Where Will C3.ai Stock Be in 3 Years?

The artificial intelligence (AI) hype train sent C3.ai's (AI 3.02%) stock price flying in 2023, as shares of the pure-play enterprise AI software provider more than tripled so far this year. However, August turned out to be a terrible month for C3.ai investors so far thanks to analysts from investment banking firm Morgan Stanley, who recently suggested that AI is a bubble that is close to popping.

That concern goes some way to explaining why C3.ai stock is down 21% this month. The drop is not all that surprising considering the stock's surge in 2023 has mostly been driven by the growing interest in AI applications instead of enthusiasm for the company's financial performance, which has left a lot to be desired over the past year.

Should C3.ai investors consider booking their profits with Wall Street expecting the stock to struggle? Or should they continue holding this AI play in their portfolios in anticipation of more long-term gains? Let's see if an answer presents itself.

A closer look at Morgan Stanley's "AI bubble" argument

Morgan Stanley analysts' argument for AI being in a bubble is technical, with the firm centering its analysis around Nvidia (NVDA 6.18%). The analysis goes that Nvidia stock's 206% surge in 2023 is well over the median jump of 154% exhibited by prior bubbles in a three-year period. Morgan Stanley analyst Edward Stanley based his findings on a study of 70 prior bubbles during the past century, and he is using Nvidia as a proxy for the AI boom.

Now, C3.ai stock has delivered stronger gains than Nvidia so far this year. So a potential drop in Nvidia's stock price is likely to have a negative impact on C3.ai as well since both have tended to trade in tandem with each other.

But calling AI a bubble based on technical evidence doesn't seem like a bulletproof idea. That's because a bubble forms when stock prices run up without an accompanying appreciation in the value of the businesses they represent.

Going by that logic, it doesn't seem right to call AI a bubble since the company which Morgan Stanley is using as an AI proxy -- Nvidia -- is about to witness a significant jump in growth. The chipmaker will release its fiscal 2024 second-quarter results (for the quarter that ended in July) later this month, and its revenue guidance of $11 billion suggests that its top line could jump 64% over the prior-year period.

For comparison, Nvidia's revenue was down 13% year over year in the first quarter of fiscal 2024 thanks to the weak demand for graphics cards used in personal computers. But the booming demand for the company's graphics cards in data centers to handle AI workloads -- such as training large language models like ChatGPT -- explains why its revenue growth is expected to take off.

More importantly, Nvidia is capable of sustaining its outstanding growth in the current fiscal year and beyond. The company finished fiscal 2023 with $27 billion in revenue, and the following chart shows how fast that figure is expected to grow.

NVDA revenue estimates for current fiscal year, data by YCharts.

Nvidia's growth will be powered by the increased proliferation of AI, as the technology is expected to contribute $15.7 trillion to the global economy by 2030, as per analysis from PricewaterhouseCoopers. This will create the need for more of the AI hardware that Nvidia sells, which explains why the AI chip market is expected to clock annual growth of 29% until the end of the decade. Concurrently, the need for AI software applications will also grow, and this is where C3.ai stands to gain.

C3.ai's growth is just getting started

While Nvidia is on track to take advantage of the growing need for AI hardware, C3.ai is a play on the software side of this technology. That's a huge market expected to clock 23% annual growth over the next decade and generate $1 trillion in annual revenue in 2032.

C3.ai bears might argue that the company is not able to take advantage of this terrific opportunity since its revenue in fiscal 2023 (which ended in April this year) was up just 5% over the prior year to $267 million. That was a significant drop over the 38% revenue growth the company delivered in fiscal 2022. But the reason C3.ai's growth rate fell off a cliff last year was because of a switch in the business model.

The company is now billing customers on a pay-as-you-go basis instead of monthly or annual subscriptions. The downside to this model is that C3.ai loses out on long-term revenue visibility. But the upside is that it lowers the entry barrier for customers looking to buy its services. The company is benefiting from this change with a significant jump in the number of customer agreements it is signing now, while its sales pipeline has also increased remarkably.

Not surprisingly, C3.ai's growth is expected to accelerate from the current fiscal year as the chart below indicates.

Source: YCharts. EPS = Earnings per share.

This surge in C3.ai's revenue growth and the corresponding increase in the company's earnings could send the stock higher over the next three years. Assuming it does generate $480 million in revenue in fiscal 2026, its market cap could increase to $5.4 billion after three years based on its forward price-to-sales ratio of 11.3 (a discount to its current sales multiple of almost 15). That would translate into a 30% jump from current levels, indicating that investors who hold this AI stock should continue doing so since it seems built for more upside.