Artificial intelligence (AI) has filtered into many facets of daily life. It powers streaming content recommendations and online shopping suggestions. It allows search engines to decipher the intent behind complex questions. And it helps brands target marketing material and provide personalized customer experiences. But those innovations are just the beginning.
By 2030, AI could add trillions of dollars to global economic output by supercharging human efficiency and productivity.
Shares of Upstart Holdings (UPST 0.79%) and Lemonade (LMND -0.46%) currently trade 92% and 84% off their highs, respectively, but both AI stocks could produce market-crushing returns in the years ahead.
Here's what you should know.
Upstart Holdings: Using AI to disrupt lending
Upstart brings big data and AI to the lending industry. Traditionally, banks have relied heavily on FICO scores to determine who qualifies for a loan and at what interest rate. But even the more sophisticated FICO-based credit models incorporate only up to 30 variables, and Upstart sees that as a problem. Specifically, with limited access to data, lenders often fail to accurately quantify risk, resulting in higher loss rates.
Upstart fixes that problem by capturing over 1,500 data points per borrower, including FICO score and education and employment history, and its platform leans on AI to measure those data points against past repayment events. That theoretically means Upstart can quantify risk more precisely, which would translate into lower loss rates for lenders.
That value proposition has fueled reasonably strong financial results over the past year. Revenue climbed 128% to $1.1 billion, and the company generated a GAAP profit of $0.89 per diluted share share.
However, Upstart saw revenue growth decelerate sharply in second quarter, and management expects revenue to decline in the third quarter as the company continues to battle macroeconomic headwinds.
High inflation makes lenders less willing to fund loans because the risk of default is higher, and rising interest rates dampen borrower demand for loans because the cost of capital is higher. At the same time, Upstart has never demonstrated the efficacy of its AI models in a down credit cycle. Those factors make this a particularly volatile and risky stock, even by growth stock standards.
However, Upstart's data suggests its AI does indeed quantify risk more precisely than FICO-based models, and it has seen strong demand, even if its lending partners are more hesitant to fund loans in the current macroeconomic environment. Upstart finished the second quarter with 71 lending partners on its platform, up 184% compared to the prior year. Moreover, management puts its market opportunity at a whopping $1.5 trillion in terms of transaction volume, including $644 billion for its recently launched small-business loans product.
In short, Upstart's AI appears to be a competitive edge, which could help the company disrupt a truly massive industry. And with shares trading at a reasonable 2.9 times sales, now is a good time for risk-tolerant investors to buy a few shares of this growth stock.
Lemonade: Putting AI to work in the insurance industry
Lemonade brings big data and AI to the insurance industry. Its digital-first, mobile-friendly business model is designed to replace agents and paperwork with intelligent chatbots. That reduces friction, allowing consumers to buy insurance and receive claims payments quickly, without the hassle of human interaction. .
Lemonade's platform was designed to collect and analyze far more data than traditional systems. As with Upstart, that theoretically means it can quantify risk more accurately than legacy insurers, which should translate into better underwriting and fraud detection. Put another way, Lemonade has a data advantage that should keep its loss ratio (i.e., claims payments as a percentage of premiums) below the industry average.
Unfortunately, that investment thesis has yet to pan out. Lemonade posted a loss ratio of 86% in the second quarter, well above the industry average of 73% last year. But Lemonade is still a young insurance company, and management remains confident in its ability to underwrite policies more precisely in the long run. In fact, Lemonade estimates that customers onboarded in the second quarter will have a lifetime loss ratio of 68%, well below the industry average.
Lemonade's financial performance has been somewhat mixed over the past 12 months. Its customer count rose 31% to 1.6 million, and the average premium rose 18% to $290, evidencing a sticky relationship with existing customers. That translated into strong top-line growth, as gross profit climbed 55% to $41 million for the trailing 12 months. But the company still generated negative cash from operations of $168 million, a wider loss than the $113 million it burned in the prior year.
Looking ahead, the ongoing rollout of auto insurance (i.e., Lemonade Car) is a particularly exciting opportunity. That product puts Lemonade's addressable market at $400 billion, and it allows existing customers to consolidate more insurance policies through Lemonade. That's particularly noteworthy because management believes existing customers already spend about $1 billion on car insurance each year.
Like Upstart, Lemonade is a risky investment, and shareholders should be prepared for volatility. But its business model appears to be resonating with customers, and the stodgy insurance industry is overdue for disruption. That's why risk-tolerant investors should buy a few shares of this growth stock now.
