Why PubMatic Is a Compelling Stock

PubMatic (PUBM 1.75%) is a small but attractive growth stock. In this video from "The Virtual Opportunities Show" recorded on Jan. 25, Fool analyst Asit Sharma explains why investors might want to watch this digital advertising stock, which has only been public for about a year. 

Asit Sharma: I'm going to talk really quickly about a little company called PubMatic. PubMatic is a platform for programmatic advertising on the sell-side. That means that it works with publishers rather than the buyers, the providers of content, content creators. It's just celebrated its rough first anniversary as a public company.

I think went public in December of 2020, so it's been public for about 13 months and along with some other growth stocks, it's taken a bit of a beating in the market. I just want to go over a few things about it that I really like and I find attractive at this point where we are in this brutal market cycle here. This is a small company, you can see in the third quarter, their revenue was only 58 million, very nice growth there. It's a profitable company.

This isn't a company that is working on a promise, trying to gain market share and generating losses. It actually for years has made a profit. It's run very sensibly I think by two brothers and a really great management team. To give you just an idea of their overall strategy. They are looking at consolidation in the sell-side space so lots of publishers, right now it's a fragmented part of that side of the industry. They're looking at consolidation which benefits them as one of the premier offers of a publisher interface or a platform for this spend. Also, digital ad spending isn't going anywhere. It's only growing bigger. Now, I know there are some hesitations that some investors have around the digital advertising space, but here's something to consider. Over two-thirds of the company's revenue has alternative identifiers to third-party cookies and Apple's IVFA.

If you are following programmatic advertising, looking at The Trade Desk, companies like Magnite, you already know that Google has threatened to drop the hammer by removing the ability to use third-party cookies in its Chrome browser, which is going to challenge this whole industry. This company really isn't so reliant on third-party cookies. It works with a lot of first-party data coming from the publisher side. It is an avid participants along with The Trade Desk and developing alternate identifiers for us. When you go around the Internet, instead of having this honest feeling that sites are tracking you and having to fend off those cookies.

They are working on a future in which you'll opt-in and be able to see advertising offers that are targeted toward you, but in ways that aren't quite as invasive as the current cooking system. The company, I think it's really interesting because they have this flywheel effect. Their dollar net retention is going through the roof. I think it was above 150 percent this most recent quarter. They spend a lot of money on their own platform. Unlike a company like Magnite, they've developed their infrastructure from the ground up, so they have a whole server footprint that's global and they are an intensive CapEx business. They buy their own servers, they host their own data and they host their own options, which makes them extremely efficient in pulling data which they analyze to drive more business. That's the benefit of all that CapEx. What you have here is a company that is generating more and more cash flow. It's growing sales, it's already net positive, it's getting caught up in a lot of market selling. I see maybe a fun opportunity here and I'm going to just try to breeze through these last few points. They are working on supply path optimization. I had the opportunity to interview their CEO, Rajeev Goel, along with our fellow Fool Rick Munarriz in December. He talked about the fact that the bigger companies they are targeting, he used Ford as an example, work with multiple agencies who themselves work with multiple demand side and sell side advertising platforms. This company is trying to make it simpler for a large company to utilize their platform and consolidate some of the players in the space. That's a really good selling proposition on both sides. They play a little bit on the buy-side as well.

They are more and more getting into high-growth formats that competitors like Magnite have been known for, they're playing more in the connected TV space. Just to wrap this up, I wanted to call out a few things. Here's that net dollar-based retention. It's 157 percent for the trailing 12 months ended September 30th, 2021. I believe they report in February. As you can see, they have plenty of operating cash flow generated off of that 50 million of revenue that I showed about 26.4 million in the third quarter. What has really attracted me to this company even more than I was attracted before is here's the peak after the company went public.

They're down now from that $3.4 billion market cap peak to about $1.2 billion in market cap. Now, why that is interesting is that this number is something like a multiple of 15 against the company's estimated 2022 free cash flow, not operating cash flow but free cash flow. Which means it's pretty cheap. If you're thinking about a company which can grow at a rate of 30 percent plus a year, and it's selling it only 15 times the free cash flow it generates, that in some ways is a bargain and it's an even smaller multiple if you look ahead to 2023 earnings. Very consistent in meeting their estimates so far and I think that the management team is extremely solid. They don't try to make money in a hurry unlike some competing platforms, they are very methodical. That's paid off over time. This company has been at it for about 10 years now, they're only public as of last year. We just want to keep your eye on, symbol is PUBM, PubMatic.