My top stock pick in July is a leading direct-to-student learning platform. Chegg (CHGG 0.85%) was a prime beneficiary of the pandemic as millions of students were abruptly forced into remote learning.
The switch to online learning left a void in resources that students normally accessed on campus. Students now had to continue studies without the campus library, tutors, and in-person professor office hours. That void led to a surge in usage at Chegg.com, and the benefits of that surge will be long-lasting for the company.
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Content is king
Indeed, subscribers to Chegg services increased by 67% in 2020 to reach 6.6 million. Many of them are likely to stick around even as the pandemic goes away, primarily because many of the users of Chegg's services give it scores over 90% on several satisfaction metrics. If students are finding the product incredibly useful, they are likely to stick around. And at less than $20 per month, it's a relative bargain compared to the price of a college course or the price of a private tutor.
Moreover, as part of a subscription, students have the option to ask up to 20 questions per month from subject matter experts. The questions and answers then are made available to all Chegg subscribers going forward. The surge in usage during the pandemic allowed Chegg to build up a valuable inventory of content. Chegg reported having 53 million pieces of this type of content in the most recent quarter.
The material is not only useful in serving existing members, but it also helps attract new subscribers. A student grappling with a problem might enter that problem into an internet search engine; if Chegg has content that can help, its website will pop up in the search results. A few clicks and a payment method later, Chegg can have a new subscriber, and the student will have the help they were looking for.
Profitable expansion
The business model is built to scale efficiently. It's evident in Chegg's 78% compounded annual growth rate in adjusted EBITDA from 2016 to 2020.
Management is expecting the margin to continue expanding. Here is what CFO Andrew Brown said at an investor conference in June:
And so we don't do a lot of paid marketing. So as we think about the future, we think -- we believe that we will continue to be a high growth on the top line. We continue to believe that there's continued expansion for many years, EBITDA margin expansion on the bottom line. Last year, I think we were -- we increased EBITDA margins 200 bps. This year, based upon my guidance, it's 300. And so we continue to expand our EBITDA margin, and we just don't see that stopping in the near term.
Intuitively it makes sense. It doesn't cost Chegg much more to serve 10 million subscribers than it would to serve 5 million subscribers. And its customer acquisition costs are low because they are coming mostly through unpaid channels.
Moreover, Chegg has several years and multiple sources of growth ahead. Its international expansion is in its early stages, and management expects its professional skill-building business to be worth several hundred million dollars in roughly five years.
There's a reason Chegg's valuation is high right now
The stock is certainly not cheap, trading at 14.85 times forward sales, but there is a reason for that. Investors value the company's excellent long-run prospects, tons of proprietary content giving it a strong moat, and a business model built to scale efficiently. For those reasons, Chegg is my top stock pick right now.
