MW Fund managers see AI delivering big gains for these 5 stocks - including Duolingo
By Michael Brush
These innovative companies are using artificial intelligence in ways that can boost earnings growth
It's fashionable nowadays to be skeptical about artificial intelligence (AI). Few, if any, companies are using it to make money, the naysayers cry. This will all change next year, Morningstar analyst Brian Moriarty recently told investors. More companies will be using AI to boost growth, he explained.
But in reality, this is already happening.
To find some of the best examples of cutting-edge companies using AI to boost growth, I turned to Baron Capital, manager of the Baron mutual fund family. Many of the firm's funds outperform because of accurate calls on cutting-edge technology.
Here are five companies Baron portfolio managers singled out in recent interviews for their deployment of AI to boost growth.
1. Duolingo: Duolingo $(DUOL)$ has cracked the code on how to make money teaching foreign languages online. AI is at the core of its spectacular growth. The company currently offers online courses in more than 40 languages to more than 100 million people. Third-quarter monthly active users grew 36% to 113 million from 83 million a year earlier. Meanwhile, paid subscribers grew 47% to 8.6 million from 5.8 million. Sales grew 40% to $192.6 million.
One reason why growth is so robust is "Lily" - an AI-powered, purple-haired, sassy cartoon character who language students practice conversation with. AI helps the conversation feel realistic and spontaneous. Lily even remembers things students told her in the past, which helps make the experience feel more personal. Lily even adjusts to users' skill level.
Duolingo also uses AI to power a feature called "Birdbrain," which adjusts lessons and exercises to student proficiency. "It helps select the right exercise for the user and tailor the lesson accordingly," says Ashim Mehra, a portfolio manager who likes the company and holds it in his Baron Technology Fund BTEEX.
Duolingo founders Luis von Ahn and Severin Hacker have a background in machine-learning research at Carnegie Mellon University, so using AI comes naturally to them. "They understand where the industry is going and how to use AI in their products," Mehra says.
2. Axon Enterprise: Police officers can spend much of their time on administrative tasks like writing reports. Axon $(AXON)$, the company that sells body cam equipment and tasers, now uses AI to reduce that time significantly. Axon deploys AI to mine body-cam audio and GPS data to write rough drafts of incident reports. Axon says the product, called Draft One, cuts report writing time in half; rough draft reports, for example, are available within five minutes after recordings end. Demand for the product was strong from the outset, Mehra says.
Axon also bundles Draft One with offerings to promote its "AI Era" bundle of AI-powered services. The company uses AI to help read license plates and then mine databases for relevant data. Its AI helps flag videos for review by supervisors, and automatically redacts parts of videos such as screens and license plates.
"Our customers are as excited as we are about what's ahead. There's no place where this is more clear to me than the area of artificial intelligence," Axon CEO Patrick Smith told analysts on the company's most recent earnings call. "The interest is immense."
Besides growth spurred by AI-related services, Mehra sees strong potential demand abroad and from sectors beyond law enforcement, such as retail and health care.
3. Kratos Defense & Security Solutions: This defense contractor sells components and software used in the Patriot missile interceptor and Iron Dome, and in satellites and spacecraft.
Kratos $(KTOS)$ also sells high-performance drones, and this is where AI comes in. Kratos' "threat representative target drones" help pilots train, by acting like enemy aircraft. In combat, the Kratos XQ-58 Valkyrie drone can serve as a wingman to carry out tasks like scouting, firing on the enemy, or taking enemy fire.
AI systems in these drones crunch data from radar, sensors, and GPS systems, and follow rules of engagement to maneuver and make quick decisions. "AI is a way for systems to take a massive amount of information and distill it into actionable intelligence," says Randy Gwirtzman, portfolio manager at Baron Discovery Fund BDFFX.
Kratos has a record backlog and pipeline potential worth $12 million, CEO Eric DeMarco said on the company's most recent earnings call. For context, current revenue is about $1.2 billion per year. Gwirtzman says Kratos can triple annual revenue to $3.5 billion by 2029. This could double the stock price from here, he predicts.
4. SentinelOne: AI helps SentinelOne's $(S)$ Singularity Platform cybersecurity system quickly ingest data in real time to identify and defeat cyberattacks faster than humans can.
This security software platform is popular. SentinelOne posted 28% third-quarter sales growth in early December and boosted sales growth guidance for the current year to 32% from 31%. It cited a strong pipeline of potential business.
Gwirtzman says SentinelOne has solid growth potential because its share currently is about 2.5% of a $30 billion security-software market. Gwirtzman expects annual sales to grow to around $2.3 billion in 2029 from under $1 billion this year. This could potentially double the stock from here.
5. Tempus AI: Tempus AI $(TEM.UK)$ uses AI to improve medical diagnoses. The company deploys AI to sift through a broad array of patient data, clinical trial results, genomic data, other patient outcomes to draw more insights from laboratory tests. The result is what it calls Intelligent Diagnostics, which can provide personalized and effective treatment. "Unlike traditional diagnostic labs, we can incorporate unique patient information, such as clinical, molecular, and imaging data, to make our tests more intelligent," the company reports in filings.
Tempus started off using this approach in oncology, and has since branched into neuropsychiatry, radiology, cardiology, and infectious diseases. It also sells its databases to companies doing drug research.
Tempus posted 33% third-quarter sales growth, to $180.9 million. It also announced an agreement to buy a hereditary screening company called Ambry Genetics, which it has been using as a lab. Gwirtzman thinks the acquisition will help Tempus grow annual sales 20%-25% a year to almost $3 billion in 2029, which could produce a stock double.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned DUOL, AXON and S. Brush has suggested DUOL and AXON in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks
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-Michael Brush
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December 23, 2024 07:41 ET (12:41 GMT)
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