Earnings season is upon us, and with the broad sell-off going on right now among tech stocks, some buying opportunities have emerged. Three stocks that have taken a beating lately also happen to have the potential to soon report strong earnings: Unity Software (U +13.54%), DocuSign (DOCU 3.12%), and The Trade Desk (TTD 2.16%).
All three stocks are trading at levels down at least 40% from 52-week highs. While buying stock in quality companies at any time is the right strategy for long-term investing and timing the market is extremely hard to do successfully, making a purchase of these stocks when there is a potential positive-news catalyst on the horizon could increase your eventual long-term gains. Let's look at why these three stocks have such potential.
Image source: Getty Images.
1. Unity Software
During its third-quarter conference call back in early November, Unity Software management mentioned the word "metaverse" 14 times. When Unity reports earnings on Feb. 3 after the market close, I predict management to increase its use of the term significantly. Unity is expected to play a significant role in the development of the metaverse and has software tools it makes available to clients and users to do numerous metaverse-related development, including transforming building blueprints into realistic virtual reality models. Last quarter, it acquired Weta Digital, which will accelerate Unity's 3D creation abilities. As a key metaverse content creator, analysts and investors will be paying added attention to Unity management's comments in this area.
While the metaverse represents a huge opportunity, Unity's gaming segment keeps the lights on now. Last quarter, its revenue increased 43% year over year to $286 million. Its operations segment -- which focuses on operating and monetizing video games created on its platforms -- was the biggest driver of that growth, increased 54% year over year, and it accounted for 65% of total revenue.
Investors will look for Unity's creation segment to grow quicker than Q3's 34% year-over-year rate. If it does, expect the stock to get a bump as investors will take the growth as confirmation of the metaverse's coming.
One ding on Unity of late has been its spending and cash burn. In Q3, its loss from operations was $126.8 million, or 44% of revenue, mostly attributed to its $97 million stock-based compensation bill. Further improvement in this metric will also instill confidence that management is guiding the company toward a profitable path.
2. DocuSign
The e-signature facilitator and document management specialist had a booming business during the pandemic when finalizing deals and managing the documents associated with them in person were strongly discouraged. The difficulties created by the pandemic have eased and the company's growth has eased as well. Last quarter, investors showed their displeasure when management provided Q4 guidance that fell below expectations and gave billings-growth guidance that dropped below pre-pandemic levels. The stock price plummeted 42% the next day. It's down a further 11% since that Dec. 3 drop.
Expectations are low in Q4, setting the stage for a potential rise in guidance when earnings eventually get reported in early March, which is generally good for the stock's performance short term. Additionally, management has been crushing expectations all year.
| Metric | Q4 FY22 | Q3 FY22 | Q2 FY22 | Q1 FY22 |
|---|---|---|---|---|
| Revenue guidance (midpoint) | $560 million | $529 million | $482 million | $434 million |
| Actual revenue | TBD | $545.5 million | $511.8 million | $469.1 million |
| Beat | N/A | 3% | 6% | 8% |
Data source: DocuSign. FY = Fiscal year. TBD = to be determined.
The trend has been for lower and lower beats on guidance. However, now that management has set a low expectation, it could open the door to a big beat. After all, many companies make large financial decisions during Q4, such as signing a new contract with DocuSign or expanding its usage. These catalysts could add up to a return to stock price appreciation for DocuSign.
3. The Trade Desk
Advertising budgets plummeted in 2020 as the pandemic rose up, but they came roaring back in 2021. The Trade Desk was a huge beneficiary of this trend as it operates a demand-side digital advertising platform. With The Trade Desk's software, its customers can run ad campaigns through internet videos, podcast audio, and (increasingly) connected TV. The software also utilizes artificial intelligence to inform customers how their ad campaigns are progressing and can give recommendations to improve outcomes.
Unlike the previous two businesses, The Trade Desk's financials are at a point where it can turn a profit. During Q3, its revenue grew 39%, but its net income increased even faster at a 44% clip. Tech growth stocks rarely have explosive growth and a nearly 20% profit margin, but The Trade Desk fits the bill.
Because of its high growth and profitability, investors may expect to pay a premium for the stock. While the stock is expensive based on several metrics, I would consider it reasonably valued.
TTD PE Ratio (Forward) data by YCharts.
A forward price-to-earnings (P/E) ratio of 74 is by no means cheap, but investors must pay up for quality and growth. Additionally, traditional linear TV ads are starting to migrate toward connected TV. With about $230 billion spent on linear TV ads in 2019, The Trade Desk has a huge growth runway.
When The Trade Desk reports its Q4 results on Feb. 17, watch to see if its net income increases faster than revenue. If so, that's a sign it is improving its profitability. Regardless, The Trade Desk represents a great buying opportunity now and investors would be smart to scoop the stock up before earnings.
Investor takeaway
All three companies have strong business tailwinds blowing in their favor, and even though short-term sentiment is against them, strong earnings could be the push each stock needs to flip direction. Even if you don't buy stock in these companies before their next earnings are released, you should have some time to take action and buy in while the stocks are down from recent high points.
