the right time and should continue to post strong results for as long as AI spending remains elevated. In that sense, the elevated valuations make sense. While I do think these stocks are buys right now, a dollar-cost averaging approach may prove most prudent for most investors.
