How Morgan Stanley says to play the next wave of the AI trade

Published Fri, Jun 14 20246:22 AM EDTUpdated Fri, Jun 14 20249:32 AM EDT

As the field of stocks that both serve artificial intelligence data centers and have outperformed the rest of the market grows, Morgan Stanley is changing its approach in a search for value. De facto market leader Nvidia alone has soared more than 700% since the start of 2023. The company has become the face of AI investment on Wall Street, helping lift the broader market to record highs in recent weeks. Data centers, meanwhile, are poised to be essential components of AI investment in the future, given the computational power the technology requires. Against this backdrop, Morgan Stanley used a model derived from its global valuation, accounting and tax, or GVAT, team to dig into the relative value of companies with the greatest share of business in data centers. The model, highlighted in a 48-page report written earlier this week by 13 analysts, compared each company's implied cost of equity with its expected AI and cloud exposure. "By comparing the implied cost of equity (COE) from this model with expected AI exposures and cloud exposures of data center names, we assess relative investment opportunities – the higher the COE, the cheaper the valuation, the lower the COE, the more expensive the stock," Meta Marshall, the lead analyst, wrote in the report. "This model helps investors understand the implied cost of equity and long-term growth being priced into a stock at current market prices," Marshall added. All of the stocks included are rated overweight at Morgan Stanley. Morgan Stanley upgraded Ciena Corporation to overweight as part of the note and in concert with its GVAT model. The services and software stock has added roughly 7% in 2024. CIEN YTD mountain Ciena Corporation stock. The networking company can benefit from an AI opportunity that has yet to play out, tied to its WaveLogic 6 broadband application that Morgan Stanley predicts will be adopted more quickly than previous generations and used in data centers. Marshall also noted Ciena, in turn, will be a key beneficiary of rising data center demand to power AI. "[We] believe FY24 estimates largely de-risked with setup more achievable now as service provider inventory levels normalizing and cloud to remain robust," the analyst said. Nvidia also made the list, with its 11% cost of equity and long-term growth of 842% standing out as the second-highest among the companies screened, surpassed only by Broadcom . Shares of Nvidia are coming off of a fresh record high close on Thursday, as tailwinds, including a slate of new AI chips, continue to lift a stock that's gained more than 162% in 2024. NVDA YTD mountain Nvidia stock. But Marshall noted that despite Nvidia already benefiting from Wall Street's enthusiasm for all things AI, the gains are justified by its serving the benchmark against which all other AI beneficiaries are measured. The analyst labeled Nvidia "the poster child for AI infrastructure investment." "In general, we prefer names that see revenue sooner, i.e., NVDA, and competitive positioning is superior to any of the other names within the analysis," Marshall said. Other names on the Morgan Stanley list include Broadcom and Taiwan Semiconductor Manufacturing .