People encounter artificial intelligence (AI) on a daily basis, whether they realize it or not. AI makes search results and product recommendations more relevant, it allows smart assistants like Apple's Siri and Amazon's Alexa to understand speech, and it corrects spelling and grammar errors in office software and emails. But those use cases only scratch the surface.
AI has the potential to disrupt virtually every industry, and it will likely be the most transformative technology in human history. For that reason, Cathie Wood's Ark Invest believes AI software could generate $14 trillion in annual revenue by 2030.
Here are two growth stocks that could benefit from that trend.
Upstart: AI-powered risk assessment for lenders
The FICO score is the gold standard for assessing credit risk in the lending industry, but Upstart Holdings (UPST 0.79%) believes the methodology behind those scores is outdated. Even the more sophisticated FICO-based models consider only 30 variables, meaning lenders often make decisions based on limited information. Ultimately, that leads to higher loss rates for banks, and banks often pass those costs along to borrowers in the form of higher interest rates.
Upstart wants to solve those problems with big data and AI. Its platform incorporates over 1,500 data points per borrower, and it measures them against past repayment events to assess the risk of fraud and default. Each time a borrower makes or misses a payment, the underlying AI models get a little smarter. That ultimately leads to lower loss rates for lenders, which can translate into lower interest rates for borrowers. It also creates a network effect that should allow Upstart to quantify credit risk more precisely over time.
Unfortunately, CEO Dave Girouard called last year "the perfect storm" for Upstart. The worst inflation in 40 years put financial pressure on borrowers, causing delinquency rates and defaults to rise, and banks compensated by tightening lending policies. Meanwhile, the Federal Reserve raised interest rates at their fastest pace in four decades, causing demand for loans to fall. Taken together, those headwinds led to ugly financial results for Upstart. Revenue fell 57% to $147 million in the fourth quarter, and the company reported a net loss of $55 million, down from a profit of $59 million in prior year.
However, investors still have reason to be bullish on Upstart. Over the last four years, its AI models have separated high-risk borrowers from low-risk borrowers with four times more precision than FICO scores. That hints at a durable competitive advantage, which positions Upstart to reaccelerate growth as economic conditions improve.
On that note, Upstart values its total addressable market (TAM) at $1.6 trillion, but its platform powered just $10.7 billion in loans last year. That means Upstart has captured less than 1% of its TAM, and its TAM will only get larger as the company delves into other lending verticals, like mortgage originations. With that in mind, shares currently trade at 1.7 times sales, an absolute bargain compared to the historical average of 12.2 times sales. At that price, investors that can handle volatility should buy a small position in this growth stock.
Riskified: AI-powered fraud prevention for merchants
Fraud is a significant concern for online merchants, and Riskified (RSKD -0.20%) believes traditional fraud management solutions are frequently inaccurate, which actually creates two problems. The approval of fraudulent transactions results in chargeback expenses, and the rejection of legitimate transactions (i.e. false declines) reduces revenue. For context, analysts Edgar, Dunn, & Company estimate that online merchants lost $720 billion in revenue due to false declines last year, and Juniper Research estimates that fraud-related expenses will cost merchants $25 billion by 2024.
Riskified wants to solve those problems with big data and AI. Its fraud management platform measures hundreds of consumer data points (captured through deep integrations with its merchants' systems) against historical transactions to quantify the risk of fraud and automate the approval process. Riskified says its 10 largest merchants have seen an 8% uptick in sales due to fewer false declines and a 39% drop in fraud-related operating expenses.
Financially, Riskified reported decent results in the third quarter, especially in the context of a challenging economic environment. Gross merchandise volume (GMV) increased 21% to $25 billion, revenue climbed 20% to $63 million, and the company generated $5 million in cash from operating activities, up from a loss of $63 million in the prior year.
As a caveat, Riskified faces competition from a plethora of payments companies, including giants like Mastercard and PayPal. But Riskified believes it collects richer data due to deeper integrations with its merchants' systems. That data theoretically makes its AI models more effective in preventing fraud.
Looking ahead, Riskified has a long runway for growth. It currently handles about $100 billion in annual GMV, which represents less than 2% of global e-commerce spend. Currently, shares trade at 3.9 times sales, a discount to the historical valuation of 6.5 times sales. That creates an attractive buying opportunity for risk-tolerant investors.
