2 Artificial Intelligence (AI) Stocks With Explosive Potential | The Motley Fool

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Alphabet (Google) and Upstart are at opposite ends of the risk spectrum, but both offer a great way for investors to play the AI revolution.

It’s no secret artificial intelligence (AI) has been the dominant theme in the stock market this year. Technology giants have bet mind-boggling amounts of money on this emerging industry so far, and it’s still in the very early stages. Microsoft invested $10 billion in ChatGPT developer OpenAI back in January, and Amazon recently bet $4 billion on generative AI start-up Anthropic.

Going forward, there will be an incredible number of AI opportunities for investors to sink their teeth into. I’ll share two with explosive potential below.

Alphabet (GOOGL -1.96%) (GOOG -2.02%) is the parent company of Google, but it’s also home to subsidiaries like YouTube and the Waymo autonomous vehicle business, among others. But this year, Alphabet has been under the microscope for its position in the fast-moving AI space.

See, Microsoft’s investment in OpenAI rocked the tech world. It immediately began integrating ChatGPT into its product portfolio, including the Bing search engine, which promised to transform how we seek information online. Prompting a chatbot can, in many cases, produce faster and more direct results than using a traditional search engine like Google. That made Alphabet’s investors incredibly nervous.

But the company has been developing its own AI for years and, this year, even launched its own chatbot, Bard, to compete with ChatGPT. More importantly, Google is using AI to improve the traditional search experience. Now, when users enter a query, they are often presented with a text-based response at the top of the page, saving them from sifting through web pages to find the information they seek.

But that’s just the tip of the AI iceberg for Alphabet. Google Cloud offers over 100 AI models to its customers so they can build upon them to develop their own applications. Plus, it continues to develop its own data center chips to give customers more options beyond Nvidia’s popular hardware. Google Cloud unveiled its new v5e tensor processor (TPU) in August, which offers developers a twofold increase in training performance per dollar compared to the previous TPU v4.

Alphabet’s valuation might be its best feature right now, pointing to strong upside potential in its stock price. With just the final quarter of 2023 left to report, Wall Street analysts estimate the company is on track to deliver $5.74 in earnings per share. Alphabet’s stock price of $131.57 places it at a price-to-earnings (P/E) ratio of just 22.9.

That’s a notable discount to the Nasdaq-100 technology index, which trades at a P/E of 28.9. It suggests Alphabet stock will have to rise by 26% just to trade in line with its peers in the tech sector.

But it gets better. Wall Street expects Alphabet’s earnings per share to grow to $6.69 in 2024, placing its stock at a forward P/E ratio of just 19.7. That points to a potential 47% upside in the stock next year, assuming the forecast holds up. Alphabet might be the best bargain in the AI industry right now.

Upstart Holdings (UPST 5.93%) has sent investors on a rollercoaster ride since it came public in 2020, priced at $20 per share. Its stock quickly rocketed to an all-time high of $401 before plummeting all the way back down to trade at $32 as of this writing. It’s a perfect example of the substantial risks — and potential rewards — associated with investing in new technologies like AI.

Upstart has developed an AI algorithm designed to determine the creditworthiness of potential borrowers, and it uses that technology to originate loans for more than 100 banks and credit unions. Upstart says traditional assessment methods are outdated, especially those that rely on Fair Isaac’s decades-old FICO credit scoring system.

FICO considers five key metrics, like how much existing debt a potential borrower has and their repayment history. Upstart, on the other hand, looks at over 1,600 data points to build a more complete picture of the customer’s likelihood of repaying the loan. Analyzing that much data would take a human assessor weeks, but thanks to AI’s ability to rapidly process information, Upstart’s algorithm instantly (and autonomously) approves applications 88% of the time.

Unfortunately, the U.S. Federal Reserve embarked on the most aggressive campaign to hike interest rates in its history in 2022 (to tame soaring inflation). Consumer demand for credit collapsed, and banks grew concerned that Upstart’s models hadn’t been battle-tested in such a tough economic environment before. It dealt the company a double whammy, leading to a drop in originations and revenue.

However, Upstart has since released a substantial amount of data to prove its lending models are holding up, and they are even outperforming traditional assessment methods in many cases. As a result, the company continues to see new bank partners and car dealers flock to its platform. Demand for credit among consumers, however, remains soft. Upstart continued to experience a drop in originations even as recently as the third quarter of 2023 (ended Sept. 30).

Wall Street estimates Upstart will close 2023 with $506 million in full-year revenue, marking a 40% drop from 2022 — its second consecutive annual decline. However, Upstart hasn’t stopped innovating. In addition to personal loans and car loans, it now offers home equity lines of credit (HELOCs) in four U.S. states, with more to come.

The Street predicts the company could return to top-line growth in 2024. But longer term, Upstart believes its annual origination opportunity is worth a whopping $4 trillion. Considering the company has originated only $35 billion in loans since inception, it has barely scratched the surface.

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