There's a strong argument that 2023 was the year that artificial intelligence (AI) came of age, sparking a market recovery in the process. After plunging 35% in 2022, the Nasdaq Composite rebounded with a vengeance last year, gaining 43%.
While AI has been around for decades, recent advances in the field of generative AI have been a game changer. This breakthrough technology can, among other things, create original text and images based on a few user prompts. But that's just the beginning. These sophisticated algorithms can search company databases and the internet for information, summarize emails and draft responses, recap meetings, create presentations from available data, and even write and review computer code. The resulting productivity advances are expected to be worth trillions of dollars, and companies are scrambling to capture their share of this windfall.
Investors, too, are looking to profit from this trend, snatching up any stock they can in the field of AI. While that's certainly understandable, not all AI stocks are created equal. One high-profile example is C3.ai (AI 3.02%). The stock soared more than 156% last year, driven by the excitement surrounding AI. A review of the evidence, however, suggests there's a better way for investors to profit from the AI revolution -- one that provides much more upside potential.
Image source: Getty Images.
The case for (and against) C3.ai
Investors' attraction to this stock isn't surprising given C3.ai's eponymous ticker, but looks can be deceiving. The company bills itself as a "leading enterprise AI software provider for building enterprise-scale AI applications." Management goes on to point out that the company "provides over 40 turnkey enterprise AI applications that meet the business-critical needs of global enterprises," serving a number of business and industry verticals.
This would seem to suggest that C3.ai would be well situated to benefit from the AI gold rush. However, the company's business performance is lackluster at best.
C3.ai's recent financial results held more questions than answers. During its fiscal 2024 second quarter (ended Oct. 31), C3.ai delivered revenue that grew 17% year over year to $3.2 million, resulting in a loss per share of $0.59, barely improved from the $0.63-per-share loss it generated in the year-ago period. This is particularly troubling given the mad dash to adopt AI over the past year should have dramatically boosted C3.ai's fortunes. But that simply hasn't been the case. Furthermore, the company continues to burn cash, with free cash flow of negative $55.1 million.
To be fair, C3.ai is making some progress, boasting of "a return to accelerating revenue growth," though the numbers are hardly inspiring. "We have seen top-line year-over-year revenue growth increase from -4% in Q3 FY23, to 0% in Q4 FY23, to 11% in Q1 FY24, to 17% in Q2 FY24," said CEO Thomas Siebel.
However, its forecast suggests that trend may be over, as management is calling for fiscal 2024 third-quarter revenue of $76 million at the midpoint of its guidance, which would represent year-over-year growth of 14%, while its operating losses will continue to mount. Despite its tepid results and weak outlook, the stock sells for 11 times sales, and with not even the suggestion of profitability on the horizon.
In the face of unprecedented adoption of AI, C3.ai should be scrambling to meet the burgeoning demand. Given its lackluster performance thus far, investors would do better looking elsewhere to profit from AI.
A much better AI play
The breakout beneficiary of the AI boom thus far has been Nvidia (NVDA 6.18%), and the evidence suggests the trend will continue. The company's graphics processing units (GPUs) were originally designed to generate lifelike images in video games but have evolved over time.
The secret to its success is parallel processing, which takes massive, computationally intensive tasks and breaks them up into bite-sized bits, allowing it to perform a multitude of mathematical calculations simultaneously. Researchers and scientists found this provided the computational horsepower necessary to accelerate AI tasks.
Rivals have tried to unseat Nvidia from its position as the industry leader, but those efforts have thus far proven unsuccessful. If you have any doubts, consider this: Nvidia is the leading provider of processors used for machine learning, an earlier, more established branch of AI, according to data supplied by New Street Research. It also maintains an estimated 95% share of the GPUs used in the data center market -- where most business-centric AI lives -- according to CFRA Research analyst Angelo Zino. While the field of generative AI is still in its infancy, it stands to reason that Nvidia will control an equally dominant share of the market. As evidence, there's been a run on Nvidia AI chips that shows no signs of slowing.
In its fiscal 2024 third quarter (ended Oct. 29), Nvidia generated record revenue of $18.1 billion, up 206% year over year, while its earnings per share (EPS) of $3.71 soared 1,274%. Management left no doubt the surging demand was the result of the rapid adoption of AI.
For its fiscal fourth quarter, Nvidia forecast all-time high revenue of roughly $20 billion, representing growth of 231% year over year and 10% sequentially.
A quick look at its valuation shows that Nvidia stock is remarkably inexpensive. For a high-growth stock like this, the most appropriate valuation metric is the price/earnings-to-growth (PEG) ratio. For Nvidia, this clocks in at less than 1 -- the benchmark for an undervalued stock, compared to 2 for the S&P 500, which shows just how cheap it really is by comparison.
The evidence clearly shows that Nvidia is a much better AI stock than C3.ai.
