These two disruptive small-caps can deliver big returns for investors.
Breakthroughs in artificial intelligence (AI) technology are transforming various industries. Innovations from mega-cap tech leaders like Nvidia have opened the door for emerging companies to capture their slice of a significant market opportunity.
BigBear.ai (BBAI 1.34%) and SoundHound AI (SOUN) are two small-caps attempting to leverage unique AI-powered applications into long-term growth. Let’s explore which stock could be a better buy for your portfolio.
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The case for BigBear.ai
BigBear.ai is developing a suite of proprietary machine learning and computer vision technology into a platform of AI-driven analytical tools.
Solutions covering cybersecurity, supply chains & logistics, and autonomous systems have found success with government and commercial markets. The company’s advanced facial recognition and image-based threat detection are in use at major airports around the world. BigBear.ai also counts on the U.S. Department of Defense as a customer for its ConductorOS platform.
Ultimately, the attraction of BigBear.ai as an investment is the potential that the company can consolidate its leadership in these specialized areas of AI.
On the other hand, the operating and financial results have been marred by weaker-than-expected momentum. In the second quarter (for the period ended June 30), BigBear.ai revenue of $40 million climbed by just 3.4% year over year, impacted by the timing of certain large contracts.
The other challenge is that profitability remains elusive. The company reported a loss on Q2 adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $3.7 million, expanding from a loss of $3.2 million in the year-ago period. BigBear.ai also has more than $134 million in net debt without a clear path for generating free cash flow anytime soon.
Those headline numbers aren’t great, but there are still enough positives in the outlook for investors to stay upbeat on the stock. Favorably, Q2 revenue was up 20% sequentially from the first quarter, while management is guiding for full-year revenue growth of around 11% from 2023 with an effort to improve margins going forward.
What I like most about BigBear.ai is its pure-play exposure to AI in a cutting-edge corner of the technology. The stock is trading at just 2 times its 2024 revenue guidance as a forward price-to-sales (P/S) ratio. This modest level, reflecting the risks associated with poor earnings trends, could prove to be a bargain if the company begins generating stronger and more profitable growth.
The case for SoundHound AI
SoundHound AI has emerged as a leader in conversational artificial intelligence dealing with speech-enabled applications for people to interact with smart devices. The technology is integrated by automakers for in-vehicle voice commands and generative AI as a core part of its business.
The company has also expanded into the food service industry, including AI voice-enabled point-of-sale interfaces that fast-food restaurants are increasingly adopting. Earlier this year, SoundHound acquired Amelia, an enterprise AI software specialist, to accelerate the company’s customer service solutions, such as virtual call center automation. Indeed, the company’s strong point is its diverse portfolio of disruptive offerings.
Compared to BigBear.Ai, the trends from SoundHound AI have been much more impressive. The company reported 54% revenue growth in the second quarter (for the period ended June 30) with management citing strong customer momentum across its key industries.
The company expects 2024 revenue growth of around 77%, with an initial forecast for 2025 of $150 million, implying an even stronger 88% growth rate next year.
At the same time, investors are faced with paying a lofty premium for shares while SoundHound AI remains unprofitable. The company reported negative $13 million in Q2 adjusted EBITDA with negative free cash flow expected to continue for the foreseeable future. In this case, the stock is trading at 20 times its full-year revenue forecast as a forward P/S ratio, which only modestly narrows to 11 based on the 2025 revenue estimate.
It appears the market is pricing in a growth runway through the next decade, which could be justified based on the opportunity, but also creates a high level of expectations. That tricky balance adds to the risks SoundHound AI investors must consider.
The better buy: SoundHound AI
There’s a lot to like about BigBear.ai and SoundHound AI, which may both be in the early stages of transformational growth. Recognizing the speculative nature of these two small-caps with an expectation for volatility, I believe SoundHound AI is the better stock to buy today. Its lofty valuation is justified by the company’s stronger growth prospects.
A position in SoundHound AI stock within a diversified portfolio could work for investors with a long-term time horizon.
