Seth Klarman is CEO and portfolio manager of Baupost Group, an investment firm that manages billions in assets for families, foundations, endowments, and other institutions.
However, some might know Klarman as the author of Margin of Safety -- a long out-of-print title that is considered one of the best books on value investing, with copies selling for over $1,000 on eBay. It's understandable, considering Baupost Group has reportedly earned an annualized return of about 20% since 1983, which is in Warren Buffett's league.
Given those awe-inspiring returns, it is always worth checking out what Baupost is buying, and there were some interesting moves in the first quarter. Here are two stocks related to artificial intelligence (AI) Klarman was buying recently.
1. SoundHound AI
Baupost Group reported a new position in SoundHound AI (SOUN -1.00%) in the first quarter. SoundHound is an emerging provider of voice assistance technology that is seeing growing adoption in the automotive and restaurant industries. The company is growing revenue at a rapid clip and sports a market capitalization of $1.7 billion.
It's an interesting bet for a value investor, considering that SoundHound is not a profitable business yet. While revenue grew 73% year over year in the first quarter, it reported a loss of $33 million on just $11.6 million of revenue.
Its lack of profitability hasn't kept investors bidding up the stock to a high valuation of 25 times trailing revenue. Even assuming Klarman bought shares at the low share price during the first quarter, the stock was still trading at a high price-to-sales ratio of 8.1, which is typically not the kind of discounted valuation associated with classic value investing.
Sometimes, however, companies that have messy financials can make it more difficult to estimate a company's true worth, and therefore can create a large disconnect between the company's intrinsic value and share price. The value in the company is obviously not found in the company's financials today, but where it is headed if it continues to experience rapid adoption of its AI voice technology.
Many of the most popular restaurant brands are starting to use SoundHound's technology, including Chipotle Mexican Grill and Jersey Mike's. SoundHound also partnered with Nvidia in the quarter to deliver generative AI-powered voice assistance in vehicles using Nvidia Drive. The relationship with Nvidia goes a long way to validate the company's potential.
While it's unprofitable right now, that could change if it keeps growing revenues. SoundHound has seen its gross profit margin improve to over 70% over the last few years, consistent with other profitable software companies.
The stock's wild price swings are not for every investor, but if the company continues to execute in controlling costs, improving margins, and winning new deals with car manufacturers and restaurant chains, the stock's upside could be massive.
2. Alphabet (Google)
One of Baupost's largest holdings is none other than Alphabet (GOOGL -1.76%) (GOOG -1.84%), the parent of Google and YouTube. The firm added to its position in the first quarter, which likely means Klarman believes Alphabet's position as the leading online advertiser and investments in AI are underestimated by most investors.
Sometimes, bargains can be found in plain sight among the biggest companies in the world. Alphabet already commands a market capitalization of $2.1 trillion. Billions of people use Google products and YouTube every day, but it clearly has a lot of growth left in the tank. Alphabet reported double-digit growth in revenue and earnings per share in the first quarter, as Google continues to push its lead in AI.
Google has been investing heavily in AI since at least 2015, when it launched TensorFlow, an open-source machine learning platform. It continues to ramp up capital spending to build out its data center infrastructure to support development of its Gemini AI model and Vertex AI development platform.
AI is essential to everything it does, from powering its Search algorithms, recommending content to YouTube viewers, and automating ad creation for advertisers.
It's understandable why successful investors like Klarman have been scooping up the stock recently. The shares trade at a reasonable forward price-to-earnings ratio of 23 -- in line with the S&P 500 average. But an average valuation looks very attractive for a company expected to grow earnings at above-average rates. The current consensus calls for the company's earning to grow at an annualized rate of 17% in the coming years.
Alphabet's ability to grow profits at these rates while investing in AI deserves a higher valuation.
