3 Key Sector Trends and 6 Stocks Poised to Ride Them

Key Takeaways

• Generative AI and the cloud infrastructure transition remain the key trends among tech stocks.
• Among utility stocks, improving infrastructure and supply chain are important.
• The defense sector’s outlook is focused on increased global spending on military R&D and the purchases of existing inventories.

The current backdrop for stock investing sees ripples from the artificial intelligence boom spreading beyond technology stocks, along with significant geopolitical upheaval.

At the Morningstar Investment Conference on Thursday, Morningstar’s senior equity analyst Dan Romanoff, strategist Travis Miller, and equity analyst Nicholas Owens offered their thoughts on major trends in the technology, utility, and defense industries. They also discussed which stocks are best-positioned to benefit from these trends in the coming years.

Technology

Romanoff homed in on AI as continuing to be the dominant force in tech. “It’s sort of supporting everyone’s growth at this point, and I think it’s only going to accelerate over the next two or three years, once the adoption is more widespread,” he said.

Coupled with this, he pointed to the ongoing transition from on-premises to cloud-based data delivery. “Investors, of course, love the different cash margins and the stability as results, versus what used to be getting whipsawed around quarter to quarter on one big deal.” Romanoff highlights two stocks with competitive advantages.

Amazon

• Economic Moat: Wide
• Fair Value Estimate: $240.00
• Morningstar Uncertainty Rating: Medium

“They are the leader in public cloud. If you look at their menu of services within AWS, it’s been 15 years where they had a service called AI and machine learning. So this is not new to Amazon, but the generative AI part is new. They’re really well-positioned; they’re benefiting a lot already. They have billions of dollars in revenue already annually from being the largest public cloud provider. They’re going to benefit disproportionately.”

Microsoft 

• Economic Moat: Wide
• Fair Value Estimate: $505.00
• Morningstar Uncertainty Rating: Medium

“They’ve transitioned their business to being subscription-based. They’re the second-largest cloud vendor behind AWS, with Microsoft Azure. So they benefit disproportionately because they already have all these enterprise relationships. And they still have all those monopoly positions in areas like Windows and Office.”

Utilities

Miller highlighted the significant gap between demand and supply of energy. “The idea of this tightening supply and demand—not just the absolute amount of demand, but the tightness between electricity generation and demand.” He highlighted two stocks with the most expertise in infrastructure construction and supply chain optimization to fill the gap in the supply.

Edison International 

• Economic Moat: Narrow
• Fair Value Estimate: $80.00
• Morningstar Uncertainty Rating: Medium

“You have to build a lot of distribution. That’s a lot of businesses building infrastructure. Edison is planning to spend $8 billion a year over the next 10 years … They’re going to spend a lot of money that’s going to drive a lot of earnings growth.”

Eversource Energy 

• Economic Moat: None
• Fair Value Estimate: $73.00
• Morningstar Uncertainty Rating: Low

“Eversource is the largest utility up in the northeast—Connecticut, Massachusetts, New Hampshire. Again, the story is infrastructure, especially interstate transmission. So you can move any kind of clean energy—say, from upstate New York, where there’s less demand, to Massachusetts, and even all the way possibly to Boston or to Connecticut. So that’s the big challenge, and the big opportunity”

Defense

Owens noted a key difference between this industry and many other parts of the market: “The defense industry doesn’t really march to the drum of the economy the way most of your stocks might. It really is driven by military spending, which is itself a function of, let’s say, the perception of geopolitical risk in the world. I’m debating whether to call this a mega trend or not, but what you see is the growth rate of military spending globally. So that’s driven largely by the US, but now increasingly European defense budgets as well.” Owens highlighted two undervalued stocks that he sees as well-positioned for these geopolitical trends.

Huntington Ingalls Industries 

• Economic Moat: Wide
• Fair Value Estimate: $316.00
• Morningstar Uncertainty Rating: Medium

General Dynamics 

• Economic Moat: Wide
• Fair Value Estimate: $313.00
• Morningstar Uncertainty Rating: Low

“Huntington is more or less a monopoly, all their business is exposed to shipbuilding. General Dynamics has a meaningful portion of its business in the same line. They both produce nuclear subs, and essentially cooperate on producing nuclear subs and destroyers. Huntington is the only company that makes aircraft carriers and refuels and reequips them.”