C3.ai (NYSE: AI) has become a fairly popular stock due to the artificial intelligence (AI) investing trend . Because it's one of the few companies that is nearly a pure-play investment in AI, many investors have taken a look at it.
However, if you're considering investing in C3.ai, I'd urge you to consider this one red flag, as it could save you from heartache in the future.
C3.ai's growth is strong and is picking up speed
Although growth investors love to see revenue increase, all companies need to be able to turn a profit and return value to shareholders. When a company is still rapidly expanding, investors are willing to look past unprofitability because they know a day will come when profits eventually occur.
C3.ai falls into this camp, as it has posted solid growth for multiple quarters. In its fourth quarter of fiscal year 2024 (ended April 30), its total revenue rose 20% year over year, and it gave guidance for revenue to grow 23% in fiscal year 2025.
However, my red flag lies a few rows down on the operating statement: C3.ai's spending is out of control.
C3.ai's profits are nowhere in sight
After subtracting the cost of revenue, C3.ai had a gross profit of $51.6 million. So, if C3.ai were to break even, its expenses had to be less than this figure. Unfortunately, they weren't even close.
In Q4, C3.ai had operating expenses of $134 million. That equates to a loss from operations of $82.3 million . With revenue of $86.6 million in Q4, C3.ai spent nearly double its revenue.
No financial advisor in the country would tell you to spend double what you make in a year, but that's what C3.ai is doing. To fuel this spending, C3.ai is burning its cash on hand and compensating its employees with stock.
Stock-based compensation is a noncash expense because C3.ai can create this currency essentially out of thin air. In Q4, C3.ai's stock-based compensation expenses totaled $56.7 million, or 66% of revenue. That's a massive amount and hurts shareholders, who essentially end up footing the bill for some of C3.ai's employee compensation.
When a company continuously issues shares, it dilutes existing shareholders. This mechanism is similar to how inflation works if the issuing government continuously prints new money.
You can see this effect with C3.ai's share count. Anyone who bought shares in the 2020 IPO now controls much less of the company than they once did because C3.ai has flooded the market with additional shares.
AI Shares Outstanding data by YCharts
It will take many years for C3.ai to dig out of this hole. If the company didn't change any of its expenses, its revenue would need to increase by $82.3 million to break even. At C3.ai's current projected 23% growth rate, it would take over three years to reach that point.
I doubt C3.ai's expenses would stay stagnant over that time, and that calculation also assumes its gross profit would increase at a similar speed, which isn't realistic.
If you factor in C3.ai's 60% gross profit margin, then C3.ai would need $223 million in quarterly revenue to break even. That's four and a half years of growth at a 23% pace, which is a long time to wait.
So, if you're considering investing in C3.ai, you must understand that the company is deeply unprofitable and will take years to break even. I'm not OK with that risky financial strategy, which is why I'm passing on C3.ai stock.
Keithen Drury has no position in any of the stocks mentioned. The Motley Fool recommends C3.ai. The Motley Fool has a disclosure policy .
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