The first quarter earnings season confirms that artificial intelligence has the attention of investors. Companies are making every effort to highlight their AI capabilities to investors. And, for the most part, investors believe the best AI stocks to buy now are in the large-cap sector.

That makes sense, because companies like Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOG, GOOGL), Meta Platforms (NASDAQ:META), and Nvidia (NASDAQ:NVDA) are unquestionable leaders in where AI is today. Owning shares of any of these tech giants makes sense in any portfolio.  

But if you’re an investor with an appetite for speculation – and a long time horizon, the small-cap sector may be the place to find some of the best AI stocks to buy. Many of these stocks have been pummeled in the recent sell-off. However, they are still drawing the attention of institutional investors.

That brings to mind one truth that investors should know. You should pay less attention to what the “smart money” says and more attention to what they do. Here are three small-cap AI stocks that highlight the risk and the reward in the sector.

BigBear AI (BBAI) 

BigBear AI (NASDAQ:BBAI) stock clearly illustrates the volatility of investing in pure-play AI stocks. BBAI stock started the year as a penny stock. However, shareholders have been rewarded with a 253% gain in 2023 as of the market close on May 12, 2023.

In the last month, however, BBAI stock is down over 25%. The major catalyst is a 113 million share offering. The company also reported mixed earnings. The revenue beat expectations, but it missed badly on earnings at a time when investors are punishing even the smallest miss.

BigBear AI provides AI and machine learning solutions. The company counts the U.S. Army and the U.S. Air Force as two clients. While there is considerable angst over the U.S. budget, defense spending tends to be sticky. That means BigBear should be alright with two of its key customers even if there are budget cuts.

There’s no way to hide that the company’s financials are bad. And BBAI stock doesn’t receive much analyst attention. But it’s receiving significant interest from institutional investors who bought over $6 million of the stock in the first quarter (as opposed to selling just $71,000). That suggests the stock may be closer to its $5 price target than its current price of $2.38.

SoundHound AI (SOUN) 

Shares of SoundHound AI (NASDAQ:SOUN) are down about 6% in the last month. But the stock is still up about 40% in 2023, with a price target of $4.77, which suggests a 92% upside for SOUN stock.

SoundHound is a leader in the niche market of conversational AI technology. The company uses AI to help process speech similarly to how the human brain processes it. The company’s client list includes many of the top names in the automotive industry. The company believes that up to 90% of all new cars will include voice assistants in the future.

SoundHound is also branching into the customer engagement sector, having signed a contract with Airmeez. It will be providing its technology for Airmeez’s intelligence voice assistants.

The company reported revenue of $6.71 million in its May earnings report. That was 56% higher on a year-over-year basis, and expectations are for strong revenue growth in the second half of 2023. Overall institutional ownership is low at approximately 8%. However, there has been significant buying in the last 12 months, which may predict where SOUN stock is heading.

Nerdy (NRDY) 

One of the not-so-surprising stories this earnings season was the struggles befalling Chegg (NYSE:CHGG). The stock is down 61% for the year, and a significant reason for the struggles is the emergence of generative AI and the use of AI in online learning models. That’s where the case can be made for Nerdy (NYSE:NRDY) as one of the best AI stocks.

Nerdy operates a live online learning platform accessible directly to learners and through schools and institutions. The proprietary platform includes AI to connect learners of various ages to subject matter experts.

In its most recent quarter, Nerdy generated $49.1 million in revenue. This beat estimated by 6% and was also higher than the $46 million generated in the same quarter the prior year. Institutional investors loaded up on NRDY stock in the fourth quarter of 2022, perhaps foreshadowing the 49% growth in NRDY stock so far in 2023.

The stock has dropped 17% in the last month due to the broader flight to large-cap stocks. However, the stock still has a $5 price target and is owned by 70% of institutional investors.

On the date of publication, Chris Markoch did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.