Over the past year, generative artificial intelligence (AI) platforms like ChatGPT and DALL-E have cast a blinding spotlight on the disruptive capabilities of AI technologies. That hype sparked a buying frenzy in related stocks like Nvidia, which produces the chips used by data centers to process advanced AI tasks, and C3.ai, which develops AI algorithms to streamline and automate tasks across a company's existing infrastructure.
However, I believe Nvidia's stock has gotten overheated after its recent gains, while C3.ai's recent rally was mainly driven by market hype instead of any fundamental strengths or competitive advantages.
Therefore, investors should look beyond Nvidia, C3.ai, and the market's more popular AI plays to find less obvious ways to profit from the market's secular expansion. I believe Adobe (ADBE 0.87%), Unity Software (U 3.47%), and UiPath (PATH 0.26%) check all of the right boxes. Let's take a look at why these three AI stocks are strong buys in August.
Image source: Getty Images.
1. Adobe
Over the past decade, Adobe transformed all of its flagship desktop applications -- including Photoshop, Premiere Pro, and Illustrator -- into subscription-based cloud services. It also expanded its cloud ecosystem with more e-commerce, sales, marketing, and analytics services for enterprise customers.
That transformation locked in its customers, stabilized its recurring revenue, and helped it keep pace with the broader software industry's shift toward cloud-based services. But today, Adobe is gearing up for another sweeping upgrade to that ecosystem: the rollout of generative AI tools across its cloud-based ecosystem.
Earlier this year, Adobe expanded its older Sensei AI and machine-learning framework with a new generative AI platform called Firefly. The integration of Firefly into its Creative Cloud will streamline the production of digital media by enabling its users to create images, videos, and digital models with simple text-based prompts.
Adding Firefly into its other enterprise-targeted clouds could also streamline the digital workflows and data processing capabilities of these operations. These sweeping upgrades could spark another multiyear growth cycle for Adobe as the AI market expands.
Analysts expect Adobe's revenue and adjusted EPS to grow 10% and 15%, respectively, this year. Its stock might not seem cheap at 31 times forward earnings, but its firm foothold in the booming AI market might justify that higher valuation.
2. Unity Software
Unity's game-development engine is used to create more than half of the world's mobile, console, and PC games. It also helps developers monetize their creations with in-app purchases, integrated ads, and other features.
But the company suffered a major slowdown last year after Apple's iOS changes rendered its advertising algorithms obsolete. The gaming market's post-pandemic slowdown exacerbated that pain.
Yet Unity survived that crisis by merging with the ad tech company ironSource, rebooting its advertising unit, and expanding beyond its core market with new tools for creating mixed-reality applications, digital twins, and theatrical special effects.
Unity only expects its revenue to rise 5% to 9% on a pro forma basis (including ironSource) this year, but its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) are quickly rising. Analysts expect its growth to accelerate again in 2024 after it fully laps its merger with ironSource and the macro environment improves.
Unity also recently expanded with a new AI marketplace that enables developers to plug AI tools into its game-development platform. With these tools, software developers can drastically accelerate the creation of their games by producing graphics and other assets with AI instead of human artists and programmers.
Unity's stock might seem pricey at 9 times this year's sales, but its long-term potential could support that higher valuation.
3. UiPath
UiPath is the world's largest developer of robotic process automation (RPA) tools, which can be integrated into an organization's existing software to automate repetitive tasks like onboarding customers, sending out mass emails, and processing invoices.
Consegic Business Intelligence estimates the RPA market will have a compound annual growth rate of 30.4% between 2022 and 2030 as more companies replace their workers with these software robots.
UiPath's growth cooled off last year as companies were forced to rein in their spending on big software upgrades. However, it still expects its revenue to rise 20% in fiscal 2024 (which ends next January), accelerating from its 19% growth in fiscal 2023, as the macro environment improves. Its adjusted earnings are also increasing.
The rise of ChatGPT and other generative AI platforms, which could potentially perform the same tasks as RPA services more efficiently, initially raised some troubling questions about UiPath's future. Nevertheless, the company insists it will benefit from this secular trend as it upgrades its own automation tools with generative AI features. In other words, it could leverage its early-mover's advantage in the RPA market to build its own AI ecosystem.
If UiPath can pull off that expansion and stay at the top of the growing RPA market, it could generate some impressive gains over the next few years. That's why its stock doesn't seem particularly expensive right now at 46 times forward earnings.
