The S&P 500 fell into a bear market early last year, but the index recently surpassed the threshold that some investors see as the beginning of the next bull market. Specifically, the S&P 500 is up more than 20% from the bear market low it hit last October. However, the index is still down 10% from its all-time high, so some investors and analysts say the bear market has yet to end.
Regardless, history says the next bull market is on its way, and many artificial intelligence (AI) growth stocks could soar when economic conditions improve. According to Ark Invest, AI software revenue could increase by 42% annually through the end of the decade, and Upstart Holdings (UPST 2.76%) and Riskified (RSKD 3.19%) will likely benefit from that trend.
Here's what investors should know about these two AI growth stocks.
1. Upstart Holdings: AI to improve lending
Upstart provides an artificial intelligence lending platform that improves access to affordable credit by helping banks quantify risk more precisely. The company saw its financial performance deteriorate over the past year due to the worsening macroeconomic climate, and that trend continued in the first quarter. Revenue declined 67% to $103 million, and the company reported a net loss of $129 million, down from a profit of $33 million in the prior year.
Those results can be attributed to the challenging lending environment. Rising interest rates reduced demand for credit, and rising default rates (brought on by an inflation-fueled reduction in disposable income) pushed banks to tighten their lending policies. Upstart believes the trouble will persist in the second quarter. Management's guidance calls for a 41% decline in revenue and a net loss of $40 million.
However, macroeconomic difficulties will ease in time -- inflation will normalize, and interest rates will fall -- so the long-term investment thesis remains intact. Fair Isaac's FICO score has long been the gold standard for risk assessment among banks and credit unions, but even sophisticated FICO-based models consider a relatively small number of variables (i.e., maybe 30). The Upstart platform captures more than 1,500 data points per borrower, and it leans on AI to measure those data points against past repayment events. That allows Upstart to identify risk more accurately, which ultimately results in lower loss rates for lenders and/or greater approval rates for borrowers.
In fact, according to an internal study, Upstart's AI platform can reduce defaults by 53% while holding approval rates constant, or it can increase approval rates by 173% while holding defaults constant. Those results hint at a competitive advantage over traditional FICO-based underwriting models, and if Upstart continues to demonstrate its superiority amid the ongoing contractionary phase in the credit cycle, lenders could flock to the platform once the economy improves.
Investors should be clear on the facts: Upstart is a young company attempting to disrupt the status quo in the stodgy lending industry. Banks and credit unions are understandably hesitant about replacing FICO scores with newfangled technology, especially during a difficult economic climate. But Upstart appears to have a competitive advantage in a market that management values at $4 trillion. Yet, shares currently trade at a reasonable 4.8 times sales. That's why investors should buy a small position in this AI growth stock today.
2. Riskified: AI to prevent e-commerce fraud
Riskified provides an AI risk-management platform that boosts revenue and reduces chargeback expenses for e-commerce merchants by helping them identify fraud. The company has dealt with the same challenges as many retailers over the past year -- namely, a slowdown in discretionary consumer spending brought on by high inflation -- but Riskified still reported decent financial results in the first quarter. Revenue rose 17% to $68.9 million, an acceleration from 15% growth a year earlier, and cash from operations totaled $229,000, up from a loss of $7 million in the prior year.
Fortunately, falling inflation should eventually revitalize consumer spending, and Riskified remains well-positioned to create value for shareholders. The investment thesis is straightforward: Traditional risk management platforms tend to be ineffective, meaning they often approve illegitimate transactions and reject legitimate transactions. That means merchants are losing more revenue and incurring more fraud-related operating expenses than necessary. Riskified solves that problem with AI.
Specifically, its platform integrates more deeply with its merchants' commerce infrastructure compared to products from other vendors. That means Riskified can collect richer data, and that advantage should theoretically make its AI models better at separating legitimate and illegitimate transactions. Indeed, the 10 largest merchants on its platform have reported an 8% increase in revenue due to fewer false declines and a 39% reduction in fraud-related operating expenses.
Last year, Riskified reported $100 billion in gross merchandise volume, meaning it handled less than 2% of the $5.4 trillion that consumers spent online. But management believes it has a superior risk management platform, and that should translate into strong future growth, especially when economic conditions improve, and the next bull market takes hold.
With that in mind, shares currently trade at 3.2 times sales, a discount to the historical average of 5.9 times sales, and a reasonable valuation given the potential upside. That's why this growth stock is worth buying.
