Ignore the skeptics and bet on a future powered by artificial intelligence. That's the message from analysts at Jefferies who argue that the AI frenzy is only getting started, with the potential for the market to be 10 times larger than the entirety of current software spending.
The investment bank's top stock picks for this upbeat AI scenario are familiar: Microsoft, Amazon and Alphabet's Google for their all-round presence, backed up by Oracle and CoreWeave as cloud-computing plays.
But the optimism extends to the software sector where Jefferies analysts favor cybersecurity companies Palo Alto Networks and Okta, as well as data-software players Snowflake and Dynatrace, along with a contrarian bet on current AI loser Intuit.
The chief objection to AI is the huge capital expenditure and correspondingly shrinking cash flows of the major cloud providers. But with a $26.5 trillion addressable market for AI, the Jefferies team argues that's short sighted.
"Skepticism around the scale of AI investment is understandable, but history shows each computing cycle has created substantially more value than the last, and AI ROI is already emerging across sectors," wrote Jefferies analyst Brent Thill and colleagues.
For those who want something more concrete, Thill and company note that the operating margins of cloud providers have risen for four straight quarters even in the face of surging supply-chain costs. And although their capex commitments over the last two years amount to a staggering $453 billion, the revenue backlog for the same period comes to $1.67 trillion.
A more recent objection than spending has been that a political backlash against AI data centers and cybersecurity concerns will slow down deployment. But those are only temporary issues, according to the Jefferies analysts.
"These hurdles could slow the pace of adoption, but also reinforce how much runway remains as infrastructure expands and enterprises move from experimentation to scaled deployment," Thill wrote.
The benefits should spread beyond the cloud companies. Palo Alto, Okta, Snowflake and Dynatrace are already beneficiaries of the software comeback marked by a string of positive earnings. Accounting software stock Intuit has some ground to make up, having fallen near 50% this year so far, but still enjoys dominant U.S. brands and can use its data and application of AI models to rebound, according to the analysts.
"Investors increasingly recognize that software is not dead, but weak software is. Frontier labs are more likely to partner with leading vendors than own the full stack, while systems of record, proprietary data and sticky workflows remain durable moats," Thill wrote.