Key Points
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Data centers have taken center stage of the artificial intelligence movement.
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These companies’ business models are distinctly different than those of the names that have led the AI charge thus far.
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Investors should seek out prospects that optimize the recurring revenue nature of the data center business.
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There’s little doubt that data centers themselves are one of the artificial intelligence (AI) revolution’s next big investment opportunities, boding well for owners/operators like Vertiv and CoreWeave, and just as well for data center construction specialists like Applied Digital. Is it possible that investors are looking right past the best way to plug into this next phase of AI’s existence?
That may well be the case. And it’s got everything to do with how the business works. A name like Digital Realty Trust (NYSE: DLR) could quietly be the ideal way to play the explosion of the AI data center industry.
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In the right place with the right structure
Nvidia may have gotten the ball rolling by being the first (and practically only) supplier of processing chips powerful enough to support a true AI platform. But its business was largely built on one-off sales of these processors. To grow its revenue, it needs to improve its technology and/or find new customers.
Image source: Getty Images.
The data center business is a bit different, though. While plenty of AI technology companies can and do build their own data centers, it’s often cheaper, easier, and faster to simply pay a third-party for ongoing access to their AI data center platform.
Digital Realty Trust is one of these third parties. It owns more than 300 data centers in 50 different cities, serving over 5,000 customers. It’s the world’s biggest data center operator, in fact.
That’s not the crux of the argument for owning a stake in this company, however. It’s how it’s structured. Digital Realty is a real estate investment trust, or REIT, for short. That just means as long as the majority of its profits driven by its recurring rental revenue are passed along to shareholders in the form of dividends, then these profits aren’t first taxed at the corporate level.
In other words, this REIT lets shareholders pocket more of the net benefit of being in the artificial intelligence data center industry, which Precedence Research expects to grow at an average annualized pace of more than 27% through 2035.
Different, but still more to like than not
There are some AI-related downsides to factor in. For instance, this asset-intense business doesn’t have the sort of explosive growth that the likes of Nvidia and several AI software developers like Palantir have been reporting. Digital Realty’s third-quarter top-line growth of 10% is in line with its recent history and analysts’ forward-looking expectations.
It’s also difficult to ignore the fact that this REIT hasn’t actually raised its yearly payout since 2022, opting instead to invest aggressively to meet the explosion of AI-driven demand for data center services.
Nevertheless, there’s also no denying that the data center aspect of the AI business is distinctly different than the hardware side of it. The AI data center industry could grow. It’s built to generate rising recurring income, though. That’s why the smart-money way of plugging into it is with a company like Digital Realty that’s optimally structured to make the most of this recurring revenue model.
The forward-looking dividend yield of just under 3% isn’t too shabby either, offering regular income from a sector that’s not exactly known for doing so.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Digital Realty Trust, Nvidia, Palantir Technologies, and Vertiv. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
