Artificial intelligence (AI) seems to be the new investment trend on Wall Street, and one stock stands out above the rest as a way to capitalize on this space: C3.ai (AI 3.02%). The company provides enterprise AI, which helps its clients integrate prebuilt AI solutions into their systems to become more efficient and generate savings.
The stock debuted during the IPO peak in late 2020 at roughly $100 per share and surpassed $150 within a couple of weeks. But it has had a pretty dreadful life on the public markets and is down 81% from its initial price.
However, shares are up 103% from the start of 2023. So have investors missed the boat on this one, or does C3.ai still still have plenty of room to run?
C3.ai has one of the industry's best offerings
If you're looking for a catalyst to the sudden rise of AI stocks, look no further than the emergence of ChatGPT, the AI-driven chatbot developed by OpenAI. The buzz this technology created led investors to seek AI investment opportunities, which is why C3.ai is in the spotlight.
But why is C3.ai a strong pick in this space? C3.ai has one of the industry's best offerings and was named a leader by Forrester Research, claiming the most robust strategy of any company analyzed. What's even more impressive: It beat Palantir, Alphabet (Google Cloud), Microsoft, and Amazon. To top those companies is a stunning feat and speaks to C3.ai's prowess.
Let's look at a manufacturing application as an example of what C3.ai's product can do. C3.ai's prebuilt and configurable AI tools can help analyze a supply chain risk while optimizing inventory. It can also be used in production to optimize a production schedule and reduce energy usage to save costs. This is just one industry it has tools for, but the software can be used in others, including financial services, defense, and healthcare.
C3.ai's robust offering can be widely used, but is the stock too expensive for its current financial state?
A slow-growing and highly unprofitable business
In the second quarter of fiscal 2023 (ending Oct. 31, 2022), C3.ai's revenue grew by only 7% to $62.4 million. This shows investors two things. First, C3.ai is not a very large company. Second, sales are growing slowly despite the company's superior products. Why is that?
The answer has to do with economic uncertainty, as many potential clients are unwilling to sign massive deals that could put a strain on financial resources. During the Q2 earnings call, CFO Juho Parkkinen addressed concerns about 66 deals being pushed from Q1 to Q2. While not all of them closed, he also said that the environment was stabilizing.
Furthermore, C3.ai changed its business model in Q2 from a subscription to a consumption-based model, which aligns client usage with C3.ai's financial results. Essentially, the more its products are used, the more the company makes. Investors will see this model's full effect when C3.ai reports Q3 results on March 2, but I expect the transition to have a positive long-term effect.
As you might expect, C3.ai isn't profitable, as it is still in its infancy as a business.
C3.ai's loss from operations was an incredible $72 million -- an operating loss margin of 115%. That means C3.ai has a long way to go before generating any profit. A large part of this expense was its stock-based compensation bill of $56 million -- nearly 90% of revenue. It's not uncommon for companies to have high stock-based compensation in the year after they go public, but investors will need to watch this trend throughout 2023 to see if it improves or gets worse.
Before C3.ai's run-up, it traded for a dirt cheap four times sales. That's an absurdly low valuation for a tech company like C3.ai, but after the 2023 explosion in share price, its valuation is comparable to that of AI tech stock Palantir.
Data by YCharts.
So should you buy C3.ai stock? I'd say no. The price action was driven by AI hype and an unrealistically low valuation. At nearly 10 times sales, C3.ai is now fairly valued to slightly overvalued in light of its slow growth rate and high unprofitability.
If you want to invest in C3.ai for the long term, I think that's a brilliant idea, but you'll have to live with the roller coaster that this stock will put you through, as hype cycles don't usually end well (for reference, take a look at 2020's metaverse stocks). C3.ai is an excellent company with solid long-term prospects, but the recent run-up makes me think there will be better times to establish a position in C3.ai. Right now there are simply better alternatives to consider in the AI space.
