Investing in new technologies can be risky. When the dot-com internet bubble burst in the early 2000s, thousands of high-flying tech companies in the public and private markets went under, leaving their shareholders with significant losses. However, the internet boom also gave us Amazon, which proceeded to become a $2.4 trillion titan of e-commerce, cloud computing, and more.
A new tech revolution is currently underway, and this time it's artificial intelligence (AI). AI software is already boosting productivity for businesses, and PwC thinks the technology will add $15.7 trillion to the global economy by 2030. Therefore, this opportunity could be even more valuable than the internet during its early years.
Upstart (UPST 2.72%) and Lemonade (LMND +0.25%) are two small AI companies with a combined value of less than $8 billion, as of this writing, but they have the potential to change the world and make investors very wealthy in the process. However, these stocks are certainly not risk-free.
Image source: Getty Images.
1. Upstart: Transforming consumer lending with AI
Upstart stock has soared by 235% over the last two years, but it remains 85% below its record high from 2021. Its story highlights the level of volatility investors can expect from stocks at the smaller end of the AI market. However, Upstart's AI-powered algorithm is transforming the way banks assess potential borrowers, leading to more approvals and fairer interest rates.
NASDAQ: UPST
Key Data Points
Upstart thinks Fair Isaac's FICO credit scoring system, which most banks have used for the last three decades, is outdated because it only considers a handful of factors to determine creditworthiness. Upstart's algorithm, on the other hand, uses AI to analyze over 1,600 data points for each borrower to gain a better sense of their ability to repay a loan. The result is double the number of approvals, at an interest rate that's 38% cheaper, on average.
Upstart earns a fee when it originates an unsecured personal loan, a car loan, or a home equity line of credit (HELOC) on behalf of its bank partners. Interest rates soared during 2022 and 2023, which sent demand for credit tumbling, taking Upstart's revenue and its stock price down with it. However, the Federal Reserve started cutting rates in September 2024, and demand is slowly returning.
During the third quarter (ended Sept. 30), Upstart originated 186,786 unsecured personal loans, which was a 65% increase from the year-ago period. The company will report its results for the 2024 full year sometime in February, and Wall Street's consensus estimate (provided by Yahoo!) suggests its revenue will come in at $599 million. That would be a 16% increase compared to 2023, marking a return to growth after two straight years of declines.
But it gets better, because analysts think Upstart's revenue could soar by 37% to $820 million during 2025.
Still, Upstart has only scratched the surface of its opportunity. The company says around $3 trillion worth of unsecured personal loans, car loans, small business loans, and mortgages are originated in the U.S. every year. The company has only originated around $40 billion worth of loans since it was founded in 2012, so it has a very long growth runway.
Upstart stock would have to climb by 603% just to reclaim its record high from 2021. I'm not suggesting that will happen in the near future, but it might over the long term if the company can dominate the market for AI-powered loan originations. Plus, its market capitalization would only be $37 billion if it does get there, so it would still be a tiny company compared to some of the heavyweights in the financial sector. Even Fair Isaac is worth over $46 billion as of this writing!
Investors will have to buy around $170,000 worth of Upstart stock at the current price to end up with $1 million, assuming it does reclaim its previous record high. But its steep decline from that level proves there are significant risks to holding it. In addition to a drop in loan demand, the company's funding sources tend to dry up when interest rates rise, or when economic turmoil strikes, so long-term Upstart investors need to brace for periods of extreme volatility.
Image source: Getty Images.
2. Lemonade: A new era in insurance
Lemonade stock has also been on a roller-coaster ride over the last few years. It's up by 191% from its 2023 low point, but it remains 81% below its record level from 2021. The company has been developing AI since it was founded in 2015, in order to completely transform the customer experience when it comes to buying insurance.
Lemonade currently serves over 2.3 million customers across five insurance markets: homeowners, renters, life, pet, and car. Potential customers can receive a quote in just 90 seconds by speaking with the company's AI chatbot, Maya, via its website. For existing customers, AI Jim can process claims in just three minutes with no human intervention. All this means no more lengthy phone calls or stressful waiting periods.
Lemonade also developed the Lifetime Value (LTV) models to price premiums and manage its operations. They can rapidly calculate risk by determining a potential customer's likelihood of making a claim, switching insurers, or buying multiple policies. That ensures the customer receives an accurately priced premium, which can save them money while also protecting Lemonade's business.
The LTV models are incredibly effective. During the third quarter of 2024 (ended Sept. 30), Lemonade's in-force premium (IFP) hit a record high of $889 million, which was a 24% increase from the year-ago period. It also marked an acceleration from the 22% growth it delivered in the second quarter. The company achieved all of that despite shrinking its employee head count by 7%, because it's shifting so many workloads over to AI.
Moreover, Lemonade's gross loss ratio (the percentage of premiums paid out as claims) also fell to 73% during the quarter, the best level in four years. It's a clear sign the company's AI models are working.
NYSE: LMND
Key Data Points
Lemonade expects to cross $1 billion in IFP in early 2025. However, the company has outlined a plan to grow that figure by 30% annually going forward, so it could reach $10 billion in as little as nine years from now. To put it another way, Lemonade could reach $10 billion in IFP just as fast as it reached its first $1 billion, which highlights how successfully the company is scaling its business.
I think it's not only possible, but very likely. Lemonade says 70% of its customers are under 35 years of age, a huge achievement because the insurance industry has often struggled to attract young people. Insurance is a product customers buy every single year for most of their lives, so capturing a young customer base will allow Lemonade to compound its financial growth over the span of decades.
Theoretically, Lemonade stock could rise tenfold from here if it grows its IFP to $10 billion. That means investors who buy $100,000 worth of its stock could be sitting on $1 million within the next nine years. It won't be a straightforward journey, because Lemonade is basically a start-up trying to disrupt an entrenched industry, but the bumpy road ahead could be very rewarding for patient long-term investors.
