Earlier this year, intelligent chatbot ChatGPT became the fastest-growing consumer application in history when it reached 100 million active users in just two months. That steep adoption curve has awakened Wall Street to the productivity-boosting potential of artificial intelligence (AI), and many high-profile hedge fund managers were piling into AI stocks in the second quarter.

For instance, billionaires Stanley Druckenmiller, Philippe Laffont, and David Tepper added to their positions in Microsoft (MSFT 1.25%), and fellow billionaires Israel Englander, David Shaw, and Jim Simons bought shares of Lemonade (LMND -6.69%).

Here's what investors should know about these AI stocks.

1. Microsoft

Microsoft products are the foundation on which hundreds of thousands of organizations are built. The company accounted for 16.4% of software-as-a-service sales last year, capturing nearly twice as much market share as the next-closest competitor.

Its productivity suite Microsoft 365 is the most popular enterprise application of any kind, and the company also enjoys a strong presence in unified communications, enterprise resource planning, and cybersecurity software.

Microsoft is also the second-largest cloud computing company. Its Azure accounted for 22% of cloud infrastructure and platform services in the second quarter, up from 21% in the prior year. Those share gains are due in part to strength in artificial intelligence. According to CEO Satya Nadella, Azure has the "most powerful AI supercomputing infrastructure in the cloud," and consultancy Gartner recently recognized Azure as a leader in cloud AI developer services.

The company reported solid results in the fourth fiscal quarter (ended June 30), beating consensus estimates on the top and bottom lines. Revenue rose 8% to $56.2 billion on particularly strong growth in enterprise software and cloud services, and earnings under generally accepted accounting principles (GAAP) jumped 21% to $2.69 per diluted share. But the company has a good shot at growing more quickly in the future.

It's using AI to enhance its enterprise software products and cloud computing platform. Its partnership with ChatGPT creator OpenAI gives Azure customers exclusive access to the large language models that power OpenAI applications, including the GPT family of models.

Similarly, Microsoft 365 Copilot is a personal assistant that leans on AI to improve productivity through automation; it can draft content in Word, create slides in PowerPoint, organize data in Excel, and more.

Those products led Morgan Stanley analyst Keith Weiss to conclude that Microsoft is the software company "best positioned" to monetize generative AI, a bold prediction that bodes well for shareholders. The generative AI market is expected to expand at 42% annually to hit $1.3 trillion by 2033, according to Bloomberg Intelligence.

Currently, shares trade at 11.2 times sales, roughly in line with the three-year average of 11.4. That price looks reasonable given Microsoft's strong presence in enterprise software and cloud computing, and its growth prospects in generative AI. Investors should feel comfortable buying a small position in this growth stock today.

2. Lemonade

Lemonade is a technology-centric insurance company that uses AI to automate workflows like marketing, policy underwriting, and claims processing. Traditional insurers use agents to sell policies, actuaries to assess risk, and adjusters to investigate claims, but Lemonade delegates those tasks to AI chatbots to keep labor costs low. Its digital platform also captures 100 times more data than the forms used by traditional insurance companies.

So what? Data is the foundation of AI, and Lemonade has a data advantage that should result in better risk assessment and more-precise underwriting, meaning its loss ratio (i.e., the portion of earned premiums paid out in claims) should eventually be lower than the industry average. But that theoretical truth has not translated into real results.

The average loss ratio among property and casualty insurers was 76.4% in 2022, but Lemonade reported a gross loss ratio of 90%, a figure unchanged from the prior year. Worse yet, gross loss ratio increased to 94% in the second quarter of 2023, meaning Lemonade paid out $0.94 in claims on every $1 in earned premiums.

Not surprisingly, the company reported mixed results in the second quarter. Its customer count increased 21% to 1.9 million, and premiums per customer increased 24%. But gross profit rose just 7% to $12.1 million, and GAAP net income was negative $67 million, roughly unchanged from the previous year.

Looking ahead, Lemonade has plenty of room to grow. Its total addressable market (TAM) sits at $400 billion in the U.S. alone, a very large number compared to the aggregate annualized premiums of $687 million the company recorded in the second quarter. In other words, it has captured less than 1% of its TAM.

However, I have concerns about the future, and I say that as a shareholder. If AI truly affords the company an advantage, its loss ratio should be lower. Of course, it might be elevated because Lemonade is a young insurance company, especially with regard to its homeowners and auto insurance products, and it may improve with further data collection. But I would avoid this stock until there is definitive proof of a durable competitive advantage.