Growth stocks are attractive investments to put in your portfolio because their sales are rising, which often attracts a lot of bullishness. But it's all for naught if the company isn't making much money on those sales. A key metric investors should always consider is gross margin: how much of the company's revenue is left after it's covered overhead and operating expenses. A company with a high gross margin -- say 60% or above -- has a path to hit breakeven even if it's not profitable now, especially if its sales numbers continue to rise.
Three stocks that investors should consider adding to their portfolios today -- all of which are growing and have high gross margins -- are Veeva Systems (VEEV -0.08%), DocuSign (DOCU 0.79%), and Activision Blizzard (ATVI). Not all of these companies are profitable today, but with great margins, they're in good shape to generate profits over the long term.
1. Veeva Systems
Veeva's focus is on providing cloud-based solutions for healthcare companies. Its Veeva Vault product helps companies manage data, while Veeva Commercial Cloud is a customer relationship management solution that promotes more meaningful interactions to drive sales growth. And the California-based company has been growing at a rapid pace. Its most recent quarterly results, released Aug. 27 for the period ending July 31, showed sales of $353.7 million (up 33% year over year) and net income of $93.6 million (up 18%).
Image source: Getty Images.
The company's profit margin (the amount of each dollar that turns into profit) is an impressive 26% thanks to its high gross margin, which is sitting at 72% year to date. With operating expenses accounting for just 46% of the company's top line this year, there's been plenty left over to flow through to Veeva's bottom line.
This year has been one of transition for many companies, which are moving their operations to the cloud and generally being more adaptable during the pandemic. For their part, many more employees are working from home. These trends are likely to continue for the foreseeable future, and for Veeva investors, that's great news. Thanks to its high gross margins, as the company's sales continue to rise, so too will its bottom line.
2. DocuSign
Another strong cloud-based business is DocuSign, which, through its electronic signatures, makes it easy for businesses to continue operating even during a pandemic. On Sept. 3, the company released its latest numbers for the period ending July 31, showing that sales of $342.2 million were up 45% from the prior-year period. CEO Dan Springer described the growth as "scratching the surface," noting that the company is "increasingly becoming an essential cloud-software platform for organizations of all sizes."
Year to date, its top line has reached $639.2 million, which is 42% higher than it was during the same time last year; meanwhile, its net loss of $112.4 million is 1.7% smaller than last year's. Unlike Veeva, DocuSign is still struggling with profitability, but its high gross margins can help improve its bottom line over time.
For example, this year's operating expenses of $575.1 million (up 30% this year) are 90% of its top line; a year ago, these costs ate up 99% of revenue. As DocuSign's business stabilizes and operating expenses make up a smaller portion of its top line, the company will inch closer to profitability.
In 2020, DocuSign's gross margin has been an impressive 74% of sales -- right around where it was a year ago. If it can maintain these high margins, investors can expect its bottom line to continue to show improvement, which will make it a much stronger investment overall.
The key thing to remember is that DocuSign would only need to get its operating expenses down to about 70% of revenue to turn an operating profit, and with a near-10-point improvement in just one year, it may not be too long before DocuSign's profitable.
3. Activision Blizzard
Video game company Activision Blizzard is also experiencing strong growth amid the pandemic this year as people are staying home. Through the first nine months of 2020, the company's net revenue of $5.7 billion was 26% higher than the $4.5 billion in sales it reported for all of last year. Although the company makes popular video games like World of Warcraft and Call of Duty, the beauty of its business is that the bulk of its revenue (close to 75%) comes from non-product sales, as gamers often need to pay to play online, and in-game purchases can quickly add up.
Year to date, Activision has posted a profit of $1.7 billion, for a net margin of 30%. Since Activision already has its loyal gamers and recurring revenue, it doesn't need to spend a bunch of money on growing its top line. The company doesn't specifically break out cost of sales and gross margin, but its total costs and operating expenses of $3.5 billion in 2020 have only been 62% of its total sales. Activision's strong growth this year, combined with its healthy margins, has helped its bottom line rise 73% thus far.
And with people continuing to stay indoors as COVID-19 case numbers are on the rise, things still look good for Activision. Its loyal gamers aren't likely to turn off their computers and consoles anytime soon.
Which growth stock is the best one to buy today?
All three of these stocks are dominating this year as people are spending more time at home amid the pandemic:
Despite a lack of profitability, DocuSign's been soundly outperforming the other stocks on this list. To determine which stock is the best buy, I'm going to look at their respective price-to-sales (P/S) ratios, which is useful when not every stock is profitable. Here's how they compare on that metric:
VEEV PS Ratio data by YCharts
Activision's clearly the better buy when looking at P/S, and with a great business model that benefits from a strong source of recurring revenue, it's the stock I'd go with today when choosing among these three. However, any of these growth stocks could be great to hold over the long term, as their businesses are strong and producing impressive margins.
