Artificial intelligence (AI) investments have quite the buzz but often present themselves as high-risk tech stocks. Although you might prefer direct investments, there are other ways to benefit from this AI revolution. One company that is a considerable benefactor is Digital Realty (DLR 0.71%), a data center real estate investment trust (REIT).
With the stock sporting an attractive 4.4% dividend yield, it’s also a great dividend play.
Data centers are critical to artificial intelligence
Data centers are popping up everywhere and are critical to the digital infrastructure. These buildings house computers and networking equipment that can store and process data. If you’ve heard of items being stored on the cloud or software that uses the cloud, those items don’t exist on the internet. Instead, the data is stored at a data center and accessed through the internet.
AI programs require vast amounts of data to be fed into them to learn properly. This data is stored within data centers, so these buildings are critical to the process. Furthermore, AI models require vast computational power to learn, and many of these data centers are equipped with the most powerful GPUs made by Nvidia and Advanced Micro Devices to process this data at blistering speeds.
Some companies choose to build their own data centers so that they can tailor the building to fit their needs. However, this is capital-intensive, and many companies that need data centers prefer to rent them from Digital Realty. With more than 4,000 customers, Digital Realty has a large client base using more than 300 data centers.
It also is relatively diversified. Its largest customer, an unnamed fortune 50 software company, makes up just over 10% of its annual recurring revenue (ARR). The next biggest customer is International Business Machines, which only makes up 3.8% of ARR.
Data centers aren’t cheap to build, so Digital Realty will likely have a continuous flow of new clients as they transition from on-premise computing to data centers because they likely cannot afford to build one themselves. But how is the business doing right now?
Growth has slowed but is picking back up again
While data centers saw a boom in usage thanks to the increased demand driven by the COVID-19 pandemic, Digital Realty saw its growth stagnate in early 2022 once that boost was over.
However, in the third quarter, Digital Realty’s growth returned, with revenue rising 5% year over year and funds from operations (FFO, a more accurate earnings number for REITs) squeaking $0.01 higher. Wall Street analysts are also bullish on Digital Realty’s 2023 outlook, with the average analyst guiding for 9% growth.
Digital Realty also holds a Baa2 credit rating from Moody’s, representing a medium-grade risk. This credit rating is usual for a REIT, as they are highly leveraged.
The stock trades at a reasonable price-to-free-cash-flow valuation and is substantially down from its levels in the past three years.
The dividend is also safe: Digital Realty paid a $1.22 dividend in the past four quarters, which remains below the $1.55 FFO it generated in Q3.
With how critical data centers are in AI and any other digital technology, Digital Realty has a business that will stand the test of time. With growth returning and the stock valued at a reasonable level, now seems like an excellent time to establish a position in Digital Realty.
Keithen Drury has positions in Digital Realty Trust and Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Digital Realty Trust, Moody’s, and Nvidia. The Motley Fool has a disclosure policy.