With the tech industry flying high amid the pandemic, the pace of new IPOs and interest in them has been fast and furious. Recent debuts have set a new bar for ludicrous valuation. Snowflake (NYSE:SNOW), for example, is trading for well over 100 times trailing-12-month revenue — a price tag that assumes flawless execution of its growth strategy in the cloud industry, and then some.
There are more timely purchases out there, though. Three Fool.com contributors think Veeva Systems (NYSE:VEEV), Spotify (NYSE:SPOT), and Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG) are worth some of your money right now.
A consistent home-run hitter in life sciences
Nicholas Rossolillo (Veeva Systems): First off, I need to acknowledge my pick is no value. On the contrary, cloud computing technologist Veeva Systems trades for 31 times trailing-12-month revenue and 28 times expected fiscal year 2021 (the 12 months ended Jan. 31, 2021) revenue. This kind of pricing assumes a company will continue to grow at a double-digit percentage pace for some time. However, the steep premium here is well deserved.
Veeva has been a consistent growth story since it went public in 2013, with share prices rising over 600% in that span of time. And though the technologist now carries a market cap of over $40 billion, there’s no shortage of opportunity left. The company provides cloud-based data management, regulatory solutions, quality control and safety, and communications software for the massive life sciences industry. It serves biotech, pharmaceutical, and medical device companies and recently expanded into adjacent chemical, cosmetics, and consumer goods industries. In a post-pandemic world, Veeva’s services will be more important than ever.
Veeva reported a 35% increase in revenue through the first half of the current fiscal year to $691 million, building on the 28% revenue increase last year. Better yet is the fact this is already a highly profitable company. Even as it spends to continue its expansion, trailing-12-month free cash flow (revenue less cash operating and capital expenses) is up 15% over a year ago to $488 million — good for a free-cash-flow profit margin of 38%. Additionally, the company had $1.5 billion in cash and short-term investments and zero debt on balance at the end of July.
I’ll reiterate: This is no cheap stock, and thus it’s susceptible to wild swings in price. However, the premium is justified if looking at the massive potential that lies in the next decade as Veeva is helping speed up the development and efficiency of thousands of medical treatments and advancements. It’s well worth considering for investors looking for long-term growth.
Stake an early claim in the media-streaming market with Spotify
Anders Bylund (Spotify): Media-streaming veteran Spotify hit the public market in 2018. The stock was off to a running start, gaining 29% in its first month. The COVID-19 lockdowns of 2020 have been kind to the Stockholm-based company, driving share prices more than 60% higher year to date.
Despite the market-crushing returns in 2020, Spotify shares are actually on sale right now. The stock was caught in the general tech-sector panic of early September and investors took some more profits off the table during the second wave of European coronavirus lockdowns this week. Furthermore, Spotify took a modest haircut when Amazon finally launched a podcast feature for its Amazon Music media platform.
So Spotify’s stock has fallen more than 20% from the 52-week peak in July. Many investors simply won’t touch this stock because of its sky-high valuation ratios. Shares are trading for 174 times Spotify’s free cash flows and 5.2 times the company’s annual sales, and nobody expects bottom-line earnings to turn positive anytime soon. That would be a big problem if Spotify were trying to optimize its business model for maximal profits, but that’s not what’s going on here.
Every penny of additional cash is quickly reinvested in growth-boosting operations such as exclusive deals for premium content or a beefy marketing push. Spotify has claimed a significant share of the music-streaming market so far but the long-term opportunity is many times larger and the company is only getting started. This is high-growth investing at its finest, and you can grab some Spotify shares at a temporary discount right now.
Imagine getting a high-growth cloud business for free
Google (Billy Duberstein): No doubt, high-growth cloud software companies are in demand today. Cloud software companies like Snowflake and JFrog are coming to market with incredible enthusiasm, and a week out from their IPOs, their valuations have spiked to 128 and 48 times sales, respectively. That’s compared with their revenue growth rates of 121% and 46%. While Snowflake is somewhat of an outlier, even by software-as-a-service standards, there are a whole host of newish cloud software stocks growing between 25% and 70% this year with price-to-sales ratios between 15 and 45.
Yet what if you could get one of those types of businesses for free? That’s what you appear to be getting with Alphabet, the worst-performing of the FAANG stocks in 2020, though it’s still up a respectable 9.6% on the year.
Though Alphabet investors seem to be fixated on its core digital advertising business, Alphabet’s new cloud segment appears to have all the same growth characteristics as these new-age cloud software companies. Last quarter, Alphabet’s cloud segment grew 43.2% to $3 billion, or a $12 billion run rate. It wouldn’t be totally crazy for a young, independent cloud company growing at that rate to earn itself a 25 times sales multiple. That would theoretically make Google’s cloud business worth $300 billion.
Today, Alphabet trades at a market capitalization of $960 billion and a 31.1 P/E ratio. Strip out the cloud business, which likely makes little in the way of profits today, and Alphabet’s remaining market cap would only be $660 billion, with a P/E ratio of 21.5.
But wait, there’s more! Strip out the massive $120 billion cash hoard on its balance sheet, and Alphabet outside of the cloud business and cash would only be valued at $540 billion, with a P/E ratio of 17.5. Additionally, Alphabet’s “other bets” — smaller businesses such as its Waymo self-driving car unit, Verily life sciences unit, and the Google Ventures early-stage and Capital G later-stage venture investing arms — have significant value in the tens of billions, despite losing over a billion dollars last quarter alone.
When all is said and done, Alphabet’s dominant digital advertising business appears to be valued at just a low-teens multiple. That’s far too cheap, and leads me to believe Alphabet’s high-growth cloud business is largely being ignored by the market. That makes Alphabet’s stock a much safer option than the extremely expensive cloud IPOs gobbling up investor attention in September.