SoundHound AI Reveals Its Strategy for Finding a Potential Acquisition Target, and It's Risky

SoundHound AI (NASDAQ: SOUN) is a voice artificial intelligence (AI) company that has relied on acquisitions in recent years to grow its business. In an effort to become bigger, diversify its customer base, and gain market share, acquisitions have been key to its growth strategy. They can help a company quickly advance its position in an industry, especially one that's as fast-growing as tech.

But acquisitions can also add cost and complexity, which is why investors aren't always thrilled with them. Plus, they can mask a company's true organic growth, making it difficult to assess how well the core business is really doing, since new segments and business units muddy the picture.

SoundHound's management recently outlined its acquisition strategy, and it should leave investors thinking twice about whether to invest in the tech stock.

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Why SoundHound's acquisition strategy looks particularly risky

Anytime a company acquires another business, there's a risk that the integration won't go smoothly and that it may chip away at margins and overall profitability. That's why it needs to be a careful undertaking; the net result may be negative.

On SoundHound's most recent earnings call, CEO Keyvan Mohajer explained the company's approach when looking for a potential acquisition target:

We find companies that have a great team and a great business, really strong customer relationships, and they are deeply integrated with their customers with a long history. But for some reasons, they are going through some stressful situations

There are multiple flags within here that stand out to me.

The first is that they are pursuing distressed companies, which is a challenge in itself, as turnaround efforts can be costly and aren't guaranteed to succeed. Secondly, the phrase "for some reasons" troubles me because it suggests that SoundHound AI could be acquiring companies with a range of problems, or worse, problems it may not fully understand. Either way, it means that SoundHound is seeking out troubled companies to conceivably buy at discounts. For investors, this is akin to buying cheap stocks that may simply be value traps. It's risky, and in many cases, it's not a good move.

SoundHound's stock hasn't been winning investors over with its strategy

While SoundHound has grown its business over the years, with revenue of $169 million last year doubling the $85 million it generated in the prior year, that hasn't translated into strong returns for investors. This year, the stock is down 26%. Investors may be more concerned about the company's continued losses and lack of a path to profitability, underscoring the risk that comes with going aggressively after acquisitions.

I'd avoid SoundHound AI, as there are many safer growth stocks to buy with stronger financials and growth strategies that aren't nearly as aggressive.

David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends SoundHound AI. The Motley Fool has a disclosure policy.