Is Dropbox Stock a Buy?

Dropbox's (DBX 0.68%) stock price recently dipped after the cloud storage service provider posted its fourth-quarter earnings. Its revenue rose 13% year over year to $504.1 million, beating estimates by $5.4 million.

Its adjusted net income jumped 75% to $117.9 million, or $0.28 per share, which also cleared expectations by four cents. Those growth rates look solid, so why weren't investors more impressed?

Let's dig deeper into Dropbox's strengths and weaknesses to see if it's still worth buying.

How does Dropbox make money?

Dropbox operates a freemium model, which grants paid users more storage and additional features. It offers 2GB of storage for free users, and individuals who pay $9.99 per month get 2TB of storage. A new family plan splits 2TB between six users for $16.99 a month, while its enterprise plans start at $12.50.

Image source: Getty Images.

Box (BOX +0.69%), its smaller competitor, provides 10GB of free storage, but users who pay $10 a month only get 100GB of storage. However, Box's enterprise plans start at just $5 a month.

Dropbox and Box both face intense competition from tech giants like Microsoft (MSFT 1.57%), Alphabet's (GOOG 0.56%) (GOOGL 0.42%) Google, and Amazon (AMZN 0.87%), which can all afford to offer similar services at lower prices.

The key growth rates

Dropbox believes it can continue to attract new individuals and businesses that don't want to be tethered to those big tech giants. After all, it still ranks second in the cloud storage market after Google Drive, according to Datanyze, followed by Microsoft, privately held Egynte, and Box.

However, Dropbox's revenue only rose 15% in fiscal 2020, compared to its 19% growth in 2019 and 26% growth in 2018. Its growth in paid users also decelerated over the past year.

Data source: Dropbox. YOY = Year over year. Non-GAAP margins.

On the bright side, Dropbox's ARPPU (average revenue per paying user) continued climbing, and its gross and operating margins expanded.

Data source: Dropbox. Non-GAAP margins.

Dropbox attributed its stable ARPPU growth to the growing adoption of its family plan, which was launched in late 2020; new features like Vault, which adds an additional layer of security for sensitive documents; and its integration of the electronic document signing service HelloSign in 2019.

It noted the more efficient usage of its infrastructure hardware lifted its gross margins over the past year. Meanwhile, a shift to remote work and a delayed brand campaign during the pandemic reduced its R&D and marketing costs, respectively, and boosted its operating margins.

The main weaknesses

Dropbox's core business looks stable, but there are three glaring problems. First, it expects its revenue to rise just 11% year over year in the first quarter of 2021, and a mere 9%-11% for the full year.

Image source: Getty Images.

In other words, Dropbox's slowdown will continue as the cloud storage market matures and the top platforms lose their pricing power. Google, Microsoft, and Amazon can afford to operate their cloud storage platforms at losses to tether more users to their other cloud services, but Dropbox and Box can't. 

Second, Dropbox has remained unprofitable by GAAP measures ever since its IPO in 2018. It posted a net loss of $256.3 million in fiscal 2020, compared to a loss of $57.2 million in 2019, mainly due to non-recurring real estate impairment charges in the fourth quarter.

Dropbox should post a narrower loss in 2021, but its high stock-based compensation expenses -- which gobbled up 14% of its revenue in 2020 -- should prevent it from turning profitable anytime soon.

Lastly, Dropbox is constantly buying back its own shares, which is an odd strategy for an unprofitable tech company that should be focused on growth. It authorized a $600 million buyback program in early 2020, repurchased nearly $400 million in shares throughout the year, and plans to exhaust the program in the first quarter of 2021. It plans to follow up that program with another $1 billion buyback plan.

However, Dropbox's number of outstanding shares actually increased nearly 1% in 2020. In short, it's merely repurchasing its own shares to offset the dilution from its own stock bonuses.

Is Dropbox worth buying?

Dropbox's stock looks cheap at 16 times forward earnings and less than five times this year's sales. But it's cheap because investors expect its growth to decelerate, and for its GAAP earnings to remain in the red. Dropbox's valuations should limit its downside potential, and it might still be an appealing takeover target -- but it's just not a compelling investment when other tech stocks offer much stronger growth.