For better or worse, growth stocks are notoriously volatile. But for astute investors who can manage to recognize timely buying opportunities, they can be a fantastic way to generate outsized gains over the long term.
So we asked three Motley Fool investors to each discuss a growth stock that they think investors should consider buying now. Read on to learn why they like Zillow Group (Z 1.00%) (ZG 1.15%), Red Hat (RHT), and Roku (ROKU 2.94%).
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Banking on the leader in online real estate
Steve Symington (Zillow Group): Shares of Zillow Group have climbed nearly 50% so far in 2018 as of this writing. After all, with Premier Agent revenue expected to arrive at just above $900 million this year -- still a small fraction of the roughly $12 billion that real estate agents spend each year advertising their listings -- Zillow enjoys a long runway for growth from its core business. And that's not to mention the supplemental growth of its smaller rentals, mortgages, and other real estate services segments.
But two developments have actually tempered the stock's growth in recent months, giving investors a much better chance to step in and participate in its longer-term gains.
First, in April Zillow pulled back hard after the company announced it would accelerate its home-flipping initiatives with the the expansion of Zillow Instant Offers. As part of that effort, Zillow expects to hold around 300 to 1,000 homes for resale by the end of 2018 -- a capital-intensive effort that some investors worried would come at the expense of its current core Premier Agent business. Sure enough, though Zillow has assured agents the program actually encourages sellers to use an agent regardless of whether they accept Zillow's offer for their home, Instant Offers has certainly ruffled some feathers in its early stages. Once real estate industry professionals realize Zillow still has their best interests at heart, however, I think the program should prove to be an astute move to drive incremental revenue and profits for the company.
Second, late last month, Zillow stock pulled back again when it announced plans to raise as much as $725 million in net proceeds from a combination of offering new stock and debt. As I pointed out, however, I think Zillow could use the cash to potentially acquire one of its largest competitors, further solidifying its industry leadership as more people inevitably flock to online real estate platforms.
Red Hat's stock is cheap for all the wrong reasons
Anders Bylund (Red Hat): This is a rare opportunity to pick up shares in a red-hot growth stock at a serious discount.
The Linux and open-source software veteran had seen its share prices double in 52 weeks, heading into June's first-quarter report. In that report, Red Hat exceeded its own guidance targets across the board and also stomped Wall Street's expectations. Yet, the stock took a 12% nosedive the next day and has stayed down ever since. Today, Red Hat shares are trading 23% below those pre-earnings highs.
Analysts took one look at Red Hat's modest second-quarter guidance, ignoring optimistic full-year targets, and punished the stock with a slew of downgrades and target-price cuts.
It's true that Red Hat shares were trading a little high before this correction, as the market cap amounted to 112 times trailing earnings and 36 times free cash flows. But Red Hat has earned its acclaim by posting a long string of fantastic high-growth results. In the first quarter, earnings rose 24% year over year on 20% higher sales.
The growth story hasn't changed -- analysts simply overreacted to a strong seasonal swing. Right now, Red Hat's stock trades at 27 times free cash flows -- quite comparable to larger and slower-growing enterprise software rivals SAP at 33 times FCF and Microsoft's price-to-FCF ratio of 23.
This sale won't last. Grab Red Hat's stock while the discount is hot.
A cord-cutter's dream stock
Rich Duprey (Roku): If you want to invest in a company leading the way in cord-cutting, look no further than Roku.
The streaming device maker is actually in the midst of a major transformation to move away from hardware sales to one where its advertising platform is central to its business thesis. Last quarter Roku was finally able to make the pivot so that revenues from ads and fees exceeded those of its devices. Platform revenues more than doubled to $75.1 million, significantly ahead of the $61.5 million it made on its players.
It's not abandoning the device market -- a branded sound bar for controlling a home entertainment system will be coming to market soon -- but advertising revenue will be the focus from here on out. It just launched its own ad marketplace and has lined up some heavy hitters, including Turner Broadcasting, Fox, and Viacom. According to Cord Cutter News, 70% of those who have cut the cord own a Roku device, while the maker of OTA DVRs, TabloTV, says 70% of its users also use a Roku device.
As the viewing public increasingly moves to streaming, they'll turn to Roku in one form or another, and those advertisers trying to reach them will do so as well.
The bottom line
We certainly can't guarantee that these three names will go on to outperform the broader market. Still, between Zillow's recent pullbacks and massive addressable market, Wall Street's overreaction to Red Hat's recent results, and Roku's ongoing business transformation, these three Fools believe that investors could do well to pick up shares of all three companies today.
