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Why Cloudflare, Super Micro Computer, and Other Artificial Intelligence (AI) Stocks Rallied on Wednesday

Motley Fool - Wed Nov 29, 2023

After a robust rebound so far this year, the major market indexes are taking a breather. Investors have been plagued by uncertainty and have been looking for signs that the economic recovery is still on track. Several recent developments have given them hope for a so-called "soft landing," wherein the economy narrowly avoids a recession before ultimately turning higher.

With that as a backdrop, a number of stocks poised to reap the rewards of the rapid adoption of artificial intelligence (AI) rallied today. Cloudflare(NYSE: NET) had jumped 5.6%, C3.ai(NYSE: AI) had climbed 2.7%, and Super Micro Computer(NASDAQ: SMCI) had risen 1.8% as of 1:17 p.m. ET.

A review of all the usual sources, including financial reports, regulatory filings, and analyst commentary found no company-specific news driving the gains. However, numerous tangential economic developments provided the fuel that helped drive these stocks higher.

A virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.

Image source: Getty Images.

Business conditions are improving

The revised economic report issued by the U.S. Bureau of Economic Analysis showed that real gross domestic product (GDP) rose at an annual rate of 5.2% in the third quarter of 2023, an improvement from initial estimates of 4.9% growth, and better than the 5% growth expected by economists.

A more in-depth review of the contributing factors showed the report was even more positive than it appeared at first glance. The upward revision came as the result of an increase in non-residential fixed investment -- or properties owned by landlords -- as well as a rise in business spending and profitability. Profits from business production jumped to $105.7 billion, up from just $6.9 billion in Q2. Profits from domestic financial corporations improved even more, up by $18.8 billion, compared to a decline of $54.2 billion in Q2. Taken together, these metrics suggest much-improved business conditions over the preceding three months, suggesting companies may finally be opening their purse strings after a long period of restraint.

In another sign that the economy is improving, comments by officials from the Federal Reserve Bank suggest the chances for additional interest increases are waning. In a speech earlier this week, Fed governor Christopher Waller said he was "encouraged" by the progress over the past few weeks, going on to say that current policy is "currently well positioned" to bring inflation under control. Wall Street took the comments to suggest that if the economy continues on its current trajectory, the Fed could begin cutting interest rates in the months ahead.

Finally, AI-centric cybersecurity specialist CrowdStrike delivered a record quarter, highlighting better-than-expected results and increased guidance, confirming that businesses are indeed beginning to increase spending.

For its fiscal 2024 third quarter (ended Oct. 31), CrowdStrike generated revenue of $786 million, up 35% year over year, fueled by record new annual recurring revenue of $223 million. This resulted in record profitability as adjusted earnings per share (EPS) of $0.82 improved from $0.40 in the prior-year quarter. The results were far better than expectations for revenue of $777 million and EPS of $0.74. These robust results, posted by a company identified as a AI stock, helped boost many of its peers in the space.

Are these AI-fueled stocks a buy?

So, what do these developments have to do with Cloudflare, C3.ai, and Super Micro Computer? The improving economic outlook and increasing willingness of businesses to spend money will no doubt benefit this trio of companies, particularly as many companies are spending heavily to join the AI revolution:

  • Cloudflare's cloud-based content delivery network helps websites work faster while providing greater security. The company has long enabled the use of AI and recently added new tools to facilitate the building of generative AI.
  • C3.ai's moniker speaks to its aspirations in the field of AI, providing businesses with turnkey applications that allow them to pivot quickly and get their AI models up and running with a minimum of time and difficulty.
  • Super Micro Computer provides high-end servers that are both energy efficient and highly customizable, which have experienced a spike in demand resulting from the advent of AI.

Each of these stocks has rallied hard so far this year, driven by the economic recovery and the AI connection. That said, there's one clear bargain among the group. Cloudflare, C3.ai, and Super Micro Computer are selling for 22 times, 12 times, and 2 times sales, respectively, when a reasonable price-to-sales ratio is between 1 and 2. That makes Super Micro Computer a steal at its current valuation.

Wall Street expects all three companies will grow revenue and earnings by strong double digits over the next couple of years, fueled by accelerating demand for AI. Of the three, I'm most bullish about Cloudflare's prospects and have expressed my doubts about C3.ai.

Despite their recent run-up and given their penchant for volatility, Cloudflare and Super Micro Computer represent intriguing opportunities for investors planning to hold their shares for three to five years and could continue to generate impressive gains over the long term. The jury is still out on C3.ai, in my opinion.

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Danny Vena has positions in Cloudflare. The Motley Fool has positions in and recommends Cloudflare. The Motley Fool recommends C3.ai and Super Micro Computer. The Motley Fool has a disclosure policy.

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