Tyler Le/BI
Picture a stuffy, windowless room with servers lined back-to-back. It's hot, with thousands of computers operating at once. Massive industrial-size fans are whirring in an attempt to cool things down.
Across the road, ground has been broken on another data center. A whole industrial complex is popping up. The construction companies in charge can barely keep up with demand.
The scene encapsulates the immense computing power required to fuel the artificial-intelligence boom. And while it's a far cry from the glitz and glamour of the megacap tech firms that dominate headlines, some of the movement's biggest winners will be the companies working on the back end.
This specifically means data centers, which will be increasingly key for storing information as AI becomes more mainstream. A growing chorus of analysts say they represent one of the most overlooked beneficiaries of the AI shift.
"This new architecture on gen AI, you basically have to upgrade around a trillion dollars of infrastructure," Ted Mortonson, a managing director and tech strategist at Baird, said. "And it's very early. If you use the baseball analogy, we're still probably not even at the start of the game."
Consider that Goldman Sachs says data-center power demand is set to surge 160% by the end of the decade, with the bank noting that a ChatGPT-powered search sucks up to 10 times as much electricity as a basic Google search.
"That kind of spike in power demand hasn't been seen in the US since the early years of this century," the Goldman analysts said in a report. "It will be stoked partly by electrification and industrial reshoring, but also by AI."
Extending from there, the AI revolution could be a boon for a number of construction, utility, and electrical companies that make up the data-center landscape. Typically viewed as the market's most boring and defensive sectors, they could offer some of the most exciting investment opportunities.
Companies are already pouring billions into creating data centers, and stocks related to their construction and power supply are seeing outsize gains.
For starters, utilities represent the third-best-performing sector in the S&P 500 over the past six months, out of 11 total. The group trails only the information-technology and communication-services sectors that feature pure-play AI juggernauts like Meta, Nvidia, and Alphabet. Normally, when growth stocks are leading the way, more defensive sectors like utilities perform the worst. That's not been the case.
On a single-stock basis, Digital Realty Trust — the only data-center real-estate investment trust listed on the New York Stock Exchange — has jumped 27% over the past year, while the Global X Data Center & Digital Infrastructure ETF has climbed 12%. Both those stock returns far exceed the 8% gain for the iShares Core US REIT ETF over the same period.
Stocks that aid large electricity use have also had a strong 2024. Super Micro Computer — whose liquid-cooling technology has been called a must-have for AI hardware — is up 117% year to date. Nvidia may be the king of AI, but even it is "only" up 167% in 2024.
Meanwhile, Vertiv — which also makes power and cooling equipment for data centers — is up 70% this year. The company's dominance recently earned it the label of "the real AI darling" from Bank of America.
Globally, grid- and electricity-equipment stocks in the US, South Korea, India, and Europe have rallied as much as 140% from levels at the start of the year, JPMorgan analysts said in recent research.
Investors probably aren't used to seeing energy and utility stocks as a gold mine, given the sector's muted returns over the past decade, according to Travis Miller, an energy and utilities strategist from Morningstar. But strong growth is coming: The firm expects to see 10% growth each year in the utility sector over the next 10 years.
"I don't think investors fully realize the impact data-center growth has," Miller told Business Insider.
While traditional hardware companies and their data center and real-estate counterparts soar, software stocks have been largely left in the dust.
Hardware-tech stocks have outperformed their software peers by 30 percentage points this year amid skyrocketing demand for graphics processing units, data centers, and other physical computing equipment. It's a 180-degree reversal from the past decade when software firms — lauded for their high profit margins and asset-light business models — beat their hardware peers by more than 250 percentage points.
Why the shift? Mortonson said it's difficult for software companies to build around AI.
"This gen-AI cycle is infrastructure, all infrastructure," Mortonson previously told BI in an interview, adding that cloud companies were set to spend over $200 billion this year on data centers. "That's the horsepower, or the engine, of Gen AI," he said.
Additionally, on a comparative-valuation basis, traditional tech stocks associated with software look expensive relative to energy and data-center names. Utilities, meanwhile, look to be about 5% undervalued, Miller said.
Still, despite recent outperformance, it may take years for the data-center boom to fully mature. The earliest data centers could significantly influence corporate earnings is 2028, Miller estimated. That means investors could be waiting a while to fully realize the trade's potential.
There's also the risk that the US doesn't build as many data centers as anticipated over concerns on whether we have the energy capacity to support them, he added.
Despite that prospect, he still expects considerable expansion.
"It's been a generation since utilities had this much growth potential that we see during the next 10 years," Miller said.
This story was originally published in July 2024.
