The rapid growth of the artificial intelligence (AI) market lit a blazing fire under many tech stocks over the past year. That red-hot market could get even hotter over the next few years, but many of the top AI names -- including Microsoft and Nvidia -- are already trillion-dollar stocks.
Those four-comma valuations are impressive, but they might not be the best option for investors looking for millionaire-making gains. For bigger long-term gains, investors should seek out smaller AI companies that have more upside potential than those trillion-dollar market leaders. I believe these three smaller AI stocks fit that description: Cloudflare (NET 1.44%), UiPath (PATH 0.26%), and SentinelOne (S 1.70%).
Image source: Getty Images.
1. Cloudflare
Cloudflare’s content delivery network (CDN) accelerates the delivery of digital content for websites. It accomplishes that by storing caches of photos, videos, and online applications on edge servers located closer to the website’s visitors than the origin server. It also shields websites from bot-based attacks.
Cloudflare’s revenue jumped 52% in 2021 and soared 49% in 2022. But its revenue only rose 33% in 2023, and it expects 27% growth in 2024.
That slowdown was mainly caused by macro headwinds that forced many companies to rein in their software spending. But its number of large customers (who spend over $100,000 annually) still rose 35% in 2023 -- and its dollar-based net retention rate stayed above 115% over the past year.
Its adjusted gross margins are also holding steady above its target range of 75% to 77%, and its adjusted earnings per share (EPS) nearly quadrupled for the year. It expects its adjusted EPS to rise another 18% to 20% in 2024 as it streamlines its spending through its cyclical slowdown.
Cloudflare might not initially seem like an AI stock, but it rolled out its dedicated “Workers AI” platform for directly building AI apps like chatbots on its CDN last year. It also started installing Nvidia’s data center GPUs into its edge networks to accelerate those AI tasks and offset the processing pressure on a company’s origin servers.
Cloudflare’s stock isn’t cheap at 20 times this year’s sales, but its leading position in the CDN market and firm foothold in the AI market could justify its premium valuation.
2. UiPath
UiPath develops software robots that can be plugged into a company’s infrastructure to automate repetitive tasks like entering data, managing invoices, onboarding customers, and sending out mass e-mails.
It doesn’t believe new generative AI tools like ChatGPT will replace its robotic process automation (RPA) services. Instead, it plans to upgrade its own RPA services with more generative AI tools so they can analyze and understand data better instead of simply automating repetitive tasks.
UiPath’s revenue rose 81% in fiscal 2021 (which ended in January 2021) as the pandemic drove companies to automate more tasks with its software robots. Revenue grew 47% in fiscal 2022, but only rose 19% in fiscal 2023 as inflation, rising interest rates, and geopolitical conflicts forced many companies to rein in their software spending.
That slowdown spooked investors, but UiPath expects its revenue to rise 21% in fiscal 2024 as the stabilizing macro environment prompts more companies to resume their digital transformation strategies. Analysts expect its adjusted EPS to more than triple for the year as it reins in its spending.
During its investor day in 2022, UiPath predicted that its total addressable market could grow from $61.1 billion to $93.2 billion by 2025. Looking further ahead, Fortune Business Insights believes the global RPA market will have a compound annual growth rate of 20% from 2023 to 2030.
Based on those bullish expectations, UiPath still looks reasonably valued at 47 times forward earnings.
3. SentinelOne
SentinelOne is a cybersecurity company that aims to replace all human analysts with AI algorithms on its Singularity XDR (extended detection and response) platform. That’s an ambitious goal, and it has grown like a weed since its initial public offering (IPO) in 2021.
SentinelOne's revenue more than doubled in each of the past three fiscal years, and it expects 46% growth in fiscal 2024 (which ended this January). It’s still deeply unprofitable by both generally accepted accounting principles (GAAP) and non-GAAP (adjusted) measures, but its adjusted gross margins are expanding and its operating losses are narrowing.
SentinelOne is still a highly speculative play that faces fierce competition from larger cybersecurity companies like Palo Alto Networks and CrowdStrike. But it still trades below its IPO price and looks reasonably valued relative to its growth at 11 times next year’s sales.
SentinelOne is often mentioned as a potential takeover target, but it could scale up its business on its own over the next few years and profit from the secular growth of the cybersecurity and AI markets.
