C3.ai (NASDAQ:AI), an artificial intelligence (AI) software company, went public at $42 in December 2020. Soon after, AI stock spiked to over $177 on Dec. 22. However, it has fallen since, trading at $49.84 as of the close of Sept. 16.
I used to think that this stock would probably just tread water because it was too highly valued. That’s what I wrote in May about AI stock. But now, after its latest earnings, I am not so sure. I suspect that, even though AI is highly valued, this growth stock will likely keep on inching higher.
One major reason for this is the fact that the company’s revenue growth continues to impress. Plus, the market seems to be willing to grant growing high-tech software companies higher valuations than others. As a result, I suspect that the stock has further to climb this year.
AI Stock: Impressive Fiscal Q1 Results
On Sept. 1, C3.ai reported that fiscal first-quarter revenue for the period ending Jul. 31 grew 29% year-over-year (YOY) to $52.4 million. This is after sales grew 17% to $183.2 million for the year ending April 2021. In other words, its July quarter revenue is already nearly 30% of the total revenue for all of the last fiscal year.
Moreover, during Q1, the company said its gross margin rose even faster at 31%. In addition, C3.ai scored a major sale; it landed Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Cloud. This will allow Google Cloud global to “co-sell and service the entire family of C3 AI applications.”
But that’s still not all. On top of that, the company has deferred revenue that more or less guarantees revenue will be higher next year. It calls this “Remaining Performance Obligation” or RPO. In other words, it has signed contracts that require the company to perform services (and book revenue) to the tune of $290.6 million.
Let’s assume that at least 50% to 70% of that revenue will be booked over the next year. This implies that, even without any new growth, the company’s sales will be between $145.3 million and $203.4 million. In other words, sales gains over last year’s $183.2 million are already baked into the numbers (that’s for certain if it books 70%, representing a gain of 11% over last year’s sales). So, any new contracts signed during the quarter add to both existing revenue and RPO, ensuring future sales growth.
What Is C3.ai Worth
At the recent market capitalization of $5.189 billion, AI stock’s price-to-sales (P/S) multiple is high at 21 times (i.e., $5.189 billion /$246 million). However, given that fiscal-year 2023 sales are forecast to rise by 34% to $329.95 million, the forward P/S ratio is only 15.7 times.
Moreover, analysts surveyed by Seeking Alpha show consistent revenue growth in their forecasts, from $246 million in 2022 to $1.3 billion by April 2026. This implies that sales will have risen 7.1 times from April 2021, from $183.2 million to $1.3 billion. That reflects a compound growth annual growth rate (CAGR) of 48% over five years.
The point is that a high level of consistent and sustained growth deserves a high P/S multiple.
What to Do with AI Stock
Analysts tend to agree with me that AI stock can rise further from here. In fact, they are even more ebullient. For example, Seeking Alpha shows 10 analysts with an average price target of $69.89, or 40% higher than the Sept. 16 price. Moreover, Tipranks indicates that seven Wall Street analysts who’ve written on the stock in the last three months have an average target of $75.14. That also represents a high potential upside of more than 50% for AI stock.
So, despite the company’s high valuation right now, it seems that analysts still think AI will rise much higher. Likewise, I find that the company’s high growth rate and existing RPO contracts bake in enough growth for this valuation to make sense.
My target price is more conservative than others — I see it rising to around $58 or so — but this might be expected as I am more of a value investor.
Bottom line? Investors can still make good money on AI stock, despite its high valuation metrics.
On the date of publication, Mark R. Hake did not (either directly or indirectly) own any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.