As 2024 heads to a close, investors are now focused on the state of the economy, its influence on the Federal Reserve’s interest rate reduction cycle, and the potential offered by the technology industry. They beckon 2025 with a rather historic run on the stock market that has seen several high-growth technology stocks flourish despite the fact that until September, interest rates in the US were at a two-decade high level.
Driving the bullishness behind technology stocks is artificial intelligence. The revolutionary new technology that relies on high-end GPUs to run advanced mathematical techniques and infer new conclusions from existing data sets has been the focus of Wall Street and big technology companies. So far, most of the AI-related stock gains have been limited to the shares of Wall Street’s favorite graphics processing unit (GPU) company whose stock is up by more than 700% since OpenAI publicly released ChatGPT.
However, the gains have to broaden out to other stocks for the AI wave to continue. This broadening is dependent on the use of AI increasing among businesses and consumers. On this front, investment bank Wells Fargo has some insights to share. In its report titled ‘Generative AI — Potential pitfalls, challenges, and risks the bank outlines that while AI “has the potential to be broadly transformative,” there are several “outstanding questions and concerns that need to be addressed before it is widely accepted on a larger scale.” Quoting its ‘The AI Index 2024 Annual Report,’ the bank points out that from 2012 to 2023, the number of AI incidents has jumped more than tenfold from sitting at roughly 10 to ~122. These incidents cover the ethical misuse of AI such as the wrong detection of criminals stemming from facial recognition systems.
WF points out that while these incidents are concerning, other factors will also determine AI’s wider acceptability and use. Broadly speaking, these factors are growing energy requirements and capital expenditure costs, global geopolitical tensions, model inaccuracies, and regulatory constraints. The bank adds that these factors are also accompanied by the potentially transformative effect of AI on the labor market. Starting from its beliefs about the labor market, WF believes that generative AI, which is different from other AI systems such as machine learning, will have a more “nuanced” impact on the labor market compared to traditional AI. Commenting on common worries of AI taking jobs away, the bank outlines that the jobs that AI will replace will in turn be replaced by new jobs created by AI. To quote WF, it believes “generative AI’s disruptive effect on the labor market to mirror other forms of automation — as in the past, its impact likely will be mitigated over time by new occupations spawned by the innovations themselves.”
To help bolster its claim, WF shares data from MIT. It points out that MIT’s estimates show that “60% of U.S. workers are now employed in occupations that did not exist 84 years ago.” As for which job functions might give way to AI, these include knowledge-based roles such as those found in financial services and support roles such as those performed by customer support agents.
Two additional key disruptive AI effects that Wall Street in particular is keenly aware of are its rising costs and the effect on the utility industry. The S&P’s utility sector is up by 28.36% year-to-date which leads the broader index’s 26.48% in gains by nearly two percentage points. Commenting on this, the bank believes that “there will be a significant increase in hardware demand, notably within the data-center environment, to accommodate the substantial increase in AI workloads,” adding that “it may take a number of years to increase the operational efficiency of various large language models and decrease costs to a level more in-line with existing search engines.” WF also shares that while existing opportunities to expand data center footprint to accommodate AI are present, as they “diminish, companies may revisit existing data-center locations to retrofit and upgrade hardware and infrastructure in support of the power and data-consumption needs of new AI technologies.”
Given the criticality of the data center space to AI, WF expands on this sector in another report. Titled ‘Generative AI transforming data center landscape” it comments on the capital expenditure required to set up data centers, future trends for data centers, and the stock market sectors that might benefit from growing interest and focus on the data center industry. According to its analysis, investor attention is mostly focused on AI-related investments in semiconductors and cloud computing.
However, other sectors, such as “cabling; steel racks; cooling (liquid and air); electrical equipment (both inside and outside the box); and backup generators” are also important. WF quotes a utility company to explain why these tertiary sectors are critical in the AI wave. It shares that utility company believes that “the server rack power density required to train a generative-AI-based large language model can require up to five to seven times more power than server racks used for traditional IT workloads in a data center.”
While semiconductor companies are natural beneficiaries of the AI boom, some oft-ignored sectors that WF mentions are industrials and materials. It outlines that when it comes to building massive data centers, estimates suggest “that approximately 35% – 45% of the cost is related to land, building shell, and basic building fit-out. These areas are addressable by companies who supply steel, aggregates, cement, and water equipment and, by extension, construction and engineering firms as well as broad non-residential construction suppliers (such as industrial distributors).” Additionally, “40% – 45% and 15% – 20% of the remaining cost can be attributed to electrical and HVAC systems respectively,” according to Wells Fargo. AI is having an effect on materials, as per the bank, in the form of “increased demand for materials that are used in the production of semiconductor chips, water handling and recycling within data centers, and steel and construction materials to build data centers.”
To make our list of Wells Fargo’s top AI & non-AI stocks that can outpace the flagship S&P, we selected technology-focused stocks from the bank’s recent Focus List and ranked them by their consensus next twelve-month EPS estimates.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
Why is Mastercard Incorporated (MA) the Top Wells Fargo’s Tech Stock to Beat the S&P?
A woman using a payment terminal at the checkout of a store showing payment products and solutions.
Number of Hedge Fund Holders In Q3 2024: 131
NTM EPS Estimate: $15.75
Mastercard Incorporated (NYSE:MA) is the second-largest payment processor firm in the US. After Visa, it holds the largest market share in several markets. The firm’s business model, like its larger rival, is dependent on the state of consumer spending in the US economy. Consequently, despite the fact that Mastercard Incorporated (NYSE:MA) commands a 24% share of the US credit card market, the firm is also vulnerable to competition from new-age financial technology firms that offer consumers and merchants alternative avenues to make and accept digital payments. Mastercard Incorporated (NYSE:MA) and Visa have also irritated merchants through their 60-day fraud protection policies that have also led to fraud. The pair’s multi-billion dollar settlement with merchants to reduce fees is also stuck in the courts, and it will have to diversify its revenue base and be on the watch-out for regulatory headwinds to generate tailwinds for the share price.
L1 Capital mentioned Mastercard Incorporated (NYSE:MA) in its Q2 2024 investor letter. Here is what the firm said:
“The share prices of Mastercard and Visa, both long term Fund investments, have both drifted down over recent months. There have been no dramatic developments, but there has been a general slight softening in the rate of growth of consumer spending in the U.S. and globally, a court decision rejecting Mastercard and Visa’s proposed settlement of a long-lasting dispute with U.S. merchants as well as other modest adverse regulatory developments. We continue to view Mastercard and Visa as two of the highest quality businesses in the world, and both are well placed to continue to deliver attractive, risk adjusted returns to shareholders over time.”
Overall, MA ranks 4th on our list of Wells Fargo’s tech stocks to beat the S&P: 14 top AI & non-AI stocks. MA is a top cyclical stock Wells Fargo is confident about. While we acknowledge the potential of MA as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than MA but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
