Chennai Investment：Answers： What are Motley Fool’s “AI Phase 2 Accelerators？”

Here’s the latest tease from the , which has been selling a special report they call AI Accelerators ($249), and using the bait of five potential AI winners to lure customers. Here’s the beginning of the ad:

“We’ve hand-picked 5 top stocks from ‘AI Accelerators’ – our brand-new report targeting AI’s SECOND wave

“In fact, even though a 5-stock report like “AI Accelerators” is typically valued at $500 on its own, you’ll only pay half that much when you act today.

“But you’ll still get 5 pure-play AI stocks….”Chennai Investment

And they drop some hints about what those five “AI Phase 2” stocks are… so let’s jump right in and see if we can identify them for you… we’ll start with the biggest one…

“A pure-play AI stock we’ve taken to calling the “Nvidia of Phase 2” – an analyst for one of the largest investment banks in the world recently came out and called this stock “one of the few true AI beneficiaries in software,” and the CEO says their new AI product is “enabling productivity on steroids.””

That’s actually enough clues for the Thinkolator to ID this stock, they’re clearly referring to … but this is one that they actually highlight in a little more detail, so we can share what else they say to convince you about NOW…

“A pure-play AI stock we’ve taken to calling the “Nvidia of Phase 2.”

“The CFO recently laid down the gauntlet, saying “AI is real in our business,” and the CEO says their new AI product is “enabling productivity on steroids.”

“It’s no wonder our internal Potential 1-Year Price Forecast** for this stock suggests there could be as much as 68% upside from this point forward! And personally, I believe the long-term upside could be FAR greater than even that.

“Despite being the largest stock in this report, it’s still 18 times smaller than Nvidia, arguably the biggest Phase 1 winner!”

Strangely enough, for a very large company (market cap now $170 billion), this is a stock I’ve almost never looked at or analyzed at all… the one time I noted someone else teasing NOW was more than a decade ago, at which point it was at a then-challenging valuation of 25X the earnings they were expected to make two years into the future. Certainly now wish I had bought shares back then, the stock has returned about 2,000% over the past 11 years — not NVIDIA territory (it’s up 40,000% over that same time period), but a phenomenal performance nonetheless.

And now, like so many of the high growth “cloud” names who thrived through the pandemic and came out of the 2022 crash with strong “AI” chops, it’s way more expensive than it was back in 2013 — today ServiceNow trades at about 40X what analysts think they’ll have in adjusted earnings in 2026.

Which could arguably make sense, if they can continue to gradually improve their margins and surprise analysts — they’re growing revenues by about 20% per year these days, and earnings by 25-30%, so you can see why investors are willing to pay a premium price — but they’re also, like so many other similarly high-growth stories, handing out stock-based compensation like it’s free, they consistently pay out 18-22% of revenue as stock-based comp, which makes their cash flow much better than their earnings but also, at least theoretically, dilutes shareholders’ ownership of the business.

To be clear, this excess stock-based compensation has not hurt shareholders to this point. They’ve roughly doubled their outstanding shares over the past 11-12 years, since going public, and that has not kept the stock from returning that 2,000%+ gain to shareholders. But eventually, as the growth slows down, it begins to matter. We’ll see when that might be. Today, ServiceNow, at $840/share, is valued at about 60X their expected adjusted earnings for 2024, but if we insist on counting their share-based compensation as an operating expense, they’re valued at about 130X expected GAAP earnings per share.

You can probably own some stocks like this, growth leaders who can really put up 20-25% revenue growth and improve margins even a little bit, as most software companies are able to do, can pretty quickly grow into even an extreme valuation like this. But if you own a lot of stocks like this, be prepared for an extremely volatile portfolio — paying 15-20X revenues and depending on very high growth means there’s not much room for any disappointment or market weakness (like many similarly-valued growth stocks, NOW fell almost 60% in 2022).

And yes, ServiceNow is trying very hard to be in the front of the AI wave — they are a Subscription as a Service/Cloud software leader, providing software to businesses for stuff like human resources management, customer service, etc., and their AI-powered product, called Now Assist, is the fastest growing product they’ve ever launched. I don’t know where it goes from here, and it will take a lot to move the needle at ServiceNow, but they are certainly a high-growth, high-valuation leader in the business software space. I’m not going to buy this one, in part because I already have enough exposure to other large cap high-growth stories that have similar valuation risk (like , for example), but it’s pretty clearly an excellent company, and if they can keep their customers happy they will very likely be able to grow into this valuation if you give it enough time — just be aware that the stock could easily fall 60-80% if the growth story falls apart or investors panic about the market during the next economic downturn… paying 100X earnings doesn’t mean the stock will fall anytime soon, valuation is a very poor predictor of immediate market returns, but it usually means you’re betting that nothing will go wrong.

What else do we get?

“A software powerhouse driving AI-powered efficiency in the construction industry – chasing an estimated $1.6 TRILLION in productivity gains, this under-the-radar stock has NEVER been recommended before in !”

And some hints dropped about that one…

“A mid-cap software powerhouse in the construction industry of all places….

“1 million construction projects around the world have already used its platform, but still, it’s an unknown name for many investors.

“The stock ticks a lot of our boxes: Founder-led… profitable with nearly half a billion dollars of cash on the balance sheet… growing fast… the list goes on!

“This stock has NEVER been recommended before in Stock Advisor, and it’s 389 times smaller than a big-name AI stock like Microsoft!”

This, sez the Thinkolator, is Procore Technologies (PCOR) — a stock the Motley Fool has recommended for at least a year, according to my look back at their disclosures, but perhaps not for Stock Advisor specificallyAgra Investment. And yes, it matches the clues quite perfectly — it’s an $8-9 billion company, so it slides into that “midcap space” and is also roughly 1/389th the size of Microsoft.

They have about $350 million in cash at the moment, but their “cash like” holdings are around $735 million today, so easily more than half a billion — mostly from the fact that they went public in 2021, when valuations were high, so they started out with a nice piggy bank. They’re not burning cash at the moment, but nor are they really making any money.

And yes, this is still a founder-led company, which the Fool tends to love, and they do say that, “Over 1 million projects and more than $1 trillion USD in construction volume have run on Procore’s platform.”

But, no surprise, it also ain’t cheap — PCOR is trading at only about 8X sales, which is generally a pretty appealing level for a growing software company… but they’re not so efficient yet, and they’re valued at 60X forward adjusted earnings (they probably won’t be GAAP profitable anytime soon, but they also pay out about 20% of revenue as stock-based compensation, and they do have positive cash flow), so the challenge is in figuring out what the growth might look like.

The stock has been in the doldrums for a while because investors expect relatively low growth over the next year or so — the revenue growth from 2023-2026 is still expected to be in the 15-20% range, on average, leading to almost 70% average earnings growth… but the big jump in earnings was this year, going from almost nothing to about 90 cents in adjusted EPS (more than 200% growth), and the expectations for earnings growth over the next couple years, especially next year, are much lower.

Analysts do think they’ll keep growing, but the expectation for 2025 specifically is about 14% revenue growth and 10% earnings growth — and that’s not what anyone is looking for when they pay 60X adjusted earnings.

I want to like the idea of Procore — This has the potential to become a real vertical SaaS software leader in the construction industry, which would be very valuable over time (vertical meaning that it becomes standard among businesses in the supply chain — so if big contractors use it, it’s easier to convince their architects, suppliers and subcontractors to use it, etc.), and the market is not very well-penetrated so there’s a lot of open space for a software provider to grow. Their Investor Day presentation from last year was quite good.

I like the story, and I like where they are in building the business, after this quick look… but clearly there’s some concern about the construction industry having slowed down with higher interest rates, and being in the middle of a reset for the office sector, as nobody is really sure what future work-from-home dynamics will be or whether all the empty office towers in major cities will ever fill back up again.

So I’ll keep an eye on this one, but I’m not in a hurry to own it. The stock has been in the doldrums for a long time, and expectations are very low for next year — I don’t understand the business well enough to chase after it and pay 60X adjusted earnings, which seems like a very aggressive bet that the business will jump back much more quickly than analysts expect. And though they are involved with AI, it’s hard to see the AI-related tools they’ve bolted on to the software platform really banging down customers doors and causing growth to jump in a meaningful way anytime soon.

More ideas?

“A global (yet little-known!) leader in the ad industry – this company’s cloud-based software platform serves over 2,000 advertisers and more than 280 billion interactions per day, yet it’s the smallest stock in ‘AI Accelerators’ with a puny market cap of just $1.7 billion!”

That’s Integral Ad Sciences (IAS), which does digital ad verification. Sort of like the somewhat larger , which is a (so far unsuccessful) holding in my portfolio. And like DoubleVerify, it’s had a rough year, with a couple quarters worth of disappointing earnings reports. IAS is also pretty cheap if you believe the analysts are on track with their estimates — it’s now at about 15X forward adjusted earnings, which is a pretty decent starting point if you’re getting 15% revenue growth and 20% earnings growth. It’s also quite small and volatile, though, and we haven’t had much evidence over the past year that says analysts are good at predicting their earnings trajectory.

The basic business is making sure that digital ads are what the seller says they are, that they’re really being shown to real people who actually look at them (or play the video, or whatever), and that you’re not showing your video of an ad for kids’ toys on a KKK website. The sales pitch for all of these kinds of companies is that if you pay a little bit for their service, you’ll have less ad fraud and better ad results. Their last big investor day presentation was more than a year ago, but it does sum up the business pretty nicely. When looking at the industry earlier this year, I found DoubleVerify’s scope and growth a little more compelling than IAS — but they’re pretty similar, and both quite small, and there is room for one of them to potentially become the industry standard, which could lead to dramatic long-term growth. There’s just no real indication that the competition between these two (and many others, they’re not the only ones) is in any way settled — they both work with all the big ad agencies and consumer brands, and with all the major social media and digital advertising companies, from TikTok to YouTube to Meta.

And yes, IAS is using AI — they’re offering AI-powered tools to select higher-quality content for advertising (ie, avoid the overcluttered sites), and to integrate other data like eye tracking for websites, etc. That seems to be somewhat standard, digital advertising is very much a data-driven business, and everyone involved has been using machine learning to improve that data collection and usage for years, though I don’t know if anyone has a product that’s markedly better than the others.

So those are the three we can be definitive about — but there are two other stocks hinted at as well, and with those we’ll have to do some guessing… here are the clues for the first one:

“A mission-critical AI-driven software smallcap – founder-led with nearly 3x revenue growth in the past 5 years and a +200% profit increase last year, this hidden gem is roughly 900 times smaller than AI giants like Microsoft and Nvidia!”

That sounds impressive, but we should note that “3X revenue growth in the past five years” is really only 25%/year. (Assuming that what they meant to say was that revenue tripled in five years – “3X Revenue Growth” doesn’t really make sense otherwise, almost nobody triples their revenue growth rate like that.)

If we’re dealing with “900X smaller than Microsoft,” that would mean a market cap somewhere in the neighborhood of $3 billion. What can match that, and also fall somewhere near those growth clues? And use AI in some way?

Well, there are a few candidates that are just too big, like Bill.com, which is now BILL Holdings (BILL), at a $5 billion market cap, or at $22 billion. And some that are about the right size and description, depending on what you mean by “mission-critical” (spoiler alert: every software company thinks their product is “mission critical”), like upstart SentinelOne (S), but that has growth much faster than 3X (their revenue has grown 15X or so in three years), and is also far from profitable right now, so we can’t say they’ve had a 200% profit increase. , a hot stock from 2021 that is now almost entirely forgotten, matches most of those clues quite well… but still has never really reported a profit.

And the list goes on… DigitalOcean (DOCN) fits that growth profile, but earnings really only went up 100% in 2023, not 200%, and it’s more of a cloud platform provider than a software company… Intapp (INTA) has about that revenue growth profile, provides mission-critical software for financial companies, and actually had more like 300% earnings growth last year, but isn’t founder-led (they’re older than most of these companies).

Hmmm… I thought I’d at least come up with a guess for you there, but no, none of these are close enough for those very imprecise clues to give me enough confidence to pick one specific name. If you’ve got a better guess, by all means, throw it on the pile with a comment below.

And one more that’s tough to identify…

“An industrial technology stalwart on the cutting-edge of innovation – expect electricity consumption from AI to nearly quadruple by 2030, and this proven innovator’s AI-driven software already has a leading position in helping those utilities with grid management, setting the business up for a potential step-change impact!”

The best thematic match that I can think of here is probably Aspen Technology (AZPN), which has been a leader in “asset optimization” software for a long time, working with industrial companies, but strengthened its grid management offerings considerably back in 2021 when they partnered with to take over that part of their business (Emerson became, and I think remains, a 50%+ shareholder of Aspen in that deal). They’ve had to recently reduce their forecasts for growth, though, and the Motley Fool’s recent free articles don’t disclose that the Fool recommends the stock, so this is probably not the pick. What else could it be?

Well, there’s , which the Fool hasn’t even covered in free stories in years, but they do sell smart meters and power management software — this was a hot story stock back when “smart meters” were the exciting flavor of the week, 15 years ago. I guess that makes them old enough to be a “stalwart”.

Or , very much an AI-driven story stock focused on grid storage, and so far a failure as a stock after their SPAC merger a few years ago, thanks to lots of over-promising, could conceivably fit in theory, and has been a Motley Fool recommendation in the past, but is also maybe the furthest thing from an “industrial technology stalwart” you’ll ever see.

But really, it’s hard for me to take seriously any company in digital grid management other than Aspen Technology (AZPN) at this point, and they are investing pretty heavily in customized AI platforms for their industrial and utility customers, so that would be me pick for this particular space — maybe it’s not the Fool’s pick, but I haven’t yet been able to find one that would be more likely… unless they’re sneaking around the back and recommending , which does do some power-management and industrial AI work.

Aspen Technology is not a high-growth story, they’re likely to grow their orders and their contract volume by about 10% per year, turning into revenue growth that averages something similar to that, but to some extent they’re priced like a high-growth story. They’re trading at about 30X adjusted earnings (there were some big asset writeoffs last year that throw things off and make the adjustment necessary, stock-based compensation is not super crazy with this one), and are only expected to grow those adjusted earnings by 5-10%/year. That’s a stiff valuation, and it’s probably largely driven by how mission-critical this software is, and how strong their position is in digital grid management software — I don’t know if that makes them strong and predictable enough to pay 30X earnings for less than 10% earnings growth, that’s a valuation which calls for a lot more research before buying, but it’s probably that Emerson connection and the dominant market share that keeps investors interested at this point.

Again, got a better match for us? Throw it on the pile, please!

I wouldn’t call most of these ideas, either our three certain matches or these two guesses, real “pure play AI accelerators” — but they could be, it’s still pretty early days in figuring out how to pay for these expensive AI programs, and whether anyone will make money at them or they’ll just become an expected layer in the offerings of most software companies, without really changing the pricing or margin dynamics. Of the stocks noted above, I think the most compelling stories are probably the niche software providers in non-sexy businesses, like Procore in construction and Aspen in industrial and utility electricity management… but lots of investors agree, apparently, because those stocks are also valued as if they’re going to grow a lot faster than analysts currently expect, so it would take some digging to decide if that’s a worthwhile row to hoe.

Chennai Investment