C3.ai (NASDAQ:AI), an artificial intelligence (AI) software company, produced stellar fiscal second-quarter (Q2) earnings on Dec. 1 for the quarter ended Oct. 31, 2021. As a result, AI stock is now worth substantially more than its trading price, which has been falling.
For example, as of Jan. 25, AI stock closed at $23.97, giving it a terrible performance both so far this year, as well as last year.
After going public at $42 in Dec. 2020, it closed 2020 at $138.75. But by the end of 2021, AI stock had fallen to $31.25, giving it a 2021 performance of negative 77.5%.
Moreover, the stock had a recent peak of $53.11 on Sep. 1, but this means it had tumbled by 41% in Q4 2021. It also shows that during 2022, AI stock is down from $31.25 to $23.97, or around 23% lower year-to-date (YTD).
So, what is going on here? Is the company going out of business? That seems to be what the stock price performance implies. The truth is very far from that. The company’s business is growing.
Where Things Stand At C3.ai
C3.ai had a stellar quarter ending Oct. 31. The company said:
“Total revenue for the quarter was $58.3 million, up from $41.3 million one year ago, an increase of 41% year over year, exceeding company guidance and sell-side analysts’ expectations.”
Most of this came from its software subscription revenue, which was $47.4 million, or 81.3% of its total sales. That revenue grew 32% year-over-year (YOY).
Moreover, the company raised its guidance from $248 million to $251 million for the year ending Apr. 30, 2022. This is up from its prior guidance of $243 million to $247 million in the prior quarter.
So, it raised its forecast by about $5 million, or about 2% more. This also implies a 36.2% growth rate over the $183.22 million C3.ai posted in April 2021.
This has allowed analysts to upgrade their forecasts for 2022 and 2023. For example, now, according to Seeking Alpha, 10 analysts foresee $332.79 million in revenue for the year to April 2023.
That implies a sales growth rate of over 33% over their average $249.5 million forecasts for the year to April 2022. This is a significant growth rate, akin to the 36% sales growth rate that is likely to occur for the year ending April 2022.
In other words, not only does the company have steady recurring sales from subscription software, but that revenue is rising on a steady growth rate of between 33% to 36%. This is ideal for analysts since it allows them to forecast revenue far into the future and then bring it back to present value.
What C3.ai Stock Is Worth
For example, let’s assume that C3.ai can grow its revenues at an average of 30% annually over the next five years. That is slightly lower than its present growth rate, but we assume that the law of large numbers will slow the growth rate down.
That implies that by the end of five years, due to the compounding effect, revenue will be 3.71x today’s price. For example, if we multiple 30% by 5, we would expect revenue would be just 1.5x higher. But due to the compounding effect, or what analysts call a “geometric progression,” the final number is twice as high as expected.
This means that by the end of five years, C3.ai’s revenue will be 3.71x $249.5 million, or $925.6 million.
By the way, if we tweak this growth rate just a little, say to 33% annually up from 30%, the effect is highly leveraged. That will raise the geometric multiplier to 4.16, or 31% higher over five years, even though the difference between 33% and 30% is only 10%. It also raises the forecast for C3.ai’s revenue to over $1 billion, or $1.037 billion.
Therefore, we can roughly estimate that C3.ai will have close to $1 billion in revenue by the end of five years. But its market value today is only $2.56 billion, or 2.67x this. That does not seem too expensive.
What to do With AI Stock
Assuming that the stock should be worth 5x sales in five years, this would give it a $5 billion future valuation. Now, if we bring this back to its present value, using a 10% discount rate, the present value will be 62% of that number. That gives it a value of $3.1 billion today, or 16% higher than today (i.e., $3.1b/$2.67b).
Moreover, at 10x sales, the future value would be $10 billion, or $6.2 billion today. That would be over 232% of today’s price. This means that the stock should be worth more than today, anywhere from 16% to 132% more. That works out to an average annual return of between 3% to 18.3% annually for AI stock.
In other words, despite today’s weakness, look for AI stock to do quite well over the next five years.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.