The AI Boom Is Entering a New Phase: 2 Stocks to Buy Now, According to Wall Street Analysts

The artificial intelligence boom began with the launch of ChatGPT in November 2022. The viral application brought generative AI into the mainstream, setting in motion a sequence of events that has led to one of the most aggressive investment cycles in history.

To date, the AI trade has largely focused on semiconductor companies and infrastructure providers, but Morgan Stanley analysts think we've reached an inflection point where the AI trade will broaden to software companies and AI adopters, meaning businesses that use the technology to reduce costs.

Here are two stocks Morgan Stanley analysts believe are well-positioned to benefit as the AI trade evolves.

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Amazon: Using AI and robotics to makes its retail operations more efficient

The next wave of the artificial intelligence boom "will likely reward companies that use the technology to improve decisions, lower costs, and strengthen margins -- not just those building AI infrastructure," according to Ellen Zenter, strategist at Morgan Stanley Wealth Management.

Amazon (NASDAQ:AMZN) is an excellent example. The company is leveraging expertise in artificial intelligence and robotics to make its retail business more efficient. Amazon has developed dozens of generative AI applications that optimize inventory management, last-mile delivery, and warehouse operations. The company has also developed AI models that make its robots faster and more productive.

While costly, investments in those areas have already moved the needle. Amazon's trailing-12-month operating margin expanded more than 3 percentage points in the last two years, reaching 12.1% in the most recent quarter. Operating income increased at 21% annually over the same period. But the company still has room to reduce costs.

Morgan Stanley analysts led by Brian Nowak view Amazon as the most underappreciated beneficiary of generative AI across their coverage universe, and they expect the company's operating margin to hit 17% by 2028 as retail operations become increasingly efficient.

"We're expanding our deployment of robotics and automation, which have been integral to our operations for decades," CFO Brian Olsavsky told analysts. He also said the company will more than double its fleet of robotic arms this year. "We see meaningful opportunities to further enhance productivity across our global fulfillment network."

Wall Street expects earnings to grow at 21% annually over the next three years, but that figure could be low. Amazon beat the consensus earnings estimate in five of the last six quarters, and it may continue to do so as AI and robotics drive efficiency gains. That makes the current valuation of 20 times earnings look downright cheap.

Datadog: Software that supports AI infrastructure and applications

Today, a significant percentage of the S&P 500's market capitalization is concentrated in AI enablers, especially chipmakers and infrastructure companies. Morgan Stanley analysts led by Stephen Byrd still see upside in semiconductor stocks like Nvidia and Broadcom, but they also expect the AI trade to broaden to software companies.

Datadog (NASDAQ:DDOG) is a leader in observability and digital experience monitoring software. Its platform integrates more than two dozen performance-monitoring products that help businesses identify and fix problems with their infrastructure and applications. Its platform leans on an artificial intelligence engine called Watchdog to automatically detect, prioritize, and resolve incidents.

Datadog has developed software products that support AI. Its Agent Observability module helps businesses evaluate, optimize, and monitor AI agents throughout development and production. Meanwhile, Bits AI is an intelligent assistant that helps IT teams investigate incidents, troubleshoot performance issues, and resolve problems faster.

Datadog reported impressive financial results in the second quarter. Revenue increased 36% to $1.1 billion, an acceleration from 32% growth in the previous quarter, driven by particularly strong demand from AI customers. And non-GAAP earnings rose 41% to $0.65 per diluted share. Management also raised its full-year guidance, with revenue growth now expected to be 30%.

Looking ahead, Wall Street expects Datadog's adjusted earnings to grow at 19% annually through 2028. But analysts have consistently underestimated the company. Datadog beat the consensus earnings estimate by an average of 11% over the last six quarters. Even so, the current valuation of 104 times adjusted earnings looks expensive.

Personally, I agree with Morgan Stanley about Datadog being well-positioned to benefit as the AI boom expands beyond semiconductor companies, and I think investors can buy a small position in the stock today. But I would wait for a substantial pullback before building a larger position. The rich valuation makes Datadog a risky investment.

Trevor Jennewine has positions in Amazon and Nvidia. The Motley Fool has positions in and recommends Amazon, Broadcom, Datadog, and Nvidia. The Motley Fool has a disclosure policy.