The tech sector has had a rough couple of months, and the major stock market indexes are feeling the pain. As of this writing, the Nasdaq index is down almost 16% from its all-time high, and many high-growth stocks are down by much more than that. With so many stocks down by 30%, 40%, even 50% or more from their peaks, it can be hard to figure out which ones are worth buying on the dip and which ones aren't.
However, if you've already narrowed your search to an industry that's poised for rapid growth, one smart next step is to narrow it even further by looking for the companies in that industry that have clear and important edges over their competitors. PubMatic (PUBM 2.19%) fits that description and is well worth considering as a buy during this stock market correction.
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The future of adtech
The shift to digital advertising has been drastic for many reasons. First, with traditional advertising -- on billboards or in newspapers, for example -- it's difficult to target a specific group of people who might especially like the products. It's also difficult to gauge the effectiveness of any individual ad, which makes it harder for a company to choose where to spend its advertising budget.
Digital advertising allows advertisers to do both of those things far more effectively, making ads more cost-efficient and valuable. As a result, the amount of money being spent on digital advertising has exploded, and will likely continue to do so. Global digital ad spending was $327 billion in 2020 and is expected to grow to $526 billion by 2024.
PubMatic plays a critical role in the digital advertising process. It serves the sell-side of the advertising technology space -- helping publishers sell their ad space profitably and efficiently. It partners with buy-side adtech companies to match advertisers with publishers, making the process easy for all parties.
It's slightly different from many sell-side players, however. With every transaction made on its platform, it gathers data that it can use to make better recommendations for its publishers. This helps them find the best offers for their ad space while also making sure those ads don't deteriorate the user experience on the publisher's site. Most of PubMatic's competitors do something similar, but they store that data with third parties, which can be expensive.
PubMatic, on the other hand, has built the tech infrastructure to store all its data in-house. This keeps operating expenses low, so it can spend more on its efforts to fuel growth -- like increasing its marketing spend or expanding internationally. With a Q3 net income margin of 23% and a free cash flow margin of 20%, PubMatic is outperforming many of its competitors.
A hard road ahead
Today, Magnite (MGNI 2.94%) is the market leader on the sell-side of the adtech space: Its trailing-12-month revenue was $389 million, compared to PubMatic's $208 million. Yet, where Magnite is unprofitable, Pubmatic is profitable and has strong income margins. PubMatic also generated $30.6 million in free cash flow in the first nine months of 2021. Magnite -- despite bringing in almost twice as much revenue -- only had about 16% more free cash flow at $36 million.
And PubMatic is growing organically, which cannot be said about Magnite. On a pro forma basis, Magnite's revenue grew 26% year over year. Its pro forma revenue factors the quarterly revenues of its recent acquisitions -- SpotX and SpringServe -- into its year-ago results, but this doesn't reveal the true organic growth of Magnite. Some or all of that 26% improvement could be coming from its acquisitions, but even if this growth came solely from Magnite's core business, it was only half of PubMatic's 54% year-over-year revenue growth in Q3.
Why I plan to buy more PubMatic
PubMatic trades at a price-to-earnings ratio of 26 -- a low multiple when considering its high revenue growth rate. It's also a much more appealing valuation than Magnite's price-to-earnings ratio of 609. But even setting valuation aside, I still believe that PubMatic is the stronger business of the two, which could result in its usurping Magnite's role as the sell-side leader in the coming years.
Financially, the company is leaps and bounds ahead of Magnite because of its impressive capital allocation and internal innovation, and this will likely allow it to invest more in this fast-growing industry than its competitor. PubMatic is also seeing organic adoption at levels unachievable by Magnite -- in an industry where growth and adoption are critical.
PubMatic shares are now trading down more than 66% from their all-time highs. At these prices, the stock offers investors a great buying opportunity, and I plan to take advantage of that within the next month.
