Artificial intelligence has evolved into one of the fastest-growing industries and continues moving at breakneck speed. Leading software company C3.ai, Inc. (AI) has gained 104.1% year-to-date, thanks to a surge in investor interest in AI-related companies after the viral success of OpenAI’s ChatGPT.

However, recent allegations of “serious accounting and disclosure issues” have resulted in a significant drop in this stock’s price. In this article, we’ll first see the prospects of the highly competitive and rapidly evolving AI industry and then discuss why it’s best to avoid the AI stock.

McKinsey & Company reported that the adoption of AI has more than doubled in the past five years. Investors are showing strong interest in artificial intelligence, which has the potential to revolutionize multiple industries. This has led to significant investment in these areas from both private and public sources.

The global AI solution market is expected to grow at a CAGR of 29.4%, reaching $301.20 billion by 2028.

Recently short seller Kerrisdale Capital alleged that AI had used aggressive accounting practices to inflate income statement metrics to meet revenue and profit expectations and conceal underlying operational issues.

Following the accusation, the stock fell 26%, its biggest one-day drop since the company’s 2020 IPO. The stock has declined 32.6% over the past five days and 16.5% over the past month, closing its last trading session at $22.84.

While AI’s revenue exceeded the company’s prescribed guidance in the fiscal third quarter, it fell from the same quarter the prior year.

Here are the factors that could influence AI’s performance in the near term:

Weak Bottom Line

During the third quarter of the fiscal year 2023, which ended January 31, 2023, AI’s total revenue declined by 4.4% year-over-year to $66.67 million. Its non-GAAP gross profit declined by 8.6% year-over-year to $50.96 million. Its total operating expense rose 16.6% year-over-year to $116.44 million.

Additionally, its non-GAAP loss from operations came in at $15.03 million. The company’s non-GAAP net loss amounted to $6.16 million, or $0.06 per share, up 60.1% and 50% from the prior-year quarter.

Stretched Valuation

In terms of forward EV/Sales, AI is currently trading at 6.71x, which is 145.9% higher than the industry average of 2.73x. Its forward Price/Sales multiple of 9.65 is 262.1% higher than the industry average of 2.67.

Weak Profitability

AI’s trailing 12-month asset turnover ratio of 0.23x is 61.6% lower than the industry average of 0.61x. Its trailing-12-month net income margin of negative 98.35% compares to the industry average of 2.71%. The stock’s trailing-12-month negative EBIT and EBITDA margin of 102.64% and 101.14% compare to the respective industry averages of 4.57% and 9.40%.

In addition, the stock’s trailing 12-month levered FCF margin of negative 42.06% compares to the 6.43% industry average. Its trailing-12-month negative ROCE, ROTC, and ROTA of 26.58%, 17.01%, and 23.95% are lower than their respective industry averages of 2.65%, 2.06%, and 0.67%.

POWR Ratings Reflect Bleak Prospects

AI’s grim outlook is reflected in its overall D rating, which equates to a Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight different categories. AI has a grade D for Value, which is justified by its stretched valuation.

Its D grade in Quality is in sync with its weak profitability. The stock also has a D grade for Stability, consistent with its 24-month beta of 2.47.

AI is ranked #22 among 23 stocks in the Software – SAAS industry.

To access additional AI ratings for Growth, Momentum, and Sentiment, click here.

Bottom Line

Artificial Intelligence is a rapidly expanding industry with enormous growth potential. It has become a buzzword in the investment world, attracting investors’ attention due to its disruptive nature and the potential to revolutionize multiple industries.

Despite the hype in its stock, AI experienced a decline in revenue and gross profit, along with an increase in operating expenses, resulting in a non-GAAP loss from operations and a net loss for the fiscal third quarter.

Furthermore, owing to macroeconomic headwinds, the stock market is quite volatile, which could further weigh on AI, as it is trading lower than its 50-day moving average of $23.44.

Given its poor financial performance in the latest quarter, stretched valuation, and weak profitability, the stock could be best avoided now.

Stocks to Consider Instead of C3.ai, Inc. (AI)

Unfortunately, the odds of AI outperforming in the weeks and months ahead are greatly compromised. However, there are many stocks in the Software – SAAS industry with impressive POWR Ratings. So, you may consider these three A-rated (Strong Buy) or B-rated (Buy) stocks instead:

Informatica Inc. (INFA)

Park City Group, Inc. (PCYG)

New Relic, Inc. (NEWR).

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AI shares were trading at $22.02 per share on Monday morning, down $0.82 (-3.59%). Year-to-date, AI has gained 96.78%, versus a 6.74% rise in the benchmark S&P 500 index during the same period.

About the Author: Kritika Sarmah

Her interest in risky instruments and passion for writing made Kritika an analyst and financial journalist. She earned her bachelor's degree in commerce and is currently pursuing the CFA program. With her fundamental approach, she aims to help investors identify untapped investment opportunities. More...

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