Growth stocks have been the place to be over the past year as the stock market recovered from the crash that marked the beginning of the pandemic in the U.S. Some stocks have delivered multi-hundred-percent returns in the matter of months, despite little or no change in long-term prospects.
The party won't last forever. Sky-high valuations will eventually fall back to earth, and even the best companies could see their stocks hit hard. Ultra-high prices make buying many growth stocks today risky, but a market crash could create some buying opportunities.
Two growth stocks that have caught my eye are The Lovesac Company (LOVE 4.09%) and Paycom Software (PAYC 2.25%). Both stocks are too expensive for me to touch right now, but I'll be interested if they get dragged down when the market takes a dive.
1. The Lovesac Company
Modular furniture seems like a pretty good idea to me, especially when it comes to large items like couches and sectionals. Bulky furniture that won't easily fit through doors becomes a big pain the moment it needs to be moved.
A modular sectional, comprised of smaller pieces that are combined into different configurations, solves this problem. The pieces can be easily shipped to the buyer using standard shipping services, and the sectional can be disassembled and moved quickly and easily.
Lovesac is one company that has found success selling modular sectionals. The company's "sactionals" aren't cheap, but they've become increasingly popular as the pandemic has dragged on. Lovesac booked 43.5% sales growth in the third quarter of last year, and the company turned a profit thanks to higher sales, a higher gross margin, and some solid operating leverage.
Lovesac is still a small company, with third-quarter revenue of just $75 million, but the total addressable market is quite large. The market for retail furniture and bedding in the U.S. this year will top $114 billion, according to IBISWorld. Lovesac only addresses a portion of this market, and its premium pricing further limits its market share. But it's not hard to imagine Lovesac eventually topping $1 billion in annual sales.
Shares of Lovesac have soared over the past year, pushing up the market capitalization to nearly $1 billion. That's a high price to pay for a small furniture company, so it may be wise to wait for a significant pullback before jumping in. There are significant risks, including lower-cost competition from other modular furniture companies and a potential slowdown in the housing market. But the modular furniture trend seems likely to continue, and Lovesac is a leader.
2. Paycom Software
Paycom is a bit of an outlier when it comes to software-as-a-service stocks. The HR and payroll software provider is growing at a double-digit rate, but it's also highly profitable. While many SaaS companies pour cash into sales and marketing to boost growth at the expense of the bottom line, Paycom does not.
Revenue was up 12.3% in Paycom's third quarter, not a bad result given Paycom's customer base skews small. Paycom's target client size range is 50 to 5,000 employees, and some of those clients have been forced to decrease headcount due to the pandemic. This is hurting Paycom's recurring revenue, and it will continue to do so until headcounts return to pre-pandemic levels.
Despite the pandemic headwind, Paycom has remained solidly profitable. GAAP net income was $27.5 million in the third quarter, and the company spent just one-third of revenue on sales and marketing. Net income was down from the prior-year period, but that dip is likely just a pandemic-driven bump in the road for Paycom.
Other SaaS companies spend far more to acquire customers. Telemedicine company Teladoc, for example, poured nearly half of its revenue into sales and marketing in its latest quarter. SaaS giant Salesforce still spends around 45% of revenue on sales and marketing despite its size.
Paycom hasn't benefited from the pandemic, but the company has remained profitable and continued to grow. The stock is pricey, trading for over 25 times sales and over 150 times earnings. If the market heads lower and drags Paycom down with it, it's a stock to consider.