Many artificial intelligence (AI) stocks soared over the past year as the bulls touted the growth potential of generative AI platforms like OpenAI's ChatGPT. That rising tide lifted stocks like Nvidia, which provides the GPUs that process those AI tasks, and Microsoft, the biggest backer of OpenAI.
However, other AI stocks generated less predictable returns. Applied Digital (APLD 10.50%), a company that rents out data centers to AI-oriented companies, saw its stock surge nearly 230% this year. But after that wild ride, it only trades about 25% above its IPO price. SentinelOne (S +1.57%), a cybersecurity company that aims to replace all human analysts with AI algorithms, experienced a year-to-date decline of 10% and remains more than 50% below its IPO price. Should investors buy either of these volatile stocks as a long-term play on the growing AI market?
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Applied Digital is gearing up for explosive growth
Applied Digital went public as Applied Blockchain last April. It initially rented out its data centers to blockchain and Bitcoin companies. But last November, it rebranded itself as Applied Digital and declared it would focus on gaining more AI and cloud clients in the high-performance computing (HPC) market.
NASDAQ: APLD
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This May, Applied Digital formed a new subsidiary called Sai Computing, which would exclusively provide data center space for AI and cloud customers. Sai subsequently signed two massive deals: a 24-month deal in May worth up to $180 million and a 36-month deal in June worth up to $460 million. Nvidia also recently added Applied Digital to its elite Nvidia Partner Network.
As a result, it expects to generate $385 million to $405 million in revenue in fiscal 2024 (which ends next May), which would represent 595% to 631% growth from its $55 million in fiscal 2023. It also expects its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to surge from $146,000 in fiscal 2023 to $195 million to $200 million in fiscal 2024. Based on those estimates, Applied Digital looks cheap at less than two times next year's sales and four times its adjusted EBITDA.
However, Applied Digital has a few notable flaws. In addition to its abrupt rebranding and obvious customer concentration issues, it faces a class action lawsuit regarding its messy ties with its IPO underwriter, B. Riley Financial.
Applied Digital's CEO, Wes Cummins, was the founder and CEO of 272 Financial, a company that B. Riley acquired in 2021. Applied Digital also relied heavily on B. Riley to fund the expansion of its data centers, and it ended fiscal 2023 with a high debt-to-equity ratio of 3.3. That high leverage could make it an unappealing investment as long as interest rates stay high.
SentinelOne faces slowing growth in a tough market
SentinelOne's revenue more than doubled in each of its past three fiscal years, and it expects 43% growth to $605 million in fiscal 2024 (which ends next January). That robust growth indicates there's still a fertile market for AI-driven cybersecurity services.
NYSE: S
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Yet, SentinelOne remains deeply unprofitable by both generally accepted accounting principles (GAAP) and non-GAAP (adjusted) measures. It faces intense competition from larger, more diversified, and more profitable market leaders like Palo Alto Networks and CrowdStrike, which have both been expanding their ecosystems with more AI-powered services.
In addition to its slowing growth and steep losses, SentinelOne's dollar-based net revenue retention rate dropped from 130% in fiscal 2023 to 125% and 115% in the first and second quarters of fiscal 2024, respectively. Like many of its peers, it blames that downturn on the macro headwinds that are driving many companies to rein in their software spending.
That pressure isn't surprising, but SentinelOne also abruptly changed the way it reported its annual recurring revenue (ARR) in early June to account for a "change in methodology and correction of historical inaccuracies." Those mistakes were highlighted again amid recent rumors that Cisco abandoned a takeover bid over concerns regarding its ARR reporting methods. SentinelOne said those rumors were all "lies" that were being spread by its "desperate competitors."
SentinelOne ended its latest quarter with a low debt-to-equity ratio of 0.4, and its stock doesn't seem expensive at seven times this year's sales. But it could stay out of favor in this tough market for three simple reasons -- its growth is slowing down, it's unprofitable, and it looks less attractive than many of its bigger cybersecurity peers.
The better buy: Applied Digital
Both of these stocks are highly speculative. But if I had to pick one over the other, I'd stick with Applied Digital because its stock is cheaper, and it could have more upside potential as it scales up its business. SentinelOne might keep growing, but it will stay in the penalty box until its sales growth stabilizes, it narrows its net losses, and it meaningfully widens its moat.
