In 2021, the S&P 500 delivered its third-best performance of the past decade, rising 26.9% during the year. Unfortunately, the market has given up some of those gains in 2022, as uncertainty surrounding high inflation and rising interest rates has sparked a selling spree. But the sell-off may be overdone, as some Wall Street analysts see significant upside in certain growth stocks.
For instance, Oppenheimer analyst Timothy Horan recently raised his price target on DigitalOcean (DOCN 0.80%) stock to $130, implying 142% upside. Likewise, Naved Khan of Truist Securities has a price target of $88 on Redfin (RDFN 2.48%), implying 227% upside. Generally speaking, price targets reflect Wall Street's expectations over the next 12 to 18 months, meaning they are short-term in nature. For that reason, I never put too much weight on any analyst's opinion -- but given the potential gains, it's worth taking a closer look at both of these stocks.
Here's what you should know about these two growth stocks with strong upside potential.
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1. DigitalOcean: Democratizing cloud services
DigitalOcean is a cloud computing company. Traditionally, providers like Amazon Web Services and Microsoft Azure have focused on large enterprises, meaning their cloud services are often too complex for small- and medium-sized businesses (SMBs). DigitalOcean has capitalized on that opportunity, building its portfolio with simplicity in mind.
Its platform features a click-and-go user interface, allowing clients to provision infrastructure and platform services in minutes, without any training. That means SMBs can easily shift resources to the cloud to boost efficiency, and they can quickly build and scale applications. DigitalOcean also provides technical support and access to thousands of developer tutorials, and the company's efforts to democratize cloud services have been met with strong demand.
As of the third quarter, DigitalOcean had approximately 598,000 customers, and the average customer spent 16% more over the past year. As a result, revenue rose 37% to $111.4 million in the quarter. And while DigitalOcean is unprofitable on a GAAP basis, the company generated $40.2 million in cash from operations, up 73% from the prior year, showing the sustainability of its business model.
Looking ahead, DigitalOcean has plenty of room to run. There are over 100 million SMBs in the world, and 14 million new businesses are started each year. To that end, management puts its addressable market at $116 billion by 2024, and that figure should continue to rise. With that in mind, given its reasonable valuation of 12.9 times sales, I wouldn't be surprised to see share prices reach $130 in the near term. But even if that doesn't happen, DigitalOcean looks like a smart long-term investment.
2. Redfin: Disrupting residential real estate
Redfin takes a disruptive approach to residential real estate. Specifically, its portfolio streamlines the moving process for homebuyers and sellers by unifying brokerage, mortgage, and title services. Also noteworthy, Redfin ranks as the third-most-popular website in the highly fragmented real estate industry, allowing the company to acquire new customers more easily than the vast majority of its rivals.
Additionally, unlike traditional brokerages, Redfin pays its agents a salary rather than commission fees. That allows the company to charge home sellers a smaller fee -- 1% to 1.5%, rather than the industry standard of 2.5% to 3% -- and it allows Redfin to refund homebuyers a portion of their commission. In short, Redfin makes residential real estate transactions less complicated and cheaper, and that value proposition has fueled impressive growth.
In the most recent quarter, Redfin facilitated over 26,600 real estate transactions, either with its own agents or partners, up 10% from the prior year. And the average revenue per transaction jumped 11% to $9,661. Driven by that compounding dynamic, gross profit soared 37% to $127.3 million, and Redfin's market share increased to 1.16%, up 12 basis points from the prior year. On a less optimistic note, the company posted a net loss of $0.20 per diluted share, but with a $93 billion market opportunity, it makes sense to invest aggressively. Over time, as Redfin's business scales, the company should find its way to consistent profitability.
On that note, one of my favorite things about Redfin is its CEO Glenn Kelman. Since taking the reins in 2005, he has helped the company expand into title and escrow services, mortgage origination, iBuying, and rental properties, while successfully navigating turbulent market conditions on several occasions. Most recently, when rivals like Zillow Group leaned too aggressively into iBuying during the pandemic, Redfin showed restraint and began lowering its offer prices. That type of leadership bodes well for shareholders, and it's helped Kelman achieve a 92% employee approval rating, according to Glassdoor.
Looking ahead, I wouldn't be surprised to see Redfin reach its $88 price target during the next 12 months. But more importantly, I think this business is well-positioned to generate substantial wealth for shareholders over a longer period of time.
