Citigroup analysts say investors should look to less-explored parts of the market to find stocks that can capitalize on the artificial intelligence boom while delivering growth at a fair price (GARP). Amid concerns about an AI investment bubble, the tech sector has become more discerning, and a wedge has recently formed between the winners and losers. November was a particularly bumpy month for tech stocks, with the tech-heavy Nasdaq Composite Index lagging the S&P 500 over the past month. “It’s not so much hedging as it is actually stock picking within the AI,” Drew Pettit, director of U.S. equity strategy at Citigroup, told CNBC’s “The Exchange” on Thursday. “There are winners and losers. We see that in MagSeven, but we also see it more broadly in the AI space. So we want to focus on companies that are getting the best cash return on the growth capital investment they are spending, and give a lower weight to companies that may not be able to self-fund.” Citi believes that while current valuations do not yet reflect the AI bubble, rapid share price appreciation and high valuations are putting additional pressure on companies. To better manage the risk of something going wrong, Citigroup earlier this fall issued a basket of stocks for clients that includes companies from a variety of industries that are still presenting their path to AI. Recommendations range from Eaton Corp. to Meta Platforms, Nvidia to Pinterest. Citi touted its “Affordable AI” group as diversified and with future consensus revenue expectations in line with or exceeding market expectations. “While some red flags have emerged about how much future growth is being dragged into today’s prices, the market is still doing a reasonable job of reflecting premium growth expectations into valuations,” Pettit said in a recent 21-page report for clients. “However, we recognize that it is ultimately performance disappointments that cause the bubble to burst. If so, we would like to focus more on GARP within AI to build on core thematic positioning as prices and valuations rise.” Design software maker Adobe is a standout performer on Citigroup’s list, with consensus earnings per share forecasts beating market-implied growth expectations. Adobe is down 26% year-to-date, significantly underperforming the Nasdaq and several tech companies. Adobe also fell 25% in 2024, but its latest third-quarter results beat analyst expectations and showed strong future prospects. Pettit’s list also includes several large chip makers, including Nvidia, Advanced Micro Devices and Micron Technology, which Citigroup said also remain trading at reasonable valuations. Citi, which rates Nvidia as a “buy,” is bullish on the Synopsys partnership with Nvidia. Nvidia announced Monday that it has purchased Synopsys common stock for $2 billion at $414.79 per share in a multi-year partnership to accelerate computing and AI engineering solutions. Despite a three-year bull market and a series of recent acquisitions, investors are taking comfort in Nvidia’s $60.6 billion cash fortress at the end of October. Other stocks that are reasonably valued for getting into AI infrastructure include Eaton, which Citi said is also considering high return potential. Other analysts agree that the power management company, once a hot stock for AI data centers, is now undervalued. Eaton’s stock is up just 2% this year, but analysts’ price targets compiled by LSEG suggest it could rise 19% next year.
