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2 Growth Stocks to Buy in the Next Downturn

By Ryan Henderson – Oct 30, 2021 at 6:50AM

Key Points

  • Broad market drawdowns provide good entry points for quality companies.
  • Match Group has a winning portfolio in a booming industry.
  • Spotify is leveraging its scale to increase profitability.

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Corrections come frequently, so investors may want to consider these two quality compounders when the next one hits.

Unfortunately for investors, best-in-class companies that are growing at a quick rate often command premium valuations. On the flip side, however, that same cohort of higher-growth stocks tends to see quicker declines during broad market sell-offs. For investors with ample liquidity, those sell-offs can present great buying opportunities.

Here are two high-quality businesses investors should keep an eye on during the next broad market decline. 

A person using their smartphone with lots of icons popping up around it.

Image source: Getty Images

Match Group

Match Group (MTCH -3.77%) is an online dating conglomerate that's home to dozens of different brands -- most notably Tinder. Since going public in late 2015, Match Group has touted an annual revenue growth rate of roughly 20% and a free cash flow growth rate of over 25%.

While the company certainly deserves responsibility for generating much of that growth, it has also benefited in a big way from the explosive adoption of the entire online dating category. In fact, in 2017, according to data from the Proceedings of the National Academy of Sciences, almost 40% of heterosexual couples in the United States met online -- roughly double the amount from 10 years prior.

With Tinder as its flagship app, Match Group is now home to roughly 15 million paying users, which is 15% more than the same period a year ago. Those paying users are also demonstrating a higher propensity to spend as the company's average revenue per payer has increased 10% during that same time period. Although Tinder continues to grow revenue at a rapid pace and still accounts for the lion's share of the company's overall sales -- 56% as of the latest quarter -- it's not the only brand under Match Group's umbrella that's seeing success. 

In its latest shareholder letter, Match Group reported that it expects to reach $300 million in revenue from its emerging brands in 2021 -- that's more than double its 2020 figure. While there are several different apps under this "emerging brands" category, it's likely Hinge that's grabbing investors' attention.

Marketed as the app that's "designed to be deleted," Hinge is more outcome-focused than Tinder and seems to be attracting an entirely new audience to the dating category. Match Group's CFO Gary Swidler even provided more color on the app's impressive growth by saying, "Hinge is on track to more than double revenue in 2021 after it tripled."

Though it's probably fair to assume that Match Group will continue to grow both its revenue and cash flow over the coming years, the company's market cap to free cash flow ratio currently stands at 59 times. That's a pretty hefty price to pay for just about any company, so investors may want to keep a close eye on it for any potential future downturns. 

Spotify

Spotify Technology (SPOT 0.53%) is the world's largest audio streaming platform. By introducing a first-of-its-kind ad-supported or subscription-based streaming experience, the company has helped return the entire music industry to growth. However, since its inception, the majority of the content on Spotify's platform belonged to artists and labels, which required the company to pay out a significant percentage of its revenue to those respective rights holders. But that percentage is beginning to shrink. 

While labels and artists will almost certainly always have a claim to some chunk of Spotify's revenue, the company is beginning to take advantage of its size. As of its second-quarter report, Spotify had 365 million total monthly active users on its platform, with many of those users hoping to discover new music. To aid in this discovery process, Spotify can utilize users' listening habits to recommend new artists or creators, and one way Spotify does this is through its own original playlists.

For artists who want to get their music in front of a bigger audience, they can recommend their own songs to be included in some of Spotify's hit playlists like Today's Top Hits or RapCaviar, which both have millions of followers. In exchange for these promotions, artists can offer reduced royalty payouts, which enable Spotify to collect a bigger slice of its revenue. 

But it's not just music that should have investors excited. Spotify is diversifying its revenue streams into all things audio -- primarily podcasting. Over recent years Spotify has made several significant podcast-related investments including distribution platforms, original and exclusive shows, and even some lesser-known live audio and discovery tools. Thanks to these acquisitions, Spotify is beginning to reap the benefits. 

Last quarter, Spotify reported that its revenue from podcasting grew by more than 600% when including acquisitions and nearly 200% without. This portion of the business gets included in the company's advertising revenue, which CEO Daniel Ek has placed heavy emphasis on lately. During Spotify's latest quarterly conference call, Ek said, "The days of our ad business accounting for less than 10% of our total revenue are behind us".

So whether it's through leveraging its scale in music or capitalizing on new forms of audio, Spotify looks poised to grow both its revenue and profitability in the near future. With this in mind, the company's current market cap to gross profit ratio of roughly 18 times doesn't seem too crazy to begin with, but it can't hurt investors to add on downswings as well.

Ryan Henderson owns shares of Match Group and Spotify Technology. The Motley Fool owns shares of and recommends Match Group and Spotify Technology. The Motley Fool has a disclosure policy.

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