Harnessing the AI revolution in dividend paying stocks

It took chip giant Nvidia’s blowout second quarter guidance in May 2023 to open investors’ eyes to the opportunity. The company had grown up supplying Graphics Processing Units (GPUs) to gamers, but the technology had evolved to sit at the heart of generative AI model training. By telling analysts that it expected second-quarter revenues to jump over 60% year-over-year, it signalled to the world that the AI revolution was already here and there were trillions of dollars at stake.

The next day the stock surged 28%, adding $185bn of market cap, and the mania for AI beneficiaries began in earnest. Attention quickly gravitated towards the rest of mega-cap US media and technology. In the absence of tangible, commercial AI-driven products, the market saw these incumbents as the most likely to harness and scale the technology first. The “Magnificent Seven” was born and 2023 ended up seeing one of the most concentrated market rallies in history.

Sadly for equity investors with a preference for income, this tsunami largely passed them by. As of 2023 year-end, only two of the seven paid a dividend one could describe as more than nominal. Four paid no dividends at all. This begs the obvious question; can income-oriented investors access this phenomenal growth theme at all?

Our response is a resounding YES! AI-fuelled revenue and profit growth is plentiful within the world of dividend-paying stocks, you just need to look a little harder and think a little differently. You also need to compromise a little on headline dividend yield as a trade-off for compounding dividend growth, though that’s typically a sound strategy across market cycles.

OpenAI and Nvidia don’t exist in a vacuum. They have deep and complex supply chains and a burgeoning customer base away from consumer facing apps. Nvidia’s GPUs are built in Taiwan by Taiwan Semiconductor Manufacturing Corp (TSMC), a company with a 2.1% current dividend yield and a history of shareholder-friendly, double-digit dividend growth. TSMC makes these chips using tools from Dutch company ASML and Japanese manufacturer Tokyo Electron, stocks where the yields are a little more modest at c.1%, but with growth genuinely turbo-charged by the semiconductor arms race.

Even further upstream sits Shin Etsu, the Japanese silicon wafer giant upon whose shimmering 12 inch discs these astoundingly complex designs get printed. It offers a 1.8% yield, growing at a healthy clip, and also substantial share buybacks from its $12bn cash pile.

Once-built, Nvidia’s chips get installed in server racks in data centres worldwide. These are incredibly electricity hungry processors and substantial power and cooling infrastructure is required to satisfy them. French electricals company Legrand has meaningful exposure here with the company estimating each Nvidia-powered server requires 4x as much of its components compared to a typical CPU-powered server. The company offers a 2.2% yield growing at a high single digit rate.

Determining winners and losers downstream, with respect to businesses commercialising AI, is a little harder. For every industry where an incumbent harnesses this technology effectively, there will be one where a hungry new entrant uses AI to catapult itself to prominence. The eventual winners from prior technology adoption cycles are rarely obvious right at the start.

We believe a combination of proprietary data, sticky customer relationships and ambitious management teams make for the right recipe here. One company close to home that fits the bill is RELX, the digital publisher and data services business. Its new Lexis+ offering in its legal division enables lawyers to engage directly with millions of pages of case law precedent, in many cases documents laboriously scanned by hand from courtroom libraries across the US. Lexis+ enables huge savings for time-hungry lawyers and should drive accelerated high single digit dividend growth for RELX.

Meanwhile there are signs that the Magnificent Seven are growing up. Meta recently surprised markets with a dividend initiation. The yield is modest at just 0.45% but the nominal sum involved, c. $6 billion annually, is not and implies Meta is taking shareholder returns seriously. Peers should take note.

All the companies mentioned here are, or have been, owned in our award-winning Global Equity Income strategy. This is a strategy which seeks to find the optimal balance between dividend yield, dividend growth and dividend resilience. Holdings of businesses generating AI-related revenue streams today make up 25% of the current portfolio and are helping us build conviction in the next leg of portfolio dividend growth.

Authors

Sam Witherow – Portfolio Manager, International Equity Group, J.P. Morgan Asset Management

Michael Rossi – Portfolio Manager, International Equity Group, J.P. Morgan Asset Management

This is a marketing communication and as such the views contained herein are not to be taken as advice or a recommendation. The value of investments and the income from them may fluctuate in accordance with market conditions and investors may not get back the full amount invested. Past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast made will come to pass. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued in the UK by JPMorgan Asset Management (UK) Limited, which is authorised and regulated by the Financial Conduct Authority.