The Data Center Boom: A New Era of Investment Opportunities

The impact of the AI revolution on the global economy has finally begun to take shape. At its core lies a critical infrastructure: data centers. These massive facilities are where computing power and storage come together to support the next generation of artificial intelligence. As major cloud service providers like Google, Meta, Microsoft, and Amazon engage in a frenzied bid to keep up with demand, the market is responding with unprecedented investment.

According to John Mowrey, chief investment officer at NFJ Investment Group, hyperscalers are projected to spend between $750 billion and $800 billion annually on data centers. This staggering figure represents 2.5-3% of U.S. GDP – a number that’s extraordinary for a capital market. A significant portion of this spending will go towards the physical construction of these facilities, as well as companies that supply essential components.

The chip shortage is at the heart of the data center buildout. Semiconductors are specialized processors that power AI workloads and drive the industry forward. However, demand has outpaced supply, creating an acute shortage that experts believe will persist for years to come. According to Craig Ellis, research director at B. Riley Securities, this shortage presents a unique investment opportunity.

Ellis notes that “we’re at a point where undersupply is so severe that there needs to be a multi-year period of unusually strong capital expenditure growth in front of us.” This growth has the potential to continue lifting expectations for revenues and earnings. To capture this opportunity, Ellis recommends shifting attention away from chip giants like Nvidia and AMD towards companies that supply equipment used to make chips.

Applied Materials (AMAT), the largest semiconductor equipment manufacturer in the world, is a key player. Its core Semiconductor Systems division makes up about 73% of its revenue, selling to companies that manufacture chips for computing, logic, and memory. What sets Applied apart from other chip suppliers is its breadth – nearly every advanced chip and display passes through its tools at some point.

Ellis also highlights Lam Research (LRCX) as a worthy alternative. While its product range is narrower than Applied Materials’, Ellis believes Lam is especially well-positioned to benefit from a surge in new capacity investment over the next two years. B. Riley Securities has raised its earnings estimates for the company by 25% to reflect this outlook.

Another strong contender in the semiconductor space is Marvell Technology (MRVL). While less of a household name, Marvell captures roughly $195 billion in market value and excels at networking – the plumbing that lets thousands of chips inside a data center talk to each other fast enough to work as one giant machine. Despite being tied to Amazon Web Services for its bulk business, Ellis sees this concentration as an opportunity rather than a red flag.

Real estate investment trusts (REITs) also play a crucial role in the data center boom. These trusts rent out climate-controlled spaces equipped with generators and high-speed connectivity required for around-the-clock operations. According to Patrick Wilson, a portfolio manager at CenterSquare Investment Management, REITs are a sound investment given the industry’s shift from the AI training phase to the inference phase.

While initial AI model training happened in large rural data centers built for cheap land and power, running those models day-to-day works best in facilities close to major cities. This change in landscape creates new opportunities for investors willing to adapt.

The data center boom presents a unique investment opportunity for those willing to take on the associated risks. With hyperscalers projected to spend trillions of dollars, companies that supply essential components will be at the forefront of this growth. While chip stocks are known for their volatility, experts believe the industry is shifting towards more durable, long-term growth.

Since the July 28 sell-off, Applied Materials, Lam Research, and Marvell have climbed back between roughly 22% and 30%. Now may be a reasonable time to buy in – but investors must be prepared for the challenges that lie ahead. The data center boom is not without its risks, from geopolitical tensions to shifts in how hyperscalers choose to fund their spending.

The AI revolution has sparked a new era of investment opportunities. Data centers are the physical backbone of this transformation, and companies like Applied Materials, Lam Research, and Marvell are poised to benefit from this growth. While the industry is not without its risks, experts believe the long-term outlook is more promising than ever before.