2021 and 2022 (at least so far) have been unkind to many growth investors. The tech- and growth company-heavy Nasdaq Composite Index is down 0.5% over the last one-year stretch, and down 10.5% since the start of the new year. In times like this, however, it's important to remember that even a year or two of poor investment performance is still very short-term in the grand scheme of things.
Recent growth stock underperformance doesn't mean companies themselves are in dire straights. On the contrary, while share prices can be highly volatile from month to month, growing companies will eventually reward patient investors. PayPal Holdings (PYPL -1.28%), ServiceNow (NOW 1.32%), and Dynatrace (DT 1.75%) look like three such stocks to give some leeway to right now.
1. PayPal: Building new digital payments relationships
Digital payments giant PayPal has been a fantastic growth story since its separation from eBay back in 2015. Revenue and free cash flow are both up over 200% since then. However, PayPal has fallen on hard times as of late. It's been lapping financial results that included stimulus spending and an e-commerce boom earlier in the pandemic, and its merchants have been dealing with supply chain problems, inflation, and other pandemic disruption.
But chief among recent investor worries is the effect eBay is still having on PayPal's financials. eBay is transitioning to its own in-house payments system and cutting PayPal out of the loop. As a result, PayPal said its 2021 revenue took a $1.4 billion hit thanks to eBay, and its full-year growth rate would have been 24% instead of the reported 17% if not for the e-commerce site's parting. This will remain a headwind in 2022. PayPal said to expect revenue growth of 15% to 17%, or 19% to 21% excluding effects from eBay.
This has contributed to PayPal's stock price plummeting over 60% from the all-time high it reached last summer. But PayPal as a business is still in good shape. Its peer-to-peer money-sharing app Venmo will begin integrating with an even more powerful e-commerce platform later this year, a little company called Amazon. And PayPal management thinks the company's on track to add no fewer than 15 million net new active accounts in 2022 (it ended 2021 with 426 million active accounts). In spite of the somewhat disappointing outlook, this is still very much a long-term growth story.
After the punishment it's received, PayPal stock now trades for a reasonable 25 times trailing 12-month free cash flow. I'm buying this leader in financial services technology again after management released its poorly received 2022 outlook.
2. ServiceNow: A highly profitable enterprise software staple
Inflation has been a rising concern this year for growth stocks, mainly because it's prompting the Federal Reserve to begin raising interest rates -- likely starting in March. Even if a growing business has no need to borrow money, rising rates are still a concern because they lower the present value of a growth stock. Some market analysts have thus been urging investors to sell shares of businesses that currently don't generate profits, as they are particularly sensitive to interest rate changes.
Amidst the sell-off, though, some high-quality names have been getting unduly penalized. I believe ServiceNow is one of those companies. A leader in automation software for enterprises, ServiceNow is a staple for organizations looking to build apps and processes that save their workforce time and improve customer experiences. Given the inflationary environment we're in, as well as a general shortage of labor for hire, ServiceNow has a clear pathway to continued growth (sales are up 290% over the last five-year stretch).
This is more than just a high-growth cloud computing software investment, too. ServiceNow is actually highly profitable. The company generated $1.87 billion in free cash flow last year, good for a 32% free cash flow profit margin. As ServiceNow continues to expand, there's room for its profit margin to expand even more. For example, during the fourth quarter of 2021, free cash flow actually represented an incredible profit margin of 46%!
Granted, growth is baked into the current stock price. Even after tumbling 14% from its all-time high, shares trade for 66 times trailing 12-month free cash flow. But with management predicting another 26% increase in subscription revenue in 2022 and robust profit generation, this is a fantastic time to give this longtime cloud leader another look.
3. Dynatrace: High-growth cloud infrastructure monitoring at a reasonable price
Dynatrace is another rock-solid cloud computing company, and it too is profitable. A pioneer of cloud infrastructure observability software, Dynatrace is quickly becoming a must-have for large organizations with sprawling IT and cloud assets. Its software suite provides real-time insights into operations, finds problem spots, and automates fixes and updates to keep mission-critical functions running in tip-top shape.
As could be expected from a software-as-a-service outfit, Dynatrace generates stable sales growth at about a 30% pace. It's adding lots of new customers, and existing users are increasing their usage of the platform too. Annualized recurring revenue grew 29%, or 32% when excluding foreign currency exchange rates, during the last quarter (Dynatrace's fiscal 2022 Q3). And even as the company ramped up spending on expansion initiatives, free cash flow was still a positive $59.2 million last quarter, or 25% of revenue.
As stable a growth story as this is, the share price as of late has been anything but stable. Dynatrace stock is now down 43% from its all-time high. Perhaps it was a bit overpriced a few months ago, but this is still a fantastic bet on the growth of the cloud industry. Dynatrace's new CEO Rick McConnell, a veteran executive from internet infrastructure giant Akamai, is off to a good start on the job. Current-year expectations for revenue were recently upgraded to imply 31% year-over-year revenue growth, up from 30% growth before.
Dynatrace now trades for 53 times trailing 12-month free cash flow and 13 times expected sales to enterprise value. The last few months have been rough for this stock, but the company itself is still growing at a fast-and-steady pace. A little patience should pay off handsomely for Dynatrace shareholders as the company rides the boom in cloud infrastructure.