One of the best parts about being a contributor with The Motley Fool is that I get to spend lots of time learning about great companies. And to be sure, there are hundreds of public companies doing some really cool things. That said, it's not necessarily a good investment opportunity just because it's a cool business. Every idea needs to have its business model dissected to see if it can create shareholder value over time.
However, like cream in fresh milk, great investment ideas rise to the top over time. And I'd like to share my five creamiest stock choices with you today. In no particular order, these five are Latch (LTCH 10.60%), Pinterest (PINS 1.81%), Zoom Video Communications (ZM 5.70%), Magnite (MGNI +1.35%), and Peloton Interactive (PTON 2.53%).
Image source: Zoom Video Communications.
Now I'll present them in order from my fifth favorite to my first and explain why I think all five of these stocks are great buys right now.
5. Zoom Video Communications
Zoom is a videoconferencing tool, and its core product is called Meetings; it's what most people likely think of first when Zoom is mentioned. The Meetings tool is primarily used by businesses of all sizes to allow their increasingly mobile workforces to communicate and collaborate. Meetings continues to entice new users to join the platform, so this core product from Zoom is doing well.
At a recent event, Zoom management detailed three other avenues for future growth, and this has me excited.
First is a product called Zoom Phone. This isn't a phone for handling incoming and outgoing calls but rather an operating system for a company's internal phone infrastructure. Right now, less than 4% of Zoom's 500,000 customers have signed up. However, in the second quarter of its fiscal 2022, 76% of Phone revenue came from customers who already had Meetings. This suggests that Zoom can continue to grow its business by upselling its Phone product to existing customers.
Speaking of upselling, Zoom can also grow via Zoom Rooms. This is a product that leverages Zoom's strengths in videoconferencing and combines it with traditional conference room necessities. Again, less than 5% of current Zoom customers are deploying Rooms, but it could become a necessity for many. According to a survey by Accenture, 83% of workers prefer hybrid work. And according to research firm Frost & Sullivan, there are over 90 million meeting places around the world, and Zoom believes it can digitize all of them with Rooms.
Finally, Zoom Apps might be the greatest optionality lever the company has. Essentially, the company is allowing third parties to build apps that integrate directly with its video platform. For example, DocuSign is an early adopter. Zoom has reserved $100 million to fund third-party app developers, and it has no idea where it could go. This is less than 2% of the company's cash but could open up doors it wasn't anticipating. For example, management mentioned that game developers are now looking to build video games on Zoom. These optionality seeds cost relatively little but could grow into large trees.
For these three reasons and more, I think Zoom is a good stock to buy now.
Image source: Peloton Interactive.
4. Peloton Interactive
I like Zoom because its core business is solid and has optionality for future growth. The exact same thing could be said about connected-fitness company Peloton. Some investors recently got worked up over customer churn because the net monthly churn rate crept up in the most recent quarter. But this minor concern misses the bigger picture. Zooming out, Peloton's retention rate is 92% over the past 12 months, which is its historical average.
Users tend to loyally subscribe to Peloton's fitness content for years after buying its workout devices. And that's great for this company considering the profit profile is completely different for its hardware and video-content businesses. In the most recent quarter, the hardware gross margin was just 11.6%, whereas the subscription gross margin was 63.3%. Therefore, as subscription revenue increases its percentage of total revenue, profitability improves.
The question investors should ask is whether Peloton can continue to attract new subscribers and grow this higher-margin business. In my opinion, the answer is yes: The company has multiple avenues to accomplish subscriber growth. It can still grow with its (now cheaper) stationary bike, but it also just relaunched its treadmill. Consider that management believes the treadmill category is up to three times larger than stationary bikes, so this could be a great growth driver, especially on the subscription side.
Moreover, consider Peloton's inroads in the commercial and corporate spaces. With commercial, the company acquired Precor to bolster its presence in fitness centers and hotels. And with corporate, it recently announced a partnership with UnitedHealthcare (part of UnitedHealth Group) to bring Peloton's App to its 4 million members.
With all of these avenues for new member acquisition, it seems many more people will be subscribing to Peloton's content in the future, and that's part of why I still like the stock for the long haul.
Image source: Getty Images.
3. Magnite
Magnite is an advertising technology company that went all-in on winning the connected-TV market. CTV refers to streaming video content on your TV. Here's what I mean by all-in: In the past two years, Magnite has grown by first merging The Rubicon Project and Telaria, then acquiring SpotX for $1.14 billion, and subsequently buying out SpringServe for $31 million.
Growth fueled by acquisitions is typically risky, but it appears to be working out for Magnite. Combining these four small players has resulted in it becoming the largest player in the space today. And, as a result, it now has the most desirable list of customers in Disney, Discovery, Roku, and more.
To further illustrate, sports-centric streaming service fuboTV was a SpotX customer but recently announced it's sticking with Magnite now that the acquisition is complete. And the ad inventory from fuboTV is perhaps the crown jewel of CTV. In fuboTV's most recent quarter, advertising average revenue per user was $8.70 per month -- that's more than double what Roku brings in, and Roku is one of the best. But fuboTV management believes it can improve further to over $20 per month in time. Furthermore, consider it has just 682,000 subscribers today. So overall ad revenue could explode higher as the user base grows, all of which will benefit Magnite as well.
However, Magnite didn't go all-in on CTV just so it could grab the best customers. It's pursuing CTV because it's a market worth pursuing in the first place. Over the next five years, management believes the CTV market will expand from $9 billion today to $50 billion. Therefore, positioning itself for a large piece of this growing pie could result in a higher stock price in the years to come.
Image source: Pinterest.
2. Pinterest
As of this writing, Pinterest's stock price is down 42% from its all-time high. The market soured on this company because its user base shrank in the last quarter. In the first quarter of 2021, it had 98 million monthly active users in the U.S. and 380 million internationally. By the second quarter, these totals had dropped to 91 million and 363 million, respectively.
I'm hopeful that the second quarter was an anomaly and Pinterest can return to user growth in the coming quarters. But here's how the business can still win even if user growth stagnates. Advertisers are just catching on to how good Pinterest's platform is, and demand is growing. In the U.S., second-quarter users were down 5% year over year, but second-quarter revenue was up 107% during that time.
Fewer users for Pinterest resulted in higher revenue because monetization is erupting higher. It's a trend that looks set to continue as the digital ad market grows. And this growing monetization has an underappreciated benefit. The company's gross margin has been steadily improving since it went public just two and a half years ago and is quickly approaching a stellar 80%, increasing Pinterest's long-term profit potential.
PINS gross profit margin data by YCharts.
Growing revenue and growing profit margins are enough on their own to make Pinterest stock a market-beater. However, I rank this stock so highly because I believe the company will also return to user growth and find other avenues to monetize its platform, only adding to the upside.
1. Latch
Investors should be looking for stocks where the balance of risk and reward is disproportionately tilted in their favor. And I believe that property-technology company Latch is more tilted in investors' favor than any other stock on the market. I know that's a bold statement, but I intend to back it up.
Latch installs smart locks in apartment buildings to save landlords time and money: no need to re-key a door with tenant turnover. The company believes this can save landlords between $100 and $300 per apartment per year, which is an incredible value proposition. Maybe this is why Latch has never lost a customer in its still young four-year history.
Smart locks from Latch are sold at a loss, which makes this company's financials look a bit messy. But these locks require an operating software subscription, and that's where this company expects to make its money. The Latch OS subscription costs between $7 and $12 per apartment per month, an expense that landlords can pass on to tenants. And the whole setup is typically sold on six-year contracts.
Because there's financial incentive from landlords and long-term contracts in place, I consider Latch a safe business. And business is booming more than expected. When it went public, Latch management expected to sign $308 million in contracts (called bookings) this year. Now that the first half of 2021 is complete, it has updated expectations to a range of $325 million to $340 million.
Latch's growth is ahead of schedule, and something exciting should start happening soon. Software revenue has a 90% profit margin but only makes up 20% of the mix right now. This is growing. And by 2025, software bookings should account for 65% of total bookings. With this complete transformation in revenue structure, management expects to generate $249 million in free cash flow (FCF) in 2025.
Stocks with dirt-cheap valuations can trade at 10 times their FCF. More-fairly valued stocks often trade at 20 times FCF. If Latch traded in this conservative range, it would have a market capitalization between $2.5 billion and $5 billion, compared to just $1.8 billion as of this writing. That's a 39% to 178% return in four years and most likely market-beating results.
Don't settle for my five
These are my five favorite stocks right now. But remember: I don't know everything. Every day I stumble across companies for the first time. And there are countless more stocks that I know about but haven't yet researched. Moreover, many companies are outside my circle of competence, so I don't give them much attention.
For these reasons, I stay on the lookout for new ideas all the time. Additionally, I do my best to read research from other people. Sometimes I'll gather priceless insights on companies I don't feel comfortable researching myself. Other times I pick up valid counterarguments to my ideas that I hadn't previously considered. The point is, finding and buying great stocks is an ongoing journey, so don't settle for just my five favorites. There are more.
