Stock market indexes like the S&P 500 and the Nasdaq are trading within about 2% of all-time highs as of this writing. But just because the market averages remain strong, that doesn't mean everything is doing well. In fact, many stocks trade well below their 52-week highs, including Zoom Video Communications (ZM 3.49%), Peloton Interactive (PTON 2.62%), and Magnite (MGNI 1.73%).
All three of these stocks were big winners in 2020, up 396%, 434%, and 276%, respectively. As we'll see, there are good reasons to buy and hold these past winners, but all three companies are down around 40% from their 52-week highs as investors abandon their long-term theses. Here's why giving up on these stocks so soon is a big mistake.
Image source: Zoom Video Communications.
But we're getting back to normal!
In 2020, Zoom enabled people to continue their social and work lives even as they physically distanced themselves to prevent the spread of the coronavirus. But the situation is rapidly changing. Half of the U.S adult population has now received a dose of a coronavirus vaccine, and about a quarter is already fully vaccinated.
Investors fear that the once ubiquitous Zoom call will be an afterthought in a post-pandemic world. But the company's management doesn't see it that way. Sure, it doesn't anticipate matching its 326% annual revenue growth from 2020, but Zoom is still guiding for 42% growth in 2021 -- over $1 billion more in incremental revenue. That's an impressive growth rate for any company, and it's especially impressive on the heels of a historic year. And management gave this guidance fully aware that the world is starting to return to normal.
Much of management's optimism comes from its Zoom Phone product. Many Zoom video customers have increased their spending to include an overhaul of their infrastructure for voice. Packaging voice and video together makes sense, giving Zoom the upper hand in landing contracts with more of its customers. And as workers return to the office, it increases the likelihood of companies seeing Zoom Phone as a timely and necessary upgrade.
However, the true wild card for Zoom, in my opinion, is its optionality for the future. It generated $1.4 billion in free cash flow in 2020 and ended 2020 with $4.2 billion in cash and marketable securities, giving it a lot of firepower to pursue other business opportunities in the workplace-management space. Furthermore, management is actively looking for suitable companies to acquire right now, giving Zoom more expansion potential.
Image source: Peloton Interactive.
But gyms are reopening!
Similar to investors' misgivings over Zoom, many are giving up on Peloton because brick-and-mortar gyms have a clear path to fully reopening. For example, consider that 90% of Planet Fitness gyms are now open. In short, the home-fitness space had little competition in 2020, but the competition is back.
Tapping into the wide open market, Peloton doubled its revenue in fiscal 2020 (ended June 30, 2020) to $1.8 billion. On a calendar basis, revenue was up 139% last year. But those who are writing off Peloton are forgetting something important: Its compound annual growth rate for revenue is over 100% since 2017. In other words, fiscal 2020's top-line result wasn't an anomaly.
Moreover, something important is happening beneath the surface with Peloton. When the company sells a treadmill or stationary bike, it also starts collecting subscription revenue for its interactive content. In fiscal 2020, roughly 20% of total revenue came from its subscription segment -- on par with the previous year. But as this subscription service scales, its profit margin is expanding. Subscription revenue had a 43% gross margin in fiscal 2019. In 2020, it carried a 57% margin.
Peloton is guiding for at least 123% revenue growth in fiscal 2021 even though gyms are reopening. And its profitability is expanding along with the subscription business. To me, its long-term prospects still look very bright.
Image source: Getty Images.
But there's limited upside!
Since its initial public offering, shares of The Trade Desk are up well over 2,000%, making it one of the biggest market winners over the last five years. In 2020, investors started looking at Magnite as a younger version of The Trade Desk -- an unfortunate comparison leading to unrealistic expectations.
The Trade Desk is a demand-side ad-tech company, whereas Magnite is the largest independent supply-side ad-tech company. We need both the demand side and supply side, yes. But supply-side players partner with publishers instead of advertisers. And because there are more advertisers than publishers, demand-side players logically have longer growth runways.
It seems investors are waking up to the more-limited upside for supply-side ad-tech players and are now giving up on Magnite stock. But just because the space is smaller doesn't mean the stock can't beat the market from here.
According to a recent survey by the Interactive Advertising Bureau, 60% of advertisers plan to shift spending away from linear-TV sources (like cable) and toward connected-TV (CTV) in 2021. And eMarketer expects CTV spending to nearly double in the next two years alone. This undeniable trend equally benefits supply-side companies like Magnite and smaller competitor PubMatic. But being the biggest supply-side player in the space has its advantages as Magnite's recent deal with Innovid illustrates.
Innovid is a company that's bringing more interactive ads to CTV, and it just announced it's partnering with The Trade Desk and Magnite to increase adoption. Interactive ads can increase consumer engagement, which is a reason advertisers may increasingly pursue this style of CTV ad. And I don't think it's a coincidence Innovid chose Magnite as a partner -- as the biggest players, Magnite and The Trade Desk have scale to increase the project's odds of success. Indeed, Magnite's scale is partly why I consider it a top way to play the CTV trend.
Don't give up
Investors shouldn't be contrarian just to be different. But when you have good reason to make a contrarian investment, it can pay off. I believe that's the case with these companies. Zoom, Peloton, and Magnite may have fallen out of favor in recent months, but if they continue to capitalize on their long-term opportunities, Wall Street will eventually come back around to these stocks, rewarding the investors who patiently endured these down times.
