Up 35% After Its IPO, Is Reddit the Next Red-Hot Artificial Intelligence Stock?

Reddit (RDDT 7.02%) launched its initial public offering (IPO) on March 21, and the stock has soared out of the gate. The company listed its stock at $34 per share, but it wound up closing out its first day of trading at $50.44 -- good for a gain of roughly 48%.

Shares pulled back somewhat in their second day of trading, but the social networking stock is still up roughly 35% from its listing price.

Many tech companies are touting their efforts to score big wins with artificial intelligence (AI) right now, and Reddit is no different. In particular, the company has outlined the opportunity to license data generated on its platform to other businesses for use in large language models (LLMs), the AI technology that underpins groundbreaking software, including OpenAI's ChatGPT, Microsoft's Copilot, and Alphabet's Gemini.

The chance to position itself as a player in the AI revolution has likely played a significant role in Reddit's strong start on the stock market. Could the social networking company emerge as one of the market's next explosive AI stocks?

How does Reddit make most of its money right now?

Reddit is essentially a social messaging platform. Users can create discussion boards based on their interests and contribute their ideas on a wide range of topics. It counted an average of 76 million daily active users (DAUs) in December and closed the quarter with 73.1 million average DAUs, up from 57.5 million at the end of the prior-year period and good for year-over-year growth of 27%.

Meanwhile, it closed out last year's fourth quarter with weekly average users of 267.5 million. For comparison, it had 207.3 million at the end of the prior-year quarter, representing annual growth of 29%.

As noted in the S-1 filing that the company submitted to the Securities and Exchange Commission (SEC) prior to its IPO, Reddit currently generates most of its revenue from digital advertising. In 2023, its sales rose about 20% year over year to reach roughly $804 million. Across the same stretch, the business posted a loss of $90.8 million, narrowing from the $158.6 million loss that it posted in the prior year period.

So the company's core advertising business is powering solid double-digit percentage revenue growth, and its losses appear to be narrowing. But it also still faces some monetization challenges, and it thinks AI might help solve them and unlock explosive growth for the stock.

AI could unlock Reddit's potential

While Reddit has a sizable and highly engaged user base, it has often struggled to monetize that base at levels comparable to other leading social media platforms. In the fourth quarter, the business recorded average revenue per user of $3.42, down from the $3.49 it posted in the prior year period.

As detailed in the company's S-1 prospectus, Reddit is making a major push into licensing its data to third-party customers for the training of large language models. Here is a quote from the prospectus: "Reddit data and information constantly grows and regenerates as users come and interact with their communities and each other in genuine and authentic ways. We expect our growing data advantage and intellectual property to continue to be a key element in the training of future LLMs."

To some extent, it already seems to be scoring some significant wins on this front. The company says that it has entered into data licensing contracts worth roughly $203 million over the next two to three years. In the near term, it anticipates that it will record at least $66.4 million in revenue from its data licensing contracts this year.

If the company continues to see solid data-licensing demand for LLMs, Reddit could score substantial improvements in the average revenue it generates per user. In turn, the social platform operator could post far more revenue and shift into delivering consistent profitability and earnings growth.

Could Reddit really be the next hot AI stock?

Overall interest and demand for AI technologies are soaring, and investors are willing to assign much higher valuation multiples to companies with real chances to capitalize on the revolutionary new trend.

In some cases, it seems investors are even willing to pay much more to own a stock just because a company has AI in its name or mentions it in a conference call. That means that it's even more important to exercise scrutiny when investing in companies that could have the potential to score big wins with AI.

Ultimately, I think Reddit has some real opportunities to capitalize on the rise of artificial intelligence. Between licensing its data for the training of large language models and using AI to improve targeted advertising and expand its user base, the company should be able to use the tech to meaningfully improve its revenue stream.

On the other hand, investors should keep in mind that these initiatives are still in their relatively early stages, and Reddit's long-term AI opportunity remains largely speculative. As such, it probably won't emerge as the market's next explosive AI stock, but it could be a worthwhile portfolio addition for risk-tolerant investors at current prices.