In the face of a pandemic, social distancing, and an economic crisis, technology stocks have been a bulwark against an otherwise forgettable year for investing. The world was already rapidly changing, but COVID-19 has left many business models reliant on in-person interaction floundering. Digital, on the other hand, is fast-becoming the new normal.
This year's second-quarter earnings results are bearing this out. And though some high-growth tech stocks have taken a breather as of late, the long-term thesis for owning them hasn't changed. Three I have my eye on are Fortinet (FTNT +3.39%), Universal Display (OLED 1.52%), and Cloudflare (NET +3.36%). Let's find out a bit more about these three companies and why their stock is still worth buying.
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1. Fortinet: A graceful pivot to address new needs
Many legacy cybersecurity firms have not fared so well in recent years. Too slow to pick up on the advent of cloud computing, many of them have been dealt a headache by younger peers born in and designed to protect a more mobile era in which devices can access data from anywhere via an internet connection and a remote data center.
But Fortinet has fared better than most. While it still has a foot firmly planted in legacy firewalls (physical devices that protect a specific footprint, like an office), it has been developing new services for more modern IT needs in-house (supplemented with a few small acquisitions). And it has been able to do so without skipping a beat. After revenue increased 20% in 2019, sales are up another 20% through the first half of 2020 -- including an 18% advance to $616 million in the second quarter.
Within the total, service revenue grew 22%, offset by a 12% increase in product sales. And the outlook for Q3 was pretty good too, with revenue expected to grow 16% at the midpoint of guidance. The best part, though, is that thanks to its disciplined approach to updating its security suite, Fortinet remains a highly profitable concern. Free cash flow (revenue less cash operating and capital expenses) was $216 million in Q2, up 21% from the same period last year and good for a free cash flow profit margin of 35%.
Perhaps investors were hoping for a little more as companies and their employees get updated for the times and switch to remote work. Either way, though, the report and outlook were solid. As of this writing, shares have fallen nearly 10% from pre-second quarter report highs and are trading for 25.6 times free cash flow. That's a reasonable price tag for one of the best cybersecurity stocks around.
2. Universal Display: A tough stretch for display manufacturing
While enterprise-grade tech has been strong thus far in 2020, consumer electronics are a different story. Many households put off device purchases -- most notably smartphones and computers -- during the spring months, tossing manufacturers into a period of uncertainty. That includes premium devices with 4K OLED displays.
Universal Display, a licensor of OLED technology and seller of OLED raw materials, hasn't been exempt. After revenue surged 28% higher to kick off the year, Q2 2020 revenue reversed course in grand fashion, declining 51% year-over-year to $58 million. Pre-purchasing from manufacturing partners at the end of the first quarter (to get ahead of possible supply disruptions from the pandemic) and sluggish demand since then were to blame.
The stock took a quick nosedive following the update but quickly rebounded back to recent highs, though OLED shares remain down some 13% from where they were a year ago. As with all businesses tied to manufacturing, sales can be volatile and highly sensitive to supply and demand, so investors were unphased by the dire-looking pandemic report card. Besides, management said results should improve in the third quarter and beyond, although it wasn't ready to give any specific numbers. Longer-term, the previous outlook for OLED screen manufacturing capacity to increase 50% from 2019 levels by the end of 2021 remains intact.
And as with Fortinet, the best thing about Universal Display is that this growth company is a highly profitable one. Even with sales drying up in Q2, free cash flow remained positive at $20.2 million through the first half of the year. And with OLED tech still making up a low-single-digit percentage of total global screen market share, there's still plenty of room for this outfit to keep going. I expect business results to rebound in grand fashion in the next year, just as they have in the past from previous sales slumps.
3. Cloudflare: Building a better internet
Shifting gears back to enterprise tech, Cloudflare stock is also down double-digit percentages since reporting on its second quarter -- but up nearly 120% so far in 2020, it was bound to take a breather sooner or later. But let's not take away from the internet infrastructure firm's accomplishments amid the pandemic.
Cloudflare, which develops web-based and edge network security and content delivery services, added 7,000 paying customers during the second quarter, bringing the total count up to over 96,000. Among those new users of its platform, large customers that pay at least $100,000 a year increased 65% from last year. With the operations of businesses large and small undergoing massive disruption and security attacks a constant concern during Q2, Cloudflare's software-based infrastructure was in high demand. Building on the 49% increase in 2019, Q2 2020 sales soared 48% during the spring months to $99.7 million.
Also of note, Cloudflare's adjusted net losses narrowed dramatically to just $9.6 million, compared to losses of $18.6 million last year. And though it was a difficult period, gross profit margin on services rendered remained high at nearly 76%. While this technologist is all about growth now and profits later (the outlook for Q3 called for year-over-year growth of 39%), those high-margin software services will eventually translate into a lucrative bottom-line.
Paired with Cloudflare's continued expansion, it explains the steep premium currently priced into the stock. Even after coming down nearly 20% from all-time highs, shares trade for 27 times expected full-year 2020 revenue. But Cloudflare has big potential in the web security and general cloud computing and edge network industry. With the long-term tailwind propelling this software firm forward only strengthening in recent months, this growth stock remains on my buy list.
