The artificial intelligence revolution is upon us, and plenty is bound to change in how to conduct ourselves in society. From work to play, the potential applications of AI are seemingly endless, and the rise of LLMs we can all use has driven a new paradigm around investing, and how investors think about the sort of exponential upside this trend can have.
Accordingly, when most investors look to play surging AI demand, certain companies come to mind. In the semiconductor sector, Nvidia (NASDAQ:NVDA) and its high-performance chips are integral to the rise of this technology. Other data center stocks and companies building out the AI applications and large language models of the future (mostly big tech names) may also come to mind.
That said, there’s a sector I think could be more impactful for investors over the course of the next five years. Here’s why I think utilities stocks could ultimately be the biggest winners from this trade, relative to the likes of Nvidia and other AI-related high flyers which currently have plenty of future growth priced into their valuations.
Power Is the Hard Constraint
Transmission lines
In order to have any sort of AI application (an LLM or otherwise), you need chips and data centers, for sure. That’s well-known, and companies like Nvidia and its peers have surged on expectations that growth may not only remain robust, but potentially accelerate from here.
That said, I’d argue the true “hard” constraint on the growth rate AI can achieve in the coming years really boils down to power. Without electricity, these chips and data centers are useless. And whether we’re talking about electricity generated from fossil fuels (natural gas power plants, for example), renewables or nuclear, there are plenty of utility stocks which still look attractively priced based on future demand growth projections I think could be the best bets to play surging AI demand.
U.S. electricity demand is projected to grow roughly 25% from 2023 levels over the course of the next year, with some in the AI space suggesting that AI power demand could 10x by the end of this decade. That’s insane growth, and a growth rate that correlates with what we’ve seen at Nvidia.
The kicker, of course, is that utility stocks are far from priced as growth plays on the AI trade in the same way as Nvidia right now.
Evolving Economics Makes This Sector One to Invest In for the Long-Term
Red arrow heading higher, above three stacks of ascending coins
In practice, the limiting factor for AI capacity has already begun to shift from land and data center development capacity (which involves the heavy use of semiconductors) to megawatts and interconnection queues. This flips the locus of scarcity from chips and racks to transmission and generation, benefiting top utility companies operating in this space.
What this means for investors in utility stocks is that these historically bond-like offerings viewed as safe and defensive dividend stocks could become the higher-growth, higher-multiple ways investors choose to achieve medium- and long-term growth in their portfolios. I’d argue a re-rating of this entire sector is warranted, with most top utility companies trading at multiples that reflect their traditionally slower-growth nature (with a significant portion of the total returns these stocks provide over the long-term coming from dividends).
I’d expect to see a much larger percentage of the growth utility companies provide in the years to come to be derived from underlying growth. As such, for those looking to earn much higher returns on equity, the utilities sector is one I think is currently overlooked right now.
Why Utility Companies Could Outperform Large-Cap Chips and Data Center Stocks
Person holding a blue microchip in a lab
My underlying thesis, at least at this point in time, is that semiconductor giants like Nvidia and top companies tied to the data center buildout have years of growth currently priced into their shares. As such, these stocks are priced to perfection. Not only will each of these names need to beat expectations (in a significant way) each and every quarter for the next five years, but they’ll need to beat the so-called “whisper number” on the Street, which can often be materially higher. And raise guidance.
On the other hand, utility companies have a much lower bar to jump over. And while valuation multiples have expanded for both groups, there’s really no comparison between the valuations garnered in the semiconductor sector relative to utilities.
I think there’s going to be one sector that’s likely to be re-rated higher as a result of booming demand over the coming years, and may not be the already-high-flying names we’ve all been conditioned to think about. Utilities stocks may become less boring in short order, and that could be a great thing for investors willing to tack on exposure to this sector right now.
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