As with nearly every other computing technology company earnings call in recent months (and non-tech company earnings calls too, for that matter), GitLab (GTLB -0.98%) led off its most recent financial report by talking about artificial intelligence (AI). AI, of course, is nothing new. Research and development into software that can automate redundant tasks has been going on for decades. But new breakthroughs in machine learning have brought generative AI services like ChatGPT to market, giving users the ability to will new digital things into existence with simple text commands.
Much has been said about why generative AI is a game changer. But what does it mean for a company like GitLab, and is its stock a buy now?
AI is a new commodity of the 21st century
To introduce the merits of investing in GitLab, let's review what software is. I like to think of it as any other product that needs to be designed, manufactured, and then sold to a business to accomplish some task -- much the same as factory equipment, vehicles, office chairs, pens, or coffee pots. The big difference is that software has this incredible ability to be made once, then copied and sold for little to no additional cost as many times as there is a willing buyer. That's where those hefty profit margins come from in software-based businesses.
But here's the problem: Software (including AI) is getting increasingly more complicated to produce. Much like a complex manufacturing process, modern software is "assembled" by large teams using smaller pre-built parts and modules. This is where GitLab -- as well as its close competitor GitHub, which Microsoft owns -- comes in.
GitLab is a DevSecOps platform (short for development, security, and operations). It's an end-to-end suite complete with software code repository (a place to store, edit, and share those software "building blocks"), workflow management and software verification systems, and ongoing software deployment and monitoring services.
Image source: GitLab.
Image source: GitLab.
AI, and especially new generative AI systems, are far more complex than your ordinary software. GitLab is thus increasing in importance and attracting lots of attention for good reason. Microsoft acquired GitHub back in 2018, not long after Alphabet invested in GitLab and got it to move from Microsoft's cloud arm, Azure, over to Google Cloud. Alphabet bought more GitLab early in 2023 and owns a significant stake in the DevSecOps outfit.
High growth doesn't mean an automatic buy
To illustrate GitLab's importance, revenue increased 45% year over year in Q1 fiscal 2024 (the three months ended April 2023) to $127 million. Guidance for full fiscal year 2024 (which will end in January 2024) implies growth of about 28% over last year. AI hype or not, many customers are slowing their pace of spending on new tech projects this year in fear of a recession. Management believes the long-term trend of hypergrowth will eventually resume, though.
But that's not the only reason to pause before jumping headlong into a GitLab investment. This small but fast-expanding company operates at a steep loss by all metrics. This will likely remain the case for the foreseeable future as GitLab's stated objective is to grow as quickly (and "responsibly") as possible.
Data by YCharts.
The upshot to this cash burn is the company is well funded. It had $938 million in cash and short-term investments at its disposal as of the end of April, available to keep the pedal to the metal in developing, marketing, and perhaps making acquisitions.
A company like this isn't easy to value, given it generates no profit (Wall Street analysts don't see free cash flow turning positive until late 2024 or 2025). But on a relative basis, it does trade for 14 times the expected current-year revenue. That might eventually be a fair value, assuming GitLab starts turning a profit eventually. For the sake of comparison, Microsoft also commands a very high premium of 12 times expected current-year sales, but Microsoft has been consistently growing for decades and gushes cash.
Given the present importance of software and AI development, GitLab might be a buy -- for the right investor. Keep any bet you make small, perhaps building a larger position over time utilizing a dollar-cost averaging plan. Then strap in for the long haul. It's going to take a company like GitLab years to prove the merits of its business model from an investment perspective.
