Artificial intelligence (AI) isn't going away. The technology has the potential to remake industries and create new ones, and every company is going to need an AI strategy. However, this doesn't mean that every AI stock will be a winner in the long run. Two AI stocks I'm staying away from are Upstart (UPST 2.76%) and C3.ai (AI 3.02%). Here's why.
Upstart
Not even AI can overcome an economic environment marked by rising interest rates and elevated inflation. Upstart found success during the pandemic with its AI-powered lending marketplace, connecting borrowers with lenders while assessing risk with its AI models. Those models worked until they didn't. Loan performance tanked in 2021 as economic conditions changed, offering a reminder that an AI model is only as good as the data it's trained on.
Upstart has improved its AI models and erased this performance deficit, but what happens the next time the economy shifts in a way it never has before? Credit scores are far from perfect for assessing risk, but it's unclear at this point whether Upstart's AI models will provide lenders a consistent advantage. And there's little stopping lenders or credit reporting companies, some of which have troves of data, from developing their own AI models.
The long-term opportunity for Upstart is enormous. The personal loan market, Upstart's core focus, is worth about $160 billion in originations annually. Include all the areas Upstart could target, and annual originations reach about $4 trillion. But tapping into that opportunity won't be easy.
Upstart is struggling to generate demand now that interest rates have jumped. Transaction volume tumbled 34% year over year in the third quarter, while revenue dropped 14%. The company expects revenue in the fourth quarter to be about the same as in the third quarter. Interest income has spiked, but revenue from fees has plunged. On $373 million of revenue through the first nine months of 2023, Upstart posted a net loss of $198 million.
Using AI to better assess credit risks seems like a good idea, but I'm not convinced investing in Upstart is the best way to profit from this trend, given the company's recent track record. The company is still valued at nearly $2.1 billion, or about 4 times expected revenue in 2023. With profits nowhere to be seen and growth proving to be a major challenge, that seems too pricey to me.
C3.ai
For a small AI software company, C3.ai isn't growing very fast. Revenue grew by just 11% year over year in the quarter that ended on July 31, and the company's guidance wasn't much better.
Part of the issue is that it takes time for a customer to fully implement the company's solutions. C3.ai offers an enterprise AI application development platform and a suite of AI applications targeting specific industries. It can take months for a customer to deploy a product, so there's a long lag between the time a customer first signs on and when that customer starts contributing meaningful revenue.
The other problem is that a customer win isn't what it sounds like. C3.ai offers pilots to prospective customers, which include unlimited use of compute resources for six months as the customer gets up and running with one of the company's AI applications. C3.ai has had little trouble winning pilot customers, but those pilot customers must then convert to production customers. The company assumes a 70% conversion rate.
C3.ai's new generative AI offerings have a shorter 12-week pilot period and are garnering substantial interest. "The market response to our Generative AI offerings is staggering," said CEO Thomas Siebel in the latest earnings report. If these solutions catch on, it should only take a couple of quarters to see growth accelerate.
Some mixed messages are coming from C3.ai, though. The company reportedly fired some employees earlier this month due to employee performance and the need for cost savings. C3.ai is highly unprofitable, reporting a net loss of $64.4 million on $72.4 million in revenue in the latest quarter. But it also has plenty of cash and no debt. It doesn't seem like there should be any urgency to cut costs, given the "staggering" demand for its latest products.
That strikes me as odd. Odd enough that I have no interest in buying C3.ai stock. The company may succeed in accelerating growth in the years ahead, but I'm fine sitting this one out.
