Artificial Intelligence, also known as AI, is all the hype in 2024. In the most basic terms, AI is a technology that enables computers and machines to simulate human intelligence and problem-solving capabilities. In other words, it is a computer that can learn and get smarter. AI can help us do our jobs more efficiently and even replace our jobs in some cases. AI is intimidating because its capabilities are very much unexplored as I write this article. We are only seeing the tip of the iceberg of what this technology is capable of.
Leveraging AI to Increase Revenue
So how and why is AI making companies more valuable in the eyes of investors? Essentially, the belief is that companies that can leverage AI will be able to increase revenues while simultaneously reducing costs required to produce those revenues, creating a double windfall. Let’s look at an example.
Let’s assume a company is currently valued at $200 million and growing at about 20.0% per year with its newly implemented AI technology. In addition, the company can increase gross profit and reduce its expense ratio (total operating expense to sales) from 10.0% of revenue to 9.0% of revenue over the next five years due to AI efficiencies. Financial data is provided below.
The question remains; why are investors willing to pay 20.0x EBITDA today for a company with AI potential? Seems expensive, doesn’t it? If you pay attention to the Implied EBITDA Multiples in 2025 through 2028, you will notice a downward trend. As the company continues to leverage AI, increasing revenue while simultaneously decreasing expenses, profit is driven higher, resulting in a lower multiple in the future.
In essence, an investor is willing to pay 20.0x today knowing that on a forward basis, it is equivalent to paying 6.82x EBITDA in five years. Now this seems cheap, doesn’t it? Growth in revenue and profitability makes companies relatively cheap today assuming minimal risk of the growth coming to fruition.
Should Business Owners Invest in AI?
Should I invest in AI? How many business owners are asking this question right now? The answer should be all of them. The time may not be right for your company, but at a minimum, you should be prepared to invest in AI at some point in the future. Let’s look at some of the AI first movers and how it has impacted their valuations over the recent period.
A summary of growth metrics and market multiples for some of the top high-flying AI companies in 2024 is provided below.
As can be seen in the table above, revenue growth is off the charts with average growth at 32.3% and 24.0% for the most recent (TTM) and next (TTM+1) trailing twelve-month periods, respectively. Even more noteworthy, average EBITDA growth is 80.0% and 68.9% for the TTM and TTM+1 periods, respectively, illustrating these companies’ ability to leverage AI to increase efficiency and lower costs while simultaneously increasing revenue. The double windfall is in play for these companies. As a result, market multiples are driven higher, as can be seen in the table below.
No words are needed to explain the chart above. Revenue and EBITDA multiples are at extreme levels, driven by expectations for AI-based growth. Notice the negative trend in market multiples from the TTM to the TTM+1 period? I reiterate, future growth makes companies relatively cheap in today’s dollars.
Conclusion
AI is and will continue to be a driving force of the market in 2024 and beyond. I’ll leave you with a thought from the great band, Creed: “Can you take me higher? To a place with golden streets. So let’s go there. Yeah, let’s go there. Come on, let’s go there.”
Can the market go higher with AI wind behind its sails? I can’t say yes or no, but ask yourself, “why not”?
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