Artificial intelligence (AI) took the world by storm last year and has investors pumped up for how it can change everything. OpenAI's ChatGPT (owned by Microsoft) and Google's Bard (owned by Alphabet) were released almost a year ago and provided an early glimpse of how AI can shape the future. Wedbush analyst Dan Ives has called AI the fourth industrial revolution and said the technology will transform the tech space over the next two to three decades.
While AI can change life as we know it, it's still in the early stages of deployment as companies fine-tune their models. With that said, three AI stocks with tremendous long-term potential are Upstart Holdings(NASDAQ: UPST), Lemonade(NYSE: LMND), and Digital Realty(NYSE: DLR). Before buying, here's what you should know about these companies' AI opportunities and possible risks.
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1. Upstart leverages AI to make lending more accessible
Upstart's goal is to ensure the lending system is fair and open to everyone. One pain point it aims to solve is providing people previously shut out of the financial system with borrowing opportunities.
The company believes that FICO credit scores designed by Fair Isaac in 1989 fail to identify risk accurately because of their simple rules-based systems that only consider a limited set of variables. To solve this problem, Upstart utilizes AI to evaluate 1,500 variables and over 44 million repayment events to assess customer risk more accurately, allowing it to approve more loans at lower interest rates.
Investors must remember that Upstart operates in a highly cyclical consumer lending market. Over the past couple of years, demand for consumer loans by both consumers and banks has become constrained due to the higher interest rate environment. Not only that, but delinquencies on consumer loans are slowly ticking higher, and Upstart's lending models could face a big test in the near term.
The company has expanded its model to chase a $3.6 trillion lending market opportunity across personal, automotive, home, and small business lending. According to a report by Allied Market Research, the global personal lending market alone could balloon to $719 billion by 2030 -- a 32% growth rate annually. If Upstart's models can ride out these near-term headwinds and prove they perform better than legacy lending models, its long-term potential is staggering.
2. Lemonade uses AI to streamline insurance buying and claims processing
Lemonade aims to streamline insurance with its AI models, from shopping for policies to processing claims. The company leverages AI to create personalized quotes, reduce customer onboarding time, and expedite customer claims.
The AI-powered insurance company is going through growing pains right now. In recent years, it has expanded from renters' insurance into homeowners, pet, life, and automotive insurance. The company has achieved impressive growth, but that has come at the cost of higher losses on its policies and it continues to be a money-losing operation.
It had done a good job improving its net loss ratio, which is the ratio of losses plus adjustment expenses, minus amounts paid to reinsurers, to its net premiums collected. However, it must continue dialing in its models as it gathers more data and adjust its premiums accordingly.
According to a report by Global Market Insights, the property and casualty market is expected to grow 5.5% through 2032. If Lemonade can achieve consistently profitable policies, its growth, coupled with industry tailwinds, could power excellent long-term growth for the company.
3. Digital Realty provides essential infrastructure for AI developers
Digital Realty differs from Upstart and Lemonade because it is a more stable business that caters to companies creating AI products. As a real estate investment trust (REIT), Digital Realty provides companies with colocation, interconnection, cloud services, and other solutions. The company has 316 data centers across 25 countries, focusing on regions with major internet and data communication hubs.
The company benefits from the growing demand for data centers in the ever-expanding digital economy. As the amount of data grows exponentially and AI becomes more prevalent, companies will need more data centers to keep up with this growth. According to a study by McKinsey & Company, demand for data centers will grow by 10% annually through 2030 -- putting Digital Realty in an excellent position to capitalize long term.
Investor takeaway
Digital Realty is a more established business, and the runway for growth is solid. As demand for data centers grows, Digital Realty should grow with it.
Upstart and Lemonade, on the other hand, face a little more risk in the near term. These companies will need time and more data points across different economic environments to dial in their models, and the stocks will likely continue to experience volatile moves as they figure things out.
Investors should understand these are higher-risk stocks, and consider the risk-to-reward ratio to decide if they are appropriate. With that said, if things go right, the long-term possibilities for these AI-driven companies are excellent.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Courtney Carlsen has positions in Alphabet and Microsoft. The Motley Fool has positions in and recommends Alphabet, Digital Realty Trust, Lemonade, Microsoft, and Upstart. The Motley Fool has a disclosure policy.
