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2 Stocks to Consider After Their Recent Sell-Offs

By Daniel Sparks - Aug 15, 2019 at 9:01AM

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These high-quality tech stocks may be oversold.

The overall stock market has pulled back recently, with the S&P 500 down nearly 6% over the past 30 days as of market close on Wednesday. Some tech stocks have fallen even faster.

Two companies that have been slammed particularly hard are streaming-TV company Netflix (NFLX 2.90%) and digital payments and point-of-sale solutions specialist Square (SQ 3.97%). A combination post-earnings decline for both companies and a recent outsize pullback in growth stocks has led to a 20% decline for Netflix and a 25% fall for Square over the past 30 days.

These two stocks' declines have put shares at attractive levels, making them potentially solid additions to a portfolio.

Here's a closer look at these companies -- and why their stocks may be good long-term bets.

A man looking out at a city on a rooftop with a table and laptop in the foreground.

Image source: Getty Images.

Netflix

Shares of Netflix certainly aren't cheap. The company currently trades at 118 times earnings. But investors looking to buy Netflix at a bargain price could end up waiting for a long time. As a fast-growing company with a rapidly expanding operating margin, Netflix arguably deserves its lofty price tag.

Just look at the company's performance in its most recent quarter. Revenue rose 26% year over year as operating income jumped 53%. This outsize growth in operating income was fueled by an expanded operating margin. Netflix's second-quarter operating margin was 14.3%, up from 11.8% in the year-ago quarter.

One concern today is Netflix's negative free cash flow (FCF). Management, however, believes positive free cash flow is on the horizon. But investors will have to be patient.

"We're still forecasting FCF of approximately -$3.5 billion for the full year 2019 and expect improvement in 2020," management explained in the company's second-quarter shareholder letter. "From there, we'll continue to reduce our free cash flow deficit as we intend to continue growing our member base, revenues, and operating margin, which provides a clear path toward positive FCF."

Investors willing to hang onto Netflix over the long haul could watch the company's earnings multiply several times over their current levels. Indeed, analysts expect Netflix's earnings per share to rise at an average annual rate of 47% over the next five years. 

Square

Financial technology company Square is growing even faster than Netflix, with revenue rising 44% year over year to $1.17 billion in its second quarter. Adjusted revenue (or total net revenue less transaction-based costs), bitcoin costs, and the effect of deferred revenue adjustment related to purchase accounting jumped 46% year over year to $563 million. However, unlike Netflix, Square isn't profitable yet. This means the company doesn't even have a price-to-earnings ratio. But its price-to-sales ratio of 6.7 is now notably lower than its more mature (and profitable) peer PayPal (PYPL 2.23%), even though Square's second-quarter year-over-year revenue growth rate was far ahead of PayPal's 12% growth over the same time frame.

PYPL PS Ratio (TTM) Chart

PYPL PS Ratio (TTM) data by YCharts.

Further, Square boasts an important catalyst. Its subscription and services-based revenue increased 87% year over year to $251 million. What's particularly interesting about this segment is the outsize growth it is seeing in its gross profit. The segment's gross profit rose 102% year over year to $191 million during the quarter. In addition, growth in this subscription and services-based revenue has been broad-based, driven by Cash App, Square Capital, and Instant Deposit.

Profitability for Square isn't far off. The company is already generating substantial adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjusted EBITDA grew 54% year over year in Q2 to $105 million -- and management expects full-year adjusted EBITDA to be between $405 million and $415 million.

Investors who buy either of these stocks today shouldn't expect smooth sailing, of course. Growth stocks typically see far more volatility than market indexes, such as the S&P 500. But given these two stocks' strong underlying businesses, they have a good chance of ultimately outperforming the market over the long haul.

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Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
NFLX
$179.95 (2.90%) $5.08
Block, Inc. Stock Quote
Block, Inc.
SQ
$63.90 (3.97%) $2.44
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
PYPL
$71.40 (2.23%) $1.56

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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