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Following an exceptional year of gains, the stock market looks to be pausing at the beginning of the new year. Investors are understandably wary after the Nasdaq Composite (NASDAQINDEX: ^IXIC) accomplished gains of 43% last year. Given those remarkable gains, investors are left to ponder whether the current rally still has the capacity to continue — and history can provide some clues.
Looking back to 1972 — the first full year the technology-based index was active — in every year subsequent to a bear market recovery, the Nasdaq has rallied another 19%, on average. The results differed by year, of course, ranging from a 7% increase in 1986 to a 38% surge in 2013. Nonetheless, and considering the ongoing economic recovery, the probability of the current market rally maintaining momentum in 2024 is high.
There’s proof that suggests it was the advent of generative AI that drove the market surge last year. These advanced algorithms were implemented to manage trivial tasks, freeing the user for higher-level tasks. While it’s still early days for AI, there are a couple of companies that stand out from the crowd and are well-placed to profit from the AI revolution.
AI stock No. 1: Microsoft
Microsoft (NASDAQ: MSFT) is arguably a well-known name, primarily recognized for its ubiquitous Windows PC operating system and Office suite of productivity tools.
Recognizing the extensive potential for generative AI, Microsoft jumped in headfirst, making a $13 billion investment in ChatGPT developer OpenAI. More importantly, the company swiftly developed Copilot, an AI-powered assistant intended to make its software users more productive by simplifying repetitive, time-consuming tasks.
Even prior to general availability, the company experienced a surge in demand during its pilot program, with 40% of the Fortune 100 using Microsoft 365 Copilot during the company’s early access program. Microsoft indicated strong interest in the digital assistant, which became generally available in November.
The increased demand is already having a positive impact on Azure Cloud, which raced ahead of its competitors as the fastest-growing of the major cloud infrastructure providers in the calendar third quarter. If there were any doubts, Microsoft stated that three percentage points of Azure’s growth was due to “AI services.”
For its fiscal 2024 first quarter (ended Sept. 30), Microsoft’s revenue grew 13% year over year, while EPS climbed 27%, even before the impact of Copilot. Considering improving macroeconomic conditions, the continuing adoption of cloud computing, and tailwinds from AI, 2024 looks to be a very promising year for Microsoft.
For all that potential, the stock is selling for 36 times forward earnings. While this is a small premium to the overall market, Microsoft’s performance justifies every cent.
AI stock No. 2: Nvidia
Nvidia (NASDAQ: NVDA) wasn’t originally intended to be the AI processor for the stars. The company garnered attention by pioneering the graphics processing units (GPUs) that present lifelike images in video games. Nevertheless, CEO Jensen Huang early on realized that its graphics cards could be adapted to a variety of uses that demanded computational horsepower, including data centers, cloud computing, and AI.
This strategy has been extremely successful, with Nvidia’s data center segment, including processors used for AI, surpassing the revenue generated by gaming chips. During the company’s fiscal 2024 third quarter (ended Oct. 29), data center revenue accounted for 80% of Nvidia’s sales, up from 41% two years earlier. During that same period, revenue for the segment skyrocketed 350%, helping to illustrate the soaring demand for AI processors.
To be fair, Nvidia already sets the standard for processors used in data centers, holding a 95% market share, according to CFRA analyst Angelo Zino. Furthermore, Nvidia controls 95% of the machine learning GPU market, according to New Street Research. With demand for AI processing escalating, data centers are scrambling to upgrade their systems to meet the rigorous demands of AI — which proves to be more favorable news for Nvidia.
The available evidence seems to support that idea. In the third quarter, Nvidia produced record revenue that surged 206% year over year to $18.1 billion, resulting in diluted earnings per share that soared 1,274% to $3.71. While easy comparisons to the downturn may skew the results, the trajectory is clear.
Despite the outstanding performance of the company and the tremendous opportunity ahead, Nvidia is still trading at a reasonable price/earnings-to-growth (PEG) ratio of less than 1 — evidence of an undervalued stock.
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Danny Vena has positions in Microsoft and Nvidia. The Motley Fool has positions in and recommends Microsoft and Nvidia. The Motley Fool has a disclosure policy.
History Suggests the Nasdaq Will Soar in 2024: 2 Brilliant Artificial Intelligence (AI) Growth Stocks to Buy Before It Does was originally published by The Motley Fool