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5 Reasons This Short-Squeeze Candidate Could Actually Pan Out in the Long Run

By Jon Quast – Nov 16, 2021 at 7:50AM

Key Points

  • The digital advertising industry is one of the fastest-growing markets around.
  • PubMatic is attracting and retaining customers very well.
  • The business is small, but it has great margins and is led by a good group of co-founders.

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There are too many positives with this business to bet against it over the long term.

Advertising technology company PubMatic (PUBM -3.73%) has been on a volatile ride since it went public last December. The initial public offering was priced at $20 per share, which some apparently thought was too expensive. In short order, PubMatic stock was one of the most heavily shorted on the market -- people were betting it would go down.

However, around that time, another group of investors were banding together to force short squeezes among the market's most heavily shorted stocks, PubMatic included. As a result, its stock price skyrocketed over $75 per share toward the end of February. It's back down to around $40 per share as of this writing, so it's been a wild ride for sure.

Here are five reasons this stock is far more than just a short-term short-squeeze trade. 

Two businesspeople discuss information displayed on a computer.

Image source: Getty Images.

1. PubMatic has a huge and growing market opportunity

Let's start with the big picture: PubMatic does business in the advertising industry, which is undergoing a transformational change -- ads are increasingly going digital because they can target specific audiences and have measurable results. Many research companies confirm how big and fast-growing the market is, but consider just one recent report from The Business Research Co. This report pegs the digital advertising market at $281 billion by 2025, growing at almost 12% annually from where it is today. 

As a supply-side platform (SSP), PubMatic partners with publishers to sell their ad slots and maximize that revenue. And the company's customer growth suggests it will grab a nice piece of the $281 billion digital-ad pie. Consider just one part of the market: connected TV (CTV). In the first quarter of this year, PubMatic had just 80 CTV publisher customers. In the third quarter, it had 154 -- nearly double the customer count in just six months.

2. PubMatic customers are happy

Gaining new customers is one thing, but investors need to be able to gauge whether PubMatic can retain its customers. Fortunately, software-as-a-service (SaaS) companies have a handy metric called the net dollar-based retention (NDBR) rate. An NDBR rate of 100% means customers spent the same this year as they did a year ago. Therefore, an NDBR rate over 100% suggests customers are satisfied -- after all, why would you spend more if you weren't pleased with the results?

In Q3, PubMatic had an NDBR rate of 157% -- you won't see many other companies with a percentage this high. Not only was this far improved from the NDBR rate of 110% PubMatic reported in the same quarter last year, but it was improved from the already stellar 150% it posted last quarter. In fact, PubMatic's NDBR rate has increased sequentially in six of the past seven quarters, enough to establish this is a long-term trend, not a fluke.

An investor lifts their glasses, seemingly impressed by something seen on a computer.

Image source: Getty Images.

3. PubMatic has market-beating financials

Because PubMatic's customer count and customer spending are both increasing, it has robust revenue growth. Through the first three quarters of 2021, the company's revenue is up 63.6% from the same three quarters of 2020. However, this is more than just a high-revenue-growth story. It also has attractive profit margins that are improving as the business scales.

First, we can look at gross-profit growth. Through the first three quarters, it's up 75.2% year over year, outpacing revenue growth. Second, we can look at operating expenses, which are only up 48.7% over this same time period. In other words, both PubMatic's gross margins and operating margins are getting better.

With no debt and $136.7 million in cash, cash equivalents, and short-term investments, PubMatic is in strong financial shape. And it's only getting stronger as the business grows.

4. PubMatic has solid management

Many good investments are founder-led companies. It doesn't guarantee success, but it's often a positive. In PubMatic's case, it doesn't just have the involvement of one founder but four co-founders who are still leading the company.

At the top are two brothers: CEO Rajeev Goel and Chairman Amar Goel. Rajeev Goel has a 92% approval rating on third-party employment review site Glassdoor. And between the two of them, they own over 2 million shares of PubMatic's Class B shares, or around 4% of the total Class A and Class B combined share count. This means their financial interests are aligned with common shareholders.  

5. PubMatic had a small starting point

If you add up the value of all of PubMatic's outstanding shares -- known as market capitalization -- it amounts to about $2 billion. That's a small starting point that makes high growth a little bit easier. Consider that if a $1 trillion company comes up with a $10 billion idea, it doesn't even register. If a $2 billion company has the same idea, it's transformational.

Investors generally agree that buying small-cap stocks like PubMatic can result in a high upside. but many stay away because they're perceived as more risky. It's certainly true that there are many high-risk small-cap stocks. But considering its huge and growing market, happy customers, market-beating financials, and strong management, PubMatic isn't high risk like many of its small-cap peers, in my opinion. 

For these five reasons, I say PubMatic stock is far more than a short-squeeze candidate. It's the kind of business that can deliver shareholder returns over the long term.

Jon Quast owns shares of PubMatic, Inc. The Motley Fool owns shares of and recommends PubMatic, Inc. The Motley Fool has a disclosure policy.

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