By Nigam Arora
Artificial intelligence is the next frontier, and investors want to get in on the ground floor. No wonder I get more emails asking how to best invest in artificial intelligence than any other subject.
At The Arora Report, we use different strategies to attain maximum risk-adjusted returns. One is the “picks and shovels” strategy that has often been profitable. Prudent investors aiming to generate returns in excess of those commensurate with the risk taken may want to take a hard look at the picks and shovels strategy when looking at artificial intelligence. Let’s explore, starting with a chart.
Please click here to see an annotated chart of Applied Materials /zigman2/quotes/209393259/composite AMAT -4.52% . It’s a monthly chart to give a long-term perspective. The Arora Report bought this stock at $16. As of this writing it is showing a gain of 251%. Please note the following from the chart:
• Applied Materials had been smoothly moving up along the trend line shown on the chart. Over the past two months, the price is significantly moving away from the trend line. This is often an early sign of a stock ready to go parabolic after a pullback.
• The chart shows RSI (relative strength index) divergence. In plain English, it means that as the price is going up, momentum is falling. This is often an early sign of a pullback.
• Applied Materials’ history shows that there is a fairly high probability of a pullback to just above the trend line shown on the chart.
• The chart shows that volume has been restrained. In traditional technical analysis, this is bearish. However, based on my 30-plus years in the markets, in this particular case, there is also a very positive interpretation: The stock has not yet become popular. If it does, there will be very heavy demand and the stock could go much higher. Applied Materials’ stock is currently in stage two. Please click here to see five stages of a long trade based on change.
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Picks and shovels strategy
During the gold rush, some prospectors did well while others went bankrupt. However, those who were selling picks and shovels to the prospectors almost universally did well.
The picks and shovels of artificial intelligence are highly complex integrated circuits. Applied Materials is one of the largest suppliers of the equipment to manufacture those circuits.
Relatively cheap stock
Applied Materials trades at a trailing price-to-earnings ratio of 19.94 and forward P/E of 15.33. Compare this with the P/E of the darling of the momo (momentum) crowd, Nvidia /zigman2/quotes/200467500/composite NVDA -4.48% . Nvidia is the leader in artificial intelligence. It is trading at a trailing P/E of 56.63 and forward P/E of 48.98.
AMD /zigman2/quotes/208144392/composite AMD -4.63% is often touted as an artificial intelligence stock because of its graphics processing unit (GPU) capabilities. AMD chips have been popular for mining cryptocurrencies such as bitcoin. However, AMD has just issued projections below consensus and, as of this writing, the stock is falling. AMD is also an expensive stock, trading at a forward P/E of around 43.