• Small-cap AI stocks have achieved mixed results this year, with some delivering impressive gains and others struggling.
• Standout performers like SoundHound, Innodata and Lemonade have captured attention with innovative use of AI but challenges remain.
• Investors should weigh the risks of small companies, including volatility, financial uncertainty and company-specific challenges.

While AI giants like Nvidia (NVDA) and Microsoft (MSFT) have dominated headlines with extraordinary gains, savvy investors have begun eying smaller firms with more-affordable entry points and remarkable potential for growth. 

Small-cap companies are pioneering niche technologies or developing cutting-edge approaches that have yet to make a big splash. For bullish investors, this presents an opportunity—the chance to invest early while valuations are still relatively modest.

On the other hand, it’s important to recognize the risks. Small-cap stocks tend to be more volatile, with lower liquidity and less financial stability, making their performance more unpredictable. But for those willing to take a chance and think long-term, smaller cap firms have the potential to deliver outsized returns that some larger-cap stocks may no longer offer.

Let’s examine the performance of a broad group of small-cap stocks operating in the AI niche. From there, we’ll take a closer look at the top performers, highlighting narratives that have resonated with investors in 2024. 

Small-cap winners

The small-cap AI sector has delivered a mixed bag of results in this year, with some companies falling short of expectations while others have posted standout gains. That divergence illustrates the inherent volatility of small-cap stocks—some struggle to gain traction while others establish themselves as rising stars.

For investors, these dynamics present both challenges and opportunities. Below, we show how some small-cap AI winners and losers have performed this year.

• SoundHound AI (SOUN) +120%
• Innodata (INOD) +100%
• Lemonade (LMND) -5%
• Verint Systems (VRNT) -7%
• Evolv Technologies (EVLV) -20%
• BigBear.ai (BBAI) -31%
• Mitek Systems (MITK) -34%
• Fastly (FSLY) -59%
• Perion Network (PERI) -74%

2024 small-cap AI narratives

To understand the dynamics at play in the top returns in small-cap AI, let’s look at three of the better performers: SoundHound AI (SOUN), Innodata (INOD) and Lemonade (LMND). In the profiles below we explore their business models, core products or services, and the factors driving their recent stock movements. 

SoundHound AI

SoundHound AI has been one of the top performers among small-cap AI companies, with its stock up 120% year-to-date. The company specializes in conversational intelligence, developing AI-powered voice technology that integrates into smart devices automotive, consumer electronics and customer service industries. 

SoundHound’s platform enables businesses to create customized voice AI systems for personalized user experiences. While the company has seen rapid growth—second-quarter revenue jumped 54% to $13.5 million—profitability remains a challenge. It posted a non-GAAP net loss of $14.8 million in Q2, a slight improvement compared to the same period last year.

In a vote of confidence, Nvidia (NVDA) invested $3.7 million in SoundHound. Although a relatively small amount for Nvidia, it underscores the increasing importance of SoundHound’s technology. Nvidia uses SoundHound’s voice AI in its Nvidia Drive systems for cars, validating the company’s role in the automotive industry.

Strategic acquisitions have also played a role in SoundHound’s growth. In late 2022, the company acquired SYNQ3 Restaurant Solutions for $25 million, making SoundHound the largest provider of voice AI technology in the food and beverage sector. More recently, SoundHound expanded into enterprise conversational AI through its $80 million acquisition of Amelia, which serves industries like healthcare, retailing and financial services.

These strategic moves position SoundHound to benefit from the growing demand for AI-powered voice technology. Analysts forecast continued revenue growth, but profitability remains a hurdle. Investors should closely monitor whether SoundHound can convert its growing influence into sustained profits.

Innodata

Innodata (INOD), a data engineering firm, has been another standout performer among small-cap AI companies, with its stock rising roughly 100% year-to-date. The company helps clients extract insight from large datasets, driving data-driven decision-making. It plays a role in industries that require efficient management, use and distribution of digital information.

The company operates three segments: Digital Data Solutions (DDS), Synodex and Agility PR Solutions. DDS, the company’s largest revenue driver, accounts for two-thirds of sales and focuses on collecting and organizing data that powers AI systems.

Synodex specializes in extracting data from medical records for underwriting and claims processing, primarily for insurance companies. Agility PR Solutions helps public relations firms distribute targeted content and monitor media coverage. These customizable platforms provide Innodata with a competitive edge, tailoring AI to meet the demands of various industries.

Innodata’s Q2 earnings reflected significant growth. Revenue surged to $32.55 million, beating estimates by $4.96 million and representing a 66% year-over-year increase. The company’s earnings per share (EPS) improved to $0.00, compared to a $0.03 loss in the same period last year. A substantial contributor to this success is the company’s PR CoPilot AI layer, integrated with its Agility platform, which has generated $5 million in revenue despite being only 30% complete.

Innodata continues to secure high-value deals, including new contracts with a major social media platform and a clinical healthcare provider. These wins showcase the broad applications of its AI-enabled platforms, which are used in healthcare, financial services and government services.

However, Innodata faces challenges. After its most recent earnings report, the stock experienced a pullback, seemingly exacerbated by a short-seller report (highlighted below)—following a similar report in February—casting the company’s optimistic outlook into question. Analysts allege in the report that that the company’s technological innovations are less groundbreaking than previously indicated. Given the recent U.S. Department of Justice (DOJ) investigation into Super Micro Computer (SMCI), prompted by a separate short report, these concerns merit consideration. 

In its most recent earnings report, Innodata did raise its full-year 2024 revenue guidance from 40% to 60%, citing growing demand for its AI offerings. However, the company has yet to achieve consistent profitability—its second-quarter earnings per share (EPS) showed only marginal improvement.

While investors bullish on Innodata’s long-term potential may still see value in the stock, the lingering negativity from the short-seller reports and lack of sustained profits present real risks. As such, conservative investors may prefer a cautious approach, waiting for an indication the profitability outlook has improved.

Lemonade

Lemonade (LMND)shares haven’t performed as well as those of SoundHound and Innodata, but the company continues to make waves with its innovative approach to insurance. It offers coverage for renters, homeowners, car, pet and term life insurance. It operates primarily in the U.S., with smaller operations in Germany, the Netherlands and France.

What sets Lemonade apart from traditional insurers is its heavy reliance on artificial intelligence and machine learning to optimize pricing and enhance its underwriting. As a disruptor in “insurtech,” Lemonade has aimed to revolutionize insurance by providing a seamless, digital-first experience that appeals to tech-savvy consumers.

Lemonade’s business model focuses on scale and customer acquisition, with an emphasis on improving retention rates and cross-selling additional insurance products. The company’s growth remains strong—Q2 2024 revenue rose 17% year-over-year to $122 million, while quarterly net loss narrowed to $57.2 million. Though not yet profitable, Lemonade’s ability to reduce losses while driving growth signals its digital-first model is making an impact.

But despite the growth in revenue, Lemonade’s Q2 earnings guidance seemingly spooked investors, triggering a sharp decline in the stock price. Before the earnings announcement, shares were trading above $22, but they dropped as low as $15 following the report. The market’s negative reaction reflects concern about Lemonade’s ability to achieve consistent profitability.

Looking ahead, Lemonade has the potential for improved underwriting performance with its expansion into new markets, such as car and pet insurance, along with its focus on increasing retention through renewals. In Illinois, the only state where all five of Lemonade’s products are available, the company boasts an annual dollar retention rate of 95%, significantly higher than its company-wide average in the mid-80s. If Lemonade can replicate this success in other regions, it could reduce expense ratios and improve loss ratios, which would enhance its profitability potential. 

Given the stock’s recent volatility and disappointing Q3 guidance, the next earnings report could have a significant impact on the underlying shares. So, conservative investors may prefer to wait until after the next report to consider a position, as the stock could experience substantial movement based on the results. On the other hand, uber bullish investors who believe in Lemonade’s long-term potential might view the recent pullback as a chance to buy at an attractive price.

Andrew Prochnow has more than 15 years of experience trading the global financial markets, including 10 years as a professional options trader. He is a frequent contributor to Luckbox Magazine.

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