With the market down in the dumps this year, it’s easy to put business imperfections under a microscope and pick on all the reasons their shares can trade for even lower. Indeed, with an economic slowdown at best already here, a case can be made that stocks aren’t going to recover quickly.
Nevertheless, successfully investing in businesses requires looking beyond the here and now, and instead looking at future potential. With that in mind, three Fool.com contributors have narrowed down the field to three stocks they think have the potential to triple in three years (that is, by the end of 2025). According to them, you’d do well to look into live work collaboration technologist Atlassian (TEAM -0.30%), PC and enterprise computing leader Dell (DELL 0.04%), and small digital advertising software company Pubmatic (PUBM 0.52%).
Atlassian’s a deeply discounted winner from Down Under
Anders Bylund (Atlassian): Project management software expert Atlassian carried a lofty stock price last year. On the eve of Thanksgiving 2021, Atlassian’s shares traded at the nosebleed-inducing valuation ratios of 125 times free cash flows and 44 times sales. We can’t talk about the price-to-earnings ratio, because even the adjusted version of the trailing bottom-line number was negative to the tune of $4.34 per diluted share.
But times have changed, and the stock was dragged down alongside the entire category of high-growth companies with richly valued stocks. Share prices have plunged roughly 70% below last Thanksgiving’s reading, and Atlassian’s valuation doesn’t look unrealistic anymore.
Now, you can pick up fresh shares of the Australia-based company at the more modest valuation of 38 times free cash flow and 11 times sales. If that still strikes you as expensive, you probably don’t buy a lot of growth-oriented stocks. That’s OK — growth investing isn’t everyone’s cup of flat white.
But for those of us who do enjoy owning companies with tremendous growth prospects, even at somewhat elevated valuation ratios, Atlassian looks mighty tasty today. Skeptics are throwing the stock out with the inflation-tainted bathwater while Atlassian’s business continues to boom:
It’s true that the latest dive on the stock chart resulted from modest second-quarter guidance targets. The company sees fewer users of its free services upgrading to premium subscriptions, and paying clients are adding fewer paid seats to their deal renewals. Atlassian can’t avoid the belt-tightening realities of a challenging global economy, and it shows in the near-term guidance targets.
However, pumping the brakes during a time of economic crisis is not the same thing as the end of the road. Downturns don’t last forever and Atlassian’s market-leading project management tools should get back to their old growth trends when businesses of all sizes start hiring information technology staff again.
Whether that upturn comes in 2023 or 2024, you’ll find that the Atlassian shares you bought for a song in the fall of 2022 were a bargain all along. If it only triples from this modest platform by 2025, I’d call that a mild disappointment.
This 3%-yielding value stock could surprise some people
Dell Technologies is certainly a value play, trading at just 6.5 times earnings. Should earnings grow just marginally and its multiple double to a still-reasonable 13 times earnings in three years, with some dividends and buybacks thrown in, it’s definitely possible for Dell to triple in that time.
Of course, there’s a reason the stock is so cheap now. Coming off the boom years during the pandemic, Dell is now feeling a hangover, as the consumer PC market is declining at its fastest annualized rate in recent history, and the threat of recession looms over corporate IT spending, which is slowing.
Yet while Dell is sometimes regarded as a mere PC play, its consumer PC division — which was down a stunning 29% in the third quarter — made up only 12.2% of sales in Q3. The larger commercial PC segment was also down, but by a more palatable 13%.
However, Dell’s infrastructure group, which provides data center servers, storage, and software solutions, grew 12%, and the segment’s operating income was up a stunning 54%, thanks to cost controls. In fact, the infrastructure segment’s operating income of $1.37 billion just surpassed the $1.06 billion in operating income for the PC segment last quarter. The growth outlook for servers and data centers is definitely much better than that of PCs, as ASML Holdings (NASDAQ: ASML) outlined at its recent investor day. Therefore, as the infrastructure segment overtakes the PC segment, Dell could post some better-than-expected growth numbers.
Finally, Dell isn’t just a cyclical hardware play, as it’s also developing its suite of enterprise software and services, including multicloud and private cloud software, software-defined storage, data protection and backup services, and other consultative services for enterprise clients. While Dell’s product revenue was down 10% last quarter, its services revenue was up 6%, making up 30.5% of revenue and a higher 41.5% of overall gross profit.
As the steadier infrastructure and services segments make up a greater portion of Dell’s financials, it’s possible investors may change their perception of Dell, and the stock could get a rerating higher in the future. Meanwhile, in three years, I would expect the PC market to recover, and for the economy to be through whatever potential downturn may be looming next year.
When you think about higher earnings three years out, a lower share count thanks to the company’s ongoing share repurchases, a higher dividend, and a potential rerating up from its lowly P/E ratio of 6.5, it’s not a stretch to think the 3%-yielding Dell can triple in three years’ time.
This digital ad slowdown too will pass
Nicholas Rossolillo (Pubmatic): Digital advertising is a secular growth trend. Efficient for marketers and more relevant to audiences, ads delivered through an internet connection have quickly been gobbling up share of the industry for years and will continue to do so for many more to come.
Right at the moment, though, it’s easy to forget the upward momentum digital advertising has going for it. Economic slowdowns — and even worse, recessions — are pesky cogs in the promotional business activity machine. With companies worldwide striking a cautious tone as 2023 approaches, ad spending is getting cut. Then add in the fact that Apple (NASDAQ: AAPL) threw a curveball to marketers and app developers. User activity tracking on electronic devices was already coming under intense scrutiny, but the iPhone maker helped accelerate the trend when it rolled out the ability to opt out of an app’s ability to monitor your usage. That has also (temporarily) reduced the value of advertising in the Apple ecosystem.
For companies like PubMatic, these factors translate into a sharp slowdown in growth. While new ad inventory continues to migrate online — a favorable trend for PubMatic, which works with publishers trying to sell ad time — buyers of ads are thinking twice before purchasing. As a result, to close out 2022, PubMatic expects revenue to slow to just about a 1% year-over-year crawl, compared with nearly 30% growth just a couple of quarters ago.
However, as economic conditions start to improve at some point, marketing activity will come roaring back. PubMatic is also already profitable, generating $50 million in free cash flow on revenue of just $258 million over the past 12 months, a free cash flow profit margin of nearly 20%. And management has said its investments into computing infrastructure will be taking a breather, meaning these profit margins could rise even further — even if revenue growth continues to stall out.
Thus, at just 17 times trailing 12-month free cash flow as of this writing, PubMatic looks remarkably cheap given its longer-term potential. As the ad industry returns to growth and drags PubMatic along with it, there could be a lot more profit in the next few years, and it also warrants discussion for a higher valuation multiple. I believe PubMatic has the potential to triple in value in three years, so I remain a buyer right now.