C3.ai (NYSE: AI) The artificial intelligence (AI) investing trend has made it a fairly popular stock, and as it’s one of the few companies focused almost exclusively on AI, it’s on the radar of many investors.
However, if you’re considering investing in C3.ai, we recommend taking this one red flag into consideration, which could help you avoid some heartache down the road.
C3.ai’s growth is strong and accelerating
Growth investors like growing earnings, but all companies need to be able to make a profit and return value to shareholders. When a company is still growing rapidly, investors ignore unprofitable situations because they know that one day they will be profitable.
C3.ai is in this group, having recorded solid growth over multiple quarters: It forecast total revenue of 20% year-over-year growth in the fourth quarter of fiscal 2024 (ending April 30) and 23% revenue growth in fiscal 2025.
But my concern lies a few lines down in the sales report: C3.ai’s spending is out of control.
C3.ai’s profits are nowhere to be seen
After deducting cost of goods sold, C3.ai’s gross profit was $51.6 million. Therefore, in order for C3.ai to break even, its expenses would have to be less than this number. Unfortunately, it wasn’t anywhere near that amount.
C3.ai reported operating expenses of $134 million in the fourth quarter, translating into an operating loss of $82.3 million. On fourth-quarter revenue of $86.6 million, C3.ai posted a loss of nearly $1.2 billion. double That revenue.
No domestic financial advisor would advise you to spend twice your annual income, but that’s exactly what C3.ai is doing. To cover this expense, C3.ai is burning through its cash reserves and compensating employees with stock.
Stock-based compensation is a non-cash expense because C3.ai can essentially create this currency out of thin air. In the fourth quarter, C3.ai’s stock-based compensation expense totaled $56.7 million, or 66% of revenue. That’s a huge amount of money, and a blow to shareholders, who are essentially footing the bill for C3.ai’s employee compensation.
When a company continually issues shares, it dilutes the equity of existing shareholders, a mechanism similar to how inflation occurs when an issuing government continually prints new money.
This effect can be seen in C3.ai’s share count: People who bought shares in the 2020 IPO have much less control over the company than they did before, as C3.ai pumped additional shares into the market.
It will take C3.ai years to get out of this predicament. If the company makes no changes to its expenses, it would need to increase revenue by $82.3 million to break even. At C3.ai’s current projected growth rate of 23%, it would take more than three years to reach that level.
It’s unlikely that C3.ai’s expenses will remain stagnant over that period, and its calculations assume gross margins will grow at a similar rate, which is unrealistic.
Given that C3.ai has a gross margin of 60%, it would take $223 million in quarterly revenue for the company to break even, which would take a long time, at 23% growth over four and a half years.
So if you are considering investing in C3.ai, you should understand that the company is not profitable at all and will take years to break even. I am not comfortable with its risky financial strategy, so I will not buy C3.ai stock.
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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool recommends C3.ai. The Motley Fool has a disclosure policy.
1 warning sign for C3.ai stock investors should know about was originally published by The Motley Fool.
