In this discussion, we will explore three “AI Phase 2” stocks being teased by the Motley Fool. Along with an in-depth look at these companies, I’ll also share some educated guesses about the other two stocks featured in their special report.
The Motley Fool has released a new special report titled “AI Accelerators,” priced at $249, highlighting five potential AI market winners. The ad opens with this enticing message:
Within this promotion, they hint at the identities of the five “AI Phase 2” stocks, and we’re here to break them down. Let’s start with the most notable one:
These clues unmistakably point to ServiceNow (NOW), which they discuss in greater detail. Here’s some additional context they provide to support their claims about.
Our internal estimates suggest this stock could see a 68% price increase within a year. The long-term prospects might be even brighter.
Interestingly, ServiceNow, valued at around $170 billion, is a company I have not examined closely before. The last time I encountered it in a teaser was more than ten years ago when it faced a challenging valuation of 25 times expected earnings two years ahead. In hindsight, I regret not investing back then, as the stock has delivered approximately 2,000% returns over the past 11 years — impressive. However, it pales compared to Nvidia’s staggering 40,000% growth during the same period.
Following the pandemic and the subsequent market downturn in 2022, ServiceNow is priced much higher than it was in 2013. Presently, it trades at roughly 40 times the projected earnings for 2026.
This valuation could be reasonable if the company continues to enhance its margins and outperform analysts’ expectations. Their revenue has grown by about 20% annually, with earnings increasing by 25-30%. Investors are willing to accept a premium, but there’s a significant concern. ServiceNow has allocated a considerable portion of its revenue, about 18-22%, to stock-based compensation. While this strategy boosts cash flow, it could dilute shareholders’ stakes in the company.
So far, this compensation approach hasn’t negatively impacted shareholders. The company has effectively doubled its outstanding shares since going public, yet it has yielded over 2,000% returns for investors. However, as growth eventually slows, this issue must be monitored. Currently, at a share price of $840, ServiceNow is valued at around 60 times its anticipated adjusted earnings for 2024. Considering stock-based compensation as an operating cost, this valuation can increase to approximately 130 times expected GAAP earnings.
Owning stocks like this—those with the potential for consistent 20-25% revenue growth and manageable margin enhancements—is feasible, but investors should prepare for volatility. High valuations like this leave little room for negative surprises or market declines. For example, many growth stocks similar to ServiceNow experienced nearly 60% drops in 2022.
ServiceNow is positioning itself at the forefront of the AI revolution. It is a leader in subscription-based cloud software for various business needs, including human resources and customer service. Their AI-driven product, Now Assist, is reportedly their fastest-growing offering. While it’s tough to predict the company’s future direction, ServiceNow is undeniably a significant player in the software market.
I’ve chosen not to invest in ServiceNow, partly due to my exposure to other high-growth companies with similar valuation risks, such as The Trade Desk (TTD). However, it remains an impressive organization. They will likely grow into their current valuation if they can satisfy their customers. That said, potential investors should know that if the growth story falters or market sentiments shift negatively during an economic downturn, the stock could decline significantly, possibly by 60-80%. While high valuations don’t guarantee immediate drops, they often indicate that investors are betting on continued success without significant disruptions.
The Motley Fool’s report also features another intriguing stock:
They drop some additional hints:
According to my best guess, this stock is likely Procore Technologies (PCOR). Based on its disclosures, the Motley Fool has recommended it for at least a year, but it may not have been explicitly featured in Stock Advisor. The clues align well—Procore is valued at around $8-9 billion, fitting neatly into the mid-cap category and approximately 1/389th the size of Microsoft.
Currently, Procore holds about $350 million in cash, with its cash-equivalent assets totaling around $735 million. These assets exceeded half a billion due to its public offering in 2021, which allowed it to secure substantial initial capital. They are not experiencing cash burn, but profitability remains elusive.
As a founder-led entity, Procore fits the profile that Motley Fool often champions. They claim, “Over 1 million projects and more than $1 trillion in construction volume have been managed on Procore’s platform.”
However, it’s important to note that Procore isn’t inexpensive—trading at about 8 times its sales, which is generally attractive for a growing software firm. Yet, with a valuation of around 60 times its forward-adjusted earnings and no anticipated GAAP profitability shortly, the question lies in the sustainability of its growth trajectory. Additionally, Procore allocates about 20% of its revenue to stock-based compensation, but it does maintain positive cash flow, complicating the analysis of its potential growth.
The stock has struggled recently as investors anticipate relatively modest growth in the upcoming year. Revenue growth from 2023 to 2026 is projected to average between 15% and 20%, leading to an impressive average earnings growth of nearly 70%. However, a significant earnings increase occurred this year, with adjusted earnings per share (EPS) rising from almost nothing to approximately 90 cents—marking over 200% growth. Expectations for earnings growth in the next couple of years, particularly next year, are much more subdued.
Analysts predict ongoing growth, with 2025 estimates indicating around 14% revenue growth and 10% earnings growth. Unfortunately, this isn’t what investors typically seek when valuing a stock at 60 times adjusted earnings.
I find the idea of Procore appealing—it has the potential to emerge as a leading vertical SaaS provider in the construction sector. This position could be precious over time. Being a vertical leader means that if significant contractors adopt the software, it becomes easier to persuade architects, suppliers, and subcontractors to follow suit, enhancing its market presence. Moreover, the construction market remains relatively underpenetrated, presenting significant opportunities for growth. Their Investor Day presentation last year was awe-inspiring.
After this preliminary assessment, I appreciate the narrative and how they are developing their business. However, there are notable concerns regarding the construction industry’s slowdown due to rising interest rates and a broader reset in the office sector. With uncertainty surrounding future work-from-home trends, it’s unclear whether the many vacant office spaces in major cities will be filled again.
While I’ll watch Procore, I’m not rushing to invest. The stock has been stagnant for quite some time, and expectations for next year are low. I need to fully grasp the business well enough to pursue it at 60 times adjusted earnings, a bold wager that the company will rebound faster than analysts predict. Although they are integrating AI features into their platform, it takes time to envision these enhancements driving substantial customer demand and meaningful growth shortly.
This company is Integral Ad Science (IAS), specializing in digital ad verification. Similar to the more significant player DoubleVerify (DV)—which, unfortunately, has not performed well in my $100K Lock Box portfolio—IAS has faced challenges this year, highlighted by a couple of quarters with disappointing earnings reports. If you trust the analysts’ forecasts, IAS appears relatively affordable, trading at approximately 15 times forward adjusted earnings. This valuation could be appealing, especially with expected revenue growth of 15% and earnings growth of around 20%. However, it is a smaller, more volatile stock, and the past year’s results suggest that analysts may struggle to accurately predict earnings trends.
The core business of IAS involves ensuring that digital advertisements meet sellers’ claims, verifying that ads are actually reaching real audiences who engage with them (watching videos, clicking, etc.), and preventing inappropriate placements—like airing a children’s toy ad on a KKK website. Companies like IAS argue that investing in their services can reduce ad fraud and improve overall ad performance. Although IAS’s last significant investor day presentation was over a year ago, it outlines the business model effectively.
Earlier this year, while exploring the industry, I found DoubleVerify’s growth potential more appealing than IAS. However, the two companies share many similarities, and both are relatively small players with the potential for one of them to establish itself as the industry standard, leading to significant long-term growth. The competition between IAS and DoubleVerify, as well as other market players, remains fluid. Both companies collaborate with major advertising agencies and consumer brands alongside prominent social media and digital advertising platforms such as TikTok, YouTube, and Meta.
Furthermore, IAS is integrating AI into its offerings, providing AI-driven tools to help advertisers select higher-quality content and avoid cluttered websites. They also utilize data integration techniques, such as eye-tracking technology for websites. This approach is becoming increasingly standard in digital advertising, a sector heavily reliant on data, with many industry participants leveraging machine learning to enhance data collection and utilization. However, it remains to be seen if any particular product stands out significantly compared to competitors.
We can confidently identify three stocks, but two additional ones are hinted at, which require little bit more guesswork. Let’s look at the clues for the first of these:
While these figures sound promising, it’s important to clarify that “3X revenue growth in the past five years” translates to a 25% annual growth rate. (Assuming they meant revenue tripled over five years, the phrasing “3X revenue growth” can be misleading; few companies can consistently sustain that growth rate.)
If we’re looking for a company that’s “900 times smaller than Microsoft,” its market capitalization would be around $3 billion. What candidates fit this description while also showcasing substantial growth and AI utilization?
Several possibilities are too large, such as Bill.com, which operates as BILL Holdings (BILL) with a market cap of $5 billion, or Samsara (IOT), valued at $22 billion. Others align more closely with the criteria, depending on what ” mission-critical ” means (note: most software companies deem their products as essential). For instance, cybersecurity newcomer SentinelOne (S) has exhibited much higher growth, achieving a revenue increase of approximately 15X over the last three years. Still, they need to be more profitable, disqualifying them from the 200% profit growth requirement.
Another option could be Appian (APPN), a stock popular in 2021 but faded from memory. While it fits many clues, it has never reported significant profits.
DigitalOcean (DOCN) might fit the growth profile as well, but its earnings only grew by 100% in 2023—not the 200% mentioned—and it operates more as a cloud platform than a traditional software company. Intapp (INTA) does align with the revenue growth profile, providing essential software for financial services, and recorded around 300% earnings growth last year. However, it isn’t founder-led, being older than many of its peers.
I had hoped to narrow down a candidate for you, but the clues are vague enough that I can’t confidently pinpoint a single name. If you have any ideas or better guesses, please share your thoughts in the comments!
Another stock’s challenge to identify described as follows:
A standout candidate could be Aspen Technology (AZPN). This company has long been recognized for its “asset optimization” software, catering to industrial firms. In 2021, it significantly enhanced its grid management capabilities by partnering with Emerson Electric (EMR), which became a significant shareholder. However, Aspen has recently had to lower its growth forecasts, and the fact that Motley Fool hasn’t mentioned this stock in its free articles raises doubts about it being their pick.
Are there other candidates that fit this description?
Itron (ITRI) is another possibility; although the Motley Fool hasn’t covered it in years, Itron specializes in smart meters and energy management software. This company was once a hot topic when “smart meters” were the latest trend in the Internet of Things over 15 years ago, qualifying it as an “old-timer.”
Another option is STEM (STEM), which heavily focuses on AI-driven energy storage solutions. However, this stock has faced challenges after its SPAC merger a few years back, struggling due to overpromising results. While Stem aligns with the AI narrative, it may not be the ideal candidate for the title of “industrial technology stalwart.”
Ultimately, it’s easier for me to consider any company in digital grid management by mentioning Aspen Technology (AZPN) at this point. They heavily invest in custom AI platforms for their industrial and utility clients. While it may not be Motley Fool’s recommendation, I haven’t identified a stronger contender. A possibility could be C3.ai (AI), which also engages in energy management and industrial AI work, but I’m not entirely confident in this selection.
Aspen Technology is different from a high-growth story. Their order and contract volume growth will likely hover around 10% annually, translating into similar revenue growth. However, they’re currently valued as if they are a high-growth company. With a trading price of about 30 times adjusted earnings—mainly due to significant asset write-offs last year, which necessitated adjustments—this valuation raises some eyebrows. Their adjusted earnings are projected to grow at a modest rate of 5-10% per year. Such a steep valuation calls for careful consideration, especially since it seems driven by their software’s critical nature and stronghold in the digital grid management sector. While this might justify some premium, paying 30 times earnings for less than 10% earnings growth seems questionable, suggesting that further research is warranted before making any investments. It could be the connection with Emerson and their dominant market position that continues to attract investor interest.
If you have a better alternative in mind, feel free to share!
I wouldn’t classify any of the stocks discussed—whether our three confirmed matches or these two speculative options—as true “pure play AI accelerators.” We’re still in the early stages of figuring out how to monetize these costly AI initiatives and whether they’ll be profitable or become a standard feature in most software companies without significantly affecting pricing or margin structures. Among the mentioned stocks, the most compelling narratives may belong to niche software providers in less glamorous sectors, such as Procore in construction and Aspen in industrial and utility energy management. However, it appears that many investors share this view, which is reflected in the high valuations of these stocks, suggesting they’re expected to grow much faster than current analyst forecasts. Consequently, a thorough investigation would be necessary to determine if investing in these companies is prudent.
