Could This Small-Cap AI Stock Be the Next 10-Bagger?

Key Points

• BigBear.ai provides customized AI software to its clients.

• BigBear.ai's margin profile differs from a typical software company's.

• 10 stocks we like better than BigBear.ai ›

Finding stocks that can increase in value by 10 times in a short period is a worthy goal for many investors. For a stock to achieve this, it must be a leader in a rapidly expanding industry. There is no bigger growth industry than artificial intelligence (AI) right now, and it's filled with many stocks that have the potential to put up tenfold returns.

One popular pick is BigBear.ai (NYSE: BBAI), but does it have the potential to increase your investment tenfold? Let's take a look.

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BigBear.ai's margins aren't comparable to its peers'

BigBear.ai specializes in providing custom software solutions to government entities seeking to integrate AI. While it can also tackle commercial clients, its biggest contracts by far are those that it has signed with various governments.

The largest is its U.S. Army contract, valued at $165 million over five years (starting in October 2024). BigBear.ai was picked to build the Army's Global Force Information Management-Objective Environment (GFIM-OE) system. This will allow its users to ensure that the Army has the proper manpower, equipment, training, and resources to accomplish its mission.

BigBear.ai also secured business in processing arrivals at airports by deploying biometric technology. This technology speeds up processing times and has been deployed by multiple airports around the U.S. and the world.

However, none of these software systems are the same, and this highlights an area of concern: BigBear.ai makes custom-tailored solutions. Most software companies offer a base software package that can be tailored for multiple uses, rather than developing a separate package for each use case. This allows most software companies to have strong gross margins. Because BigBear.ai must develop a new product for each contract, its gross margins are relatively low. BigBear.ai's gross margins are shy of 30% over the past 12 months, while most software companies have gross margins between 70% and 90%.

BBAI Gross Profit Margin data by YCharts

This is a structural problem for BigBear.ai investors, as they must adjust expectations despite BigBear.ai being an AI software company. Due to its low gross margin, it should have a significantly lower valuation, given its lower potential for profits.

Most software stocks trade at a multiple of 10 to 20 times sales. The goal for these companies is a profit margin of around 30%, which would translate to a more standard price-to-earnings (P/E) ratio of 30 to 60 when they mature to the point of generating massive profits.

BigBear.ai will never be able to achieve profit margins of that level because its gross margins aren't even 30%. If it can achieve a 10% profit margin, then it should trade at between 3 and 6 times its sales to end up at the corresponding P/E ratio by the time it becomes a mature business. However, BigBear.ai trades at a premium of 9 times sales.

BBAI PS Ratio data by YCharts

BigBear.ai is a very expensive stock for its margin profile, and it needs strong growth to justify this valuation. However, it isn't producing any growth at all.

BigBear.ai hasn't capitalized on the AI spending boom

BigBear.ai's "growth" has been pretty turbulent since 2023.

BBAI Revenue (Quarterly YoY Growth) data by YCharts

With multiple quarters of negative revenue growth, it's actually producing less revenue now than it was in 2023, the year the AI arms race began. If BigBear.ai were set to be a big winner here, it would have been generating strong growth over the past few years.

It's not, which concerns me as an investor. BigBear.ai has a lot of work to do before it can increase in value tenfold. With its expensive stock price, poor margin structure, and lack of growth, I don't think it will ever achieve this goal. Numerous other AI investment opportunities appear to be better buys than BigBear.ai, and investors should consider them first.

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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.