What happened
Many high-flying growth stocks took a beating in January 2022. For example, shares of Datadog (DDOG +1.27%) fell 18% last month while Monolithic Power Systems (MPWR +2.50%) took an 18.3% haircut, according to data from S&P Global Market Intelligence. The Trade Desk (TTD +5.99%) fell even further, posting a 24.1% price drop.
So what
None of these companies earned their discounts from bad news or disappointing results. All three are set to report quarterly results over the next two weeks.
Image source: Getty Images.
We are looking at a diverse group of technology companies here. Datadog offers cloud-based monitoring tools for servers and databases. Monolithic Power specializes in power management tools for the physical data center. The Trade Desk runs online marketplaces that connect digital advertising spaces with ad buyers. One might argue that the trio relies on similar market dynamics from different angles, as their fortunes arguably rise and fall with the general health of global demand for enterprise-scale technology services.
They do have some significant data points in common, though. The three stocks under my microscope posted market-crushing returns in the two years leading up to the painful corrections of January:
On the last market day of 2021, Monolithic Power Systems was the least expensive ticker on this list, trading at 58 times forward earnings estimates and 83 times trailing free cash flows. The Trade Desk's stock commanded valuation ratios of 101 times forward earnings and 144 times free cash flows. And Datadog's ratios stood above 300 on both counts.
In other words, these three stocks had skyrocketed over the past two years and their shares were trading at nosebleed-inducing valuations. That's why their charts turned negative in a hurry when the market backed away from risky growth stocks last month.
Now what
Market makers are treating growth stocks like a hot potato these days. Historically high inflation rates are pushing lawmakers toward a more conservative fiscal policy with rising interest rates and lower market-boosting efforts. My chosen set of tech companies are barely profitable as they focus on maximizing top-line growth above all else.
All that being said, they are very good at delivering impressive revenue growth. Monolithic and The Trade Desk both boosted their sales by roughly 70% over the past two years, while Datadog's revenue surged more than 140% higher. Furthermore, we're talking about high-quality stocks that have earned five-star ratings (out of five) in our CAPS system.
And don't forget that all three have some meaningful business catalysts on their side.
- The digital advertising market is navigating an era of rising restrictions to the user data that companies can use for planning their marketing campaigns, but The Trade Desk has already worked up a promising solution known as Unified ID 2.0.
- Datadog is a market leader in a very specific niche of the cybersecurity sector, facing few rivals to its mission-critical tools.
- Monolithic Power is shrugging off supply chain challenges as we speak, positioning the company to deliver wider profit margins and accelerated revenue growth over the next few quarters. "We have a lot more [demand] we can chew off now," CEO Michael Hsing said on October's third-quarter earnings call. "As of today, we have blue skies."
While it's true that some growth stocks raced a bit higher than they should have in 2020 and 2021, some of the recent corrections also seem overly harsh. Keep an eye on these companies as they report results over the next couple of weeks. I wouldn't be surprised to see positive surprises lighting fresh fires under some of these high-quality names.
