TLDR
- Goldman Sachs analyst Jim Covello recommends investors shift from chipmakers to hyperscalers like Amazon, Microsoft, and Alphabet
- Hyperscaler stock valuations have been pushed down as investors question AI spending returns
- The Philadelphia Semiconductor Index has risen nearly 150% in the past year, making chip stocks look expensive
- Covello sees two ways the hyperscaler trade wins: either they prove AI ROI, or they cut spending and improve cash flow
- The main risk is hyperscalers keep spending heavily without showing clear returns
Goldman Sachs analyst Jim Covello is making the case that investors have been focused on the wrong part of the AI trade. Instead of chipmakers, he says hyperscalers may offer better value right now.
Covello is co-head of equity research at Goldman Sachs and also covers semiconductors. He laid out his thinking in a note to clients on Thursday.
His argument centers on valuation. Hyperscalers like Amazon, Microsoft, Alphabet, Meta, and Oracle have seen their stock multiples compress. That’s because investors are skeptical about whether these companies will earn a decent return on their massive AI spending.
Chipmakers, by contrast, have been the market’s favorite AI bet. The Philadelphia Semiconductor Index has gained nearly 150% over the past year.
That rally has pushed chip stocks above their historical valuation averages. Hyperscalers, meanwhile, are still trading below theirs.
Two Ways the Trade Could Pay Off
Covello laid out two scenarios where betting on hyperscalers over chipmakers could work.
In the first, hyperscalers start showing positive returns on their AI investments. That would ease investor concerns and push their stock prices higher. Chip stocks would have less room to run since the market has already rewarded them.
In the second scenario, hyperscalers pull back on spending if returns stay weak. That might sound bad, but Covello argues it could actually help their stocks by boosting cash flow. It would also hurt semiconductor companies that rely on that spending.
The Risk That Could Sink the Trade
The main risk Covello flagged is a middle-ground outcome. If hyperscalers keep spending heavily without showing clear returns, their stocks could stay under pressure.
That same scenario would keep chip demand high, which would continue supporting semiconductor stocks.
Covello’s note comes as big tech companies are under close watch from investors over their data center and AI infrastructure budgets.
Amazon, Microsoft, and Alphabet have all committed to large capital spending plans for 2025 and beyond.
Meta has also ramped up its AI investment, drawing scrutiny over whether the spending will translate into revenue.
Oracle has positioned itself as a key player in AI cloud infrastructure and has seen strong demand for its services.
The semiconductor sector has benefited from that spending wave, with companies supplying chips for AI data centers seeing strong order books.
Covello’s call is a contrarian one given recent market moves, but it is based on where valuations stand today relative to history.
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