When it comes to investing in artificial intelligence (AI), there are no other stocks that garner more attention than the "Magnificent Seven." While each of those megacap tech giants presents a unique opportunity in the AI space, smart investors understand that there are other options.
Steven Cohen of Point72 Asset Management made a pretty big statement during the third quarter, having purchased 2.2 million shares of social media stock Reddit (RDDT -1.81%) -- increasing the fund's stake by a whopping 3,172%.
I understand if Reddit isn't on your radar as an AI stock. But below I'm going to explain how the company is carving out a pretty lucrative pocket for itself in the AI realm and assess if now is a good opportunity to follow Cohen's lead and scoop up some shares.
Why is Reddit a compelling AI opportunity?
Reddit is an internet forum on which users can ask questions on just about any subject matter and receive answers from contributing members. On the surface, this sounds a lot like any other social media platform. And in some ways, you'd be correct in that assessment. Similar to dominant forces in social media such as Alphabet and Meta Platforms, Reddit's primary source of revenue comes from advertising.
However, the company recently dove into the AI pool and so far has witnessed quite a bit of success. Over the last couple of years the world has been introduced to a number of large language models (LLMs), with ChatGPT being the most widely recognized. While each LLM tries to differentiate itself in terms of what it's capable of doing, these models all share one common stitch: the need for data.
In other words, an LLM in and of itself is somewhat commoditized. What separates the superior models from the rest of the pack is how data is fed into the LLM, and what the model can make from this information. As AI workloads continue to scale and generative AI applications become more complex, businesses are going to need to increase investment into data protocols for training their LLMs. This is where Reddit enters the scene.
Reddit is striking licensing deals with other companies who want access to its user data via its deep library of different forums. During its third-quarter earnings call, Reddit Chief Operating Officer Jennifer Wong referred to the company's data licensing strategy as an "evolving landscape." For now, this assessment makes a lot of sense. AI is in its early days, with most businesses still figuring out how the technology best fits into their growth strategies -- including enhanced productivity, better marketing campaigns, and more.
In my eyes, the real power for Reddit is to increase its own user base and engagement metrics -- something the company is already demonstrating it can do, underscored by rising numbers of daily active users and higher average revenue per user (ARPU).
By bolstering its user base and acquiring even more data, Reddit could theoretically command higher prices for its data library in the long run -- thereby turning its AI licensing deals into a more significant source of growth.
Image source: Getty Images.
Is Reddit stock a buy right now?
Valuing Reddit stock is a pretty challenging exercise. The company went public earlier this year and since its initial public offering, shares have experienced quite a bit of volatility.
RDDT PS Ratio data by YCharts
Even though Reddit is generating positive net income and free cash flow, the company's profitability metrics are relatively small and it's not yet clear if this will be a consistent dynamic. For this reason, I've chosen to value Reddit using the price-to-sales (P/S) ratio.
Per the graph above, Reddit stock has experienced some obvious valuation expansion over the last couple of months, and its current P/S multiple of 19.1 is hovering near all-time highs. I think investing in Reddit right now carries some risk, as the stock appears to be experiencing some prolonged momentum.
Despite its pricey valuation, Reddit is still very much worth monitoring. I think the company is onto something with its data licensing model, and see this as a long-term growth engine considering the ongoing need for data to train AI models.
While the stock may not be a good buy at its current price point, I'd encourage investors to keep Reddit on their radar and consider dollar-cost averaging into the stock over time.
