2 Artificial Intelligence Growth Stocks Smart Investors Are Buying Hand Over Fist

The S&P 500 (SNPINDEX: ^GSPC) fell 19.4% in 2022 as recession fears and interest rate headwinds hit Wall Street; it was the index's sharpest full-year decline since the Great Recession in 2008. The Dow Jones Industrial Average (DJINDICES: ^DJI) and the Nasdaq Composite (NASDAQINDEX: ^IXIC) also delivered their worst performances since the global financial crisis, dropping by 8.8% and 33.1%, respectively. But a few hedge fund managers nonetheless had a fantastic year.

Ken Griffin, Israel Englander, and James Simons delivered positive returns in 2022, and all three money managers were buying artificial intelligence (AI) stocks. For instance, Englander increased his stake in The Trade Desk (TTD 0.85%) by ninefold, while Simons added more modestly to his position in the ad tech company. Simons also increased his stake in CrowdStrike Holdings (CRWD 0.14%) by eightfold, while Griffin tripled his position in the cybersecurity vendor.

Are these growth stocks still worth buying?

1. The Trade Desk

The Trade Desk runs the largest independent demand-side digital advertising platform. Its software leans on artificial intelligence (AI) to help advertisers plan, measure, and optimize data-driven campaigns. As an independent ad tech company that works with ad buyers, The Trade Desk avoids the conflicts of interest inherent to businesses like Alphabet, and its transparency affords it a durable competitive advantage.

Alphabet provides ad tech solutions to ad buyers and ad sellers, and it sells inventory to buyers from its own web properties (e.g., Google Search, YouTube) alongside third-party inventory. In other words, Alphabet plays for both teams and it competes against its customers. But The Trade Desk does not own any ad space, so it has no reason to promote any specific ad inventory over another. Its values are better aligned with its customers because it works only on the buy side of the transaction.

That transparency has allowed The Trade Desk to build the most advanced data marketplace in the industry. The company has partnered with 80% of the largest retailers in the U.S. and most ad-supported streaming services. When using its services, advertisers can call on shopper data from Walmart, Target, and Albertsons Companies to target and measure ad campaigns in a way that isn't possible on other platforms. Brands are increasingly hesitant to share data with ad giants like Alphabet, simply because Alphabet will use that data to sell its own ads.

The Trade Desk reported solid financial results in the fourth quarter despite the challenging economic climate. Revenue increased by 24% to $491 million and cash from operations jumped 6% to $173 million. Those results are particularly impressive when compared to the digital ad industry leaders, Alphabet and Meta Platforms, both of which saw ad revenue drop 4% in the fourth quarter.

Looking ahead, The Trade Desk is well positioned to maintain its momentum. Grand View Research predicts the ad tech market's revenues will increase at an annualized rate of 14% through 2030, and The Trade Desk was recently recognized as an industry leader by consultancy Quadrant Knowledge Solutions. The report cited the company's advanced AI and data management platform as important differentiators.

Currently, shares trade at 19.6 times sales, a discount to their three-year average of 30.4 times sales, but still a pricey valuation. Risk-tolerant investors champing at the bit could buy a small position in this growth stock right now, but the most prudent move would be waiting for a cheaper entry point.

2. CrowdStrike Holdings

CrowdStrike stands out as a trailblazer in the highly competitive cybersecurity industry. Since its IPO in 2019, its platform has expanded from 10 software modules to 23 modules, and industry analysts have recognized the company as a leader in several verticals, including endpoint security, cloud protection, and threat intelligence. That success speaks to solid execution from a business perspective, but it also hints at superior technology.

Indeed, CrowdStrike upended the industry by proactively detecting threats using indicators of compromise, a fundamental improvement over the reactive indicators of attack used by other vendors. It was also one of the first companies to apply AI to cybersecurity software. In fact, the company takes its name from its ability to crowdsource data, unlike any other vendor, which makes its AI models uniquely effective.

Indeed, consultancy Frost & Sullivan recently made the following comment: "CrowdStrike leads the industry with regards to the application of artificial intelligence/machine learning to endpoint security." The report goes on to say that CrowdStrike offers unparalleled protection from malware and malware-free attacks.

CrowdStrike is not immune to economic headwinds, but the company still reported solid financial results last quarter. Revenue soared 48% to $637 million, and free cash flow jumped 65% to $210 million. One other metric investors should focus on is its gross retention rate of 98%. That figure indicates that CrowdStrike kept the vast majority of its customers over the past year despite the uncertain economic environment. In other words, the high gross retention rate tells investors that CrowdStrike has a valuable product.

Management values its addressable market opportunity at $75 billion, and that figure will only get bigger as its portfolio continues to expand, meaning shareholders can expect CrowdStrike to maintain its momentum for years. Currently, shares trade at 13.8 times sales, a discount to the three-year average of 38.1 times sales. Investors should take that opportunity to buy a small position in this growth stock. 

The importance of a diversified portfolio

Money managers Griffin, Simons, and Englander beat the market last year, but The Trade Desk and CrowdStrike did not. Both stocks fell about 50% in 2022, meaning neither one contributed to the hedge funds' success. But risk-tolerant investors with a long time horizon should still consider buying both stocks today. As discussed, The Trade Desk and CrowdStrike enjoy strong competitive positions in growing industries, and I think that will lead to market-beating returns over the next decade.

Either way, investors can learn an important lesson from Griffin, Simons, and Englander: Portfolio diversification mitigates risk by spreading capital across different companies and industries. All three money managers own thousands of stocks, and The Trade Desk and CrowdStrike account for no more than 0.2% of any hedge fund discussed in this article.