“The Motley Fool is shining a spotlight on what looks like ‘The Holy Grail of AI Sleeper Stocks’ ready to rise and roar to potentially meteoric gains… And we’re inviting YOU and an extremely select group of growth-hungry investors to follow along trade-for-trade!”

That’s the lead-in to the latest sales pitch from the Motley Fool Canada folks, selling their Microcap Mission subscription (C$1,299/yr, no refunds), and the pitch is that they’ve got a special report about those “Holy Grail” AI stocks. So what are they? We’ll put the Thinkolator on the task and get some microcap A.I. names for you… but first, here’s some of the big-picture pitch:

“It sure seems like anything AI touches turns to gold… especially when you consider the fact that AI single-handedly helped fuel a $4 TRILLION rally in tech stocks this year.

“The problem is many investors missed out on that first wave of the AI gold rush altogether.

“Maybe you were skeptical of all the AI ‘hype,’ or maybe you just didn’t know which stocks to pick.

“Even if you were fortunate enough to get a piece of the action, I’ll bet you wouldn’t mind knowing what the next Nvidia could be.

“Well, you probably won’t find it in the mid or large-cap market.

“Those stocks like Nvidia and C3.ai I just mentioned were the obvious choices for investors looking to ride what’s been an all-out AI heatwave this year, but if you ask me, those gains have already topped.

“The microcap market could be ‘The Holy Grail of AI Sleeper Stocks’ ready to rise and roar to potentially meteoric gains.

“See, microcaps as a whole are historically cheap right now.

“The data is even more shocking when you look at how much the Russell Microcap Index is down since its peak in 2021… it’s down a whopping 40%!”

That’s true, the microcap index is still in a pretty ugly bear market, having given up all of that group’s gains since late 2017. Believe it or not, though, the big tech stocks have now pretty much fully recovered from the 2022 bear market — the Nasdaq 100 is back within a whisker of the 2021 peak, thanks largely to the surge of AI enthusiasm earlier this year.

Of course, a lot of junk and smaller stuff has not recovered, the Russell 2000 small cap index is down, too, still about 25-30% below the 2021 highs, depending on which day you measure. And to be clear, “microcap” doesn’t necessarily mean a stock is all that small, these aren’t necessarily little junk penny stocks — the average market cap for that index, which includes the 1,000 smallest companies in the Russell 2000 plus the next 1,000 companies who are too small for the Russell 2000 (but otherwise would qualify), is about $600 million.

More of the Fool’s pitch:

“There could be a potential GOLD MINE hiding in plain sight with these microcap stocks!

“Now, if you’re a microcap investor, you’re already ahead of the game. Maybe you’ve seen firsthand what a single microcap stock can do for a portfolio.

“You also probably know that these are often the UNloved, UNDERestimated, UNDERvalued, and often completely UNknown companies.

“They’re the sort of stocks that Warren Buffett himself, arguably the world’s most successful investor of all time, said he thinks he ‘could make you 50% a year on $1 million. No, I know I could. I guarantee that.’

“Microcap Mission, our Motley Fool Canada team is walking investors through the microcap minefield and shining a spotlight on what we see as diamonds in the rough.

“What exactly is our mission?

“10X returns — NOT altogether average (albeit respectable) 10% gains.

“Microcaps headed for the moon — NOT run-of-the-mill “safe” plays.

“Diamonds in the rough — NOT penny stock pipe dreams bound to crash and burn.

“Will there still be risk? You bet.

“Will some stocks end up being a dumpster fire? Quite possibly….

“Some of these microcaps will fail, but our goal is that others will pick up the slack and then some.

“You don’t get an omelette without breaking a few eggs, and you don’t get the 10 or 20-baggers of the world without going through a few stinkers along the way.”

That’s pretty typical Motley Fool thinking, it’s not restricted to their “microcap” offering — buy a bunch of growth stocks, hold on for a long time, and the 1,000%+ winners will more than make up for a bunch of 90% losers. “Losing is part of winning” is a key to their philosophy, and if you have a big enough sample size it has worked well for their big newsletters.

Back to the tease:

“… what do you get when you cross historically cheap microcaps with a surging AI bull market? If you ask me, you get a bona fide powder keg that’s ready to blow.

“We’re convinced that the microcap market could be ‘the holy grail of AI sleeper stocks’ ready to rise and roar to potentially meteoric gains.”

OK, so that’s the basic argument — AI is surging, microcap stocks still are beaten down and haven’t kept up with the bigger stocks in this recent recovery, and therefore the big winners of AI who haven’t been tapped yet are likely to be the tiny stocks that aren’t as closely followed. I’d quibble with the “microcaps are historically cheap” argument — they’re not necessarily objectively cheap in terms of their price to sales or price to earnings valuations, they’re just still “beaten down” relative to the broader market. Many of the small cap indices are trading near their historic lows in terms of valuation, and the S&P 500 is recently at about a 20-year average when it comes to forward PE, but for the Russell 2000 the forward PE is still quite high, near 30, so it’s way down from where it was in 2021 but it’s also well above where it was most of the time from 2000-2014 (we don’t have good forward estimates for the Russell Microcap, which doesn’t have as much analyst coverage — I pulled those other numbers from Yardeni, in case you want to check out the data).

But anyway, which “A.I. Microcaps” does the Motley Fool like? They tease three of them…

“Inside are a carefully selected group of microcap ‘sleepers’ – as small as a $65 million market cap – that we believe are leveraging AI in innovative ways that could meaningly impact their businesses for the better.

“Not to mention potentially generate explosive gains for early shareholders.

“Here’s a little preview of the sort of stocks you’ll find inside…

“Microcap AI Sleeper No. 1: A founder-led fintech company based in Toronto and powered by proprietary AI technology which has led to triple-digit revenue growth this year along with increasing profits. The icing on the cake is that insiders own nearly 50% and the company even pays a ~5% dividend!”

That’s a repeat of the one they included in their much lower-cost “AI Disruption Handbook” pitch that we covered last week, here they’re teasing a little company called Propel Holdings (PRL.TO, PRLPF).  The story hasn’t really changed in the past few days since we “revealed” that stock for the first time, and the stock price is essentially the same, so I’ll just repeat what I noted then:

Propel is a “fintech” company that’s trying to improve the lending business, working with their AI platform and banking/lending partners to provide loans and lines of credit to consumers in the US and Canada. This can be a scary sector, as we’ve seen with other “different way of managing credit” companies in the past, like Upstart, LendingClub or SoFi, most of which have meaningfully changed their business model along the way (or failed completely), but so far Propel’s performance looks pretty exceptional.

They just reported their third quarter numbers (presentation here), and they keep adding new customers, earning a good yield from their customers and, they say, getting more selective with their credit risk exposure… so their revenue and income still look very impressive, despite the fact that they assume (and see) a very high volume of “charge-offs” (12% of loan balances) and maintain high provisions for loan losses and liabilities (more than 50% of revenue).

It would take quite a bit more research to get me comfortable with this company, I imagine, but on the surface it looks pretty impressive and very cheap — $300 million market cap, valued at about 10X earnings and only about 4X forecasted 2024 earnings, with a dividend yield of about 5% (and they’re increasing the dividend by 5% next quarter). At that very low valuation, I would assume that investors are worried about the creditworthiness of their customers, who are mostly lower income folks who live paycheck to paycheck and have been clobbered by inflation (sorry, paycheque to paycheque… this is Canada), and perhaps are concerned about any squeeze in Propel’s net interest margin — they don’t carry all the loans they facilitate on their books, but they do have some of their own debt, and the cost of that debt (13% or so) is rising.

The Canadian Fools also included Propel in their “top Canadian fintech stocks” last year, and had started to recommend it (and own it) by May.

“Microcap AI Sleeper No. 2: A tiny cloud-based platform based in BC that’s seen its stock get beaten down since its IPO a couple of years ago, but that is turning the corner on profitability and is sitting on well over $100 million of cash – almost as much as the entire market cap of the company! Plus, its recently released catalogue of AI-driven tools are just the beginning of what this company could accomplish with this powerful new technology.”

This one is indeed tiny, and it’s a new one for me — here they’re almost certainly teasing Thinkific Labs (THNC.TO, THNCF), which does have more than C$100 million in cash, thanks to the fact that they went public in 2021 at a much richer valuation (and raised about C$175 million, at C$13/share… the stock is now down around C$2.50). To their credit, they have not burned through the cash as fast as some startups, and they are actually very close to break-even as of last quarter, they had positive cash flow from operations, so they could conceivably be profitable by next year if they stay on this path.

And, yes, they did just release a suite of AI tools for their users a few months ago… so what is it that Thinkific actually does? Here’s how they describe themselves.

“Thinkific makes it simple for Creator Educators and established businesses of any size to scale and generate revenue by teaching what they know. Our Platform gives businesses everything they need to build, market, and sell digital learning products – from courses to communities – and to run their business seamlessly under their own brand, on their own site. Thinkific’s 50,000+ active creators earn hundreds of millions of dollars in direct course, membership and community sales while teaching tens of millions of students.”

So… another way for the “Creator Economy” folks to monetize their brands and their following, it appears, by selling online courses and tutorials.  I know that there are lots and lots of companies in this space, and Thinkific is very small, so that’s probably the biggest risk to the business, we’d have to understand it a lot better to make an educated guess about whether or not they have any real sustainable advantage… but they are showing some signs of steadily building their customer base and moving more of their customers onto their own payments platform, so it looks like they’re moving in the right direction.

Right now, kind of like Shopify when they were very small, most of their revenue comes from subscriptions, which is the money they earn from the developers of online courses — so if you’re a creator trying to monetize your TikTok followers, you might pay Thinkific a couple hundred bucks a month, for example, to help you develop and host your custom courses or training programs, with web and mobile interfaces… but the more scalable part of the business, if it is able to really take off and recruit more successful “creators”, might be the commerce revenue, which is basically what they earn by helping their “teachers” collect and process payments.  That part is quite small right now, and it’s much lower-margin than subscriptions, many of which are probably paid by creators who fail to build a market for their online products and eventually give up, but payment processing and those kinds of ongoing fees (sales tax management, etc.) is very scalable, and right now it’s by far the fastest-growing part of the business (“commerce revenue” grew 86% last quarter, while “subscription revenue” grew only 8%).

I like the business model, and they are doing well right now, with plenty of capital and a pretty clear path to profitability, particularly after some significant cost-cutting and layoffs this year to better match their overhead to their revenue, so this might be a rational small cap speculation — whether or not there’s a real “A.I.” connection is hard to say, they did release their creator tools suite that leverages AI a few months ago, to at least some initial excitement from their customers. They call their key product “The Leap,” which apparently helps creators quickly pull together a draft version of whatever digital products they want to sell (online courses, tutorials, special reports, etc.), though they also have AI tools for brainstorming titles and generating graphics and the like. It’s really tiny, and I have never tried it out and don’t know if there’s any sustainable quality to these AI-fueled products that will keep people coming back… but it’s at least a fun story. Maybe I should come up with a tutorial to sell… just have to develop a TikTok dance first, I guess, so I have something folks would want to learn 🙂

Next?

“Microcap AI Sleeper No. 3: A still-small Canadian company that touts behemoths like Starbucks, Zoom, Samsung, and even Amazon on its client list. Why? Because its cutting-edge learning platform is powered by AI and is one of the top-rated systems in the industry as a result. This disruptive AI player already has over 2,000 customers, but this could just be the beginning.”

Well whaddya know, that’s a repeat, too — this must be Docebo (DCBO), which the Canadian Fools have been pitching as an AI play all year — and it’s had a nice run recently, thanks to a solid earnings report last last week, so it’s up about 10% from where it was when we covered the “AI Disruption Playbook” version of the Fool’s DCBO tease.   The business actually sounds somewhat similar to Thinkific, they also help with the development of online training programs and courses — though Docebo really does it for corporate training, while Thinkific seems to be more about social media “creators” teaching people how to master a new makeup technique or caulk a bathtub.

Docebo is involved with AI, but in a fairly limited way thus far, developing AI systems to help them create better learning and training programs for their corporate customers (Docebo sells a cloud-based learning management system for education and development of employees) — so I guess that’s a similar AI connection to Thinkific, though Docebo is much larger and has a more established business.  I don’t know if they’ll become an A.I. barnburner, but they do have solid longer-term contracts for their SaaS platform, with growing revenue and good customer retention, so it’s quite possible that they’ll be able to grow into their fairly rich valuation, especially as a small company — market cap is below $2 billion, they’re valued at about 65X next year’s estimated adjusted earnings (100X trailing), and earnings growth could be in the 50%/yr range for a few years if they stay on trend (they really have just started to be profitable, and growth from zero often looks very fast).  They’re also profitable on a GAAP basis, not just “adjusted,” so the stock-based compensation is not as egregious as it is with some smaller tech companies.

Still speculative and dependent on growth, like a lot of small technology companies, but it’s probably not a ridiculous idea at a valuation of about 9X their annualized recurring revenue, the current revenue growth of 25% or so should be enough to turn that into solid results over a few years if they can keep it up and keep their customer retention numbers high, as they are right now, which will help the margins continue to steadily improve with scale.   The annual recurring revenue number keeps growing, as expected, and is now at $182 million, so that’s a pretty solid recurring revenue base, from mostly large and solid corporate customers (the average contract value is pretty big, and growing — about $49,000 last quarter, roughly 10% growth from a year ago).    Docebo feels like a big fish among minnows like Propel and Thinkific, so it’s much less of a “microcap,” but they’re still pretty small — and like many of their peers, the price has perked up in the last couple days as inflation fears moderated, but they’re still well below their 2021 highs.

So… sound like the kind of “AI Moonshots” you’d be interested in?  Have an opinion on any of the three, or other favorite small artificial intelligence beneficiaries that we should consider?  Let us know with comment below…

Disclosure: Of the companies mentioned above, I own shares of and/or options on NVIDIA, Shopify and Amazon. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.