JFrog (FROG -1.52%) was one of the hottest software stocks of 2020. It went public in Sept. 2020 at $44 per share, and its shares opened at $71.27 before hitting the company's all-time high of $86.35 later that month.
But today, JFrog's stock trades at about $25. Concerns about its slowing growth, high valuations, and lack of profits spooked the bulls, and the broader retreat from growth stocks exacerbated the pain.
Should investors consider picking up some shares of this former highflier at a steep discount to its initial public offering (IPO) price? Let's review four reasons to buy JFrog -- as well as one reason to sell it -- to decide.
Image source: Getty Images.
1. A defensible niche market
JFrog's main platform, Artifactory, stores software updates in a universal repository that can be accessed by a wide range of computing platforms. It automatically delivers those updates through a continuous software release management (CSRM) system, which eliminates the need to manually install updates across multiple hardware and software platforms.
That automation saves large organizations a lot of time and keeps their systems secure. Another key Artifactory feature is Xray, which scans a company's entire software infrastructure for security vulnerabilities.
JFrog served 6,650 enterprise customers at the end of 2021, including 85% of the Fortune 100. That's up from 6,050 organizations and 78% of the Fortune 100 a year ago. It also served 537 customers that generated more than $100,000 in annual recurring revenues (ARR) at the end of 2021, representing 53% growth from a year earlier. That expansion indicates JFrog is carving out a defensible niche in the crowded software market.
2. Robust revenue growth at a reasonable valuation
JFrog's revenue rose 44% to $150.8 million in 2020, then increased 37% to $206.7 million in 2021. It expects its revenue to rise 32% to 33% in 2022.
JFrog's growth rates are gradually decelerating, but they're still impressive for a company that trades at nine times this year's sales. Back when JFrog hit its all-time high in 2020, it traded at over 50 times its 2020 sales.
JFrog's valuation also looks reasonable relative to other software companies with comparable growth rates. Palantir (PLTR -2.18%), the data-mining firm that expects to grow its annual revenues by at least 30% through 2025, trades at 12 times this year's sales. Twilio (TWLO 0.10%), the cloud communications company that expects to generate more than 30% organic revenue growth over the next few years, trades at seven times this year's sales. Like JFrog, both stocks traded at high double-digit price-to-sales ratios last year before being crushed during the market sell-off.
3. A high retention rate
JFrog ended 2021 with a trailing 12-month net dollar retention rate of 130%, which means it squeezed out 30% more revenues from its existing customers. That high retention rate, which only dipped slightly from 133% in 2020, suggests that JFrog can still comfortably grow its revenues at about 30% annually even if its customer growth decelerates.
By comparison, Palantir ended 2021 with a net dollar retention rate of 131%, while Twilio posted a comparable dollar-based net expansion rate of 131%.
4. Expanding gross margins
JFrog's adjusted gross margin rose from 82.4% in 2021 to 84.1% in 2022. It attributed that expansion to ongoing improvements to its cost structure and the growing efficiency of its cloud-based operations.
That expansion indicates JFrog still has plenty of pricing power in its niche market -- even as it faces formidable competition from larger platforms like IBM's Red Hat, Amazon Web Services' (AWS) CodeArtifact, Microsoft's Azure DevOps with GitHub, and Alphabet's Google Cloud Platform.
One reason to sell JFrog: Its operating margins
JFrog's gross margins look stable, but its operating margins are slipping. Its adjusted operating income plunged 68% to $4.2 million in 2021, which reduced its adjusted operating margin from 8.6% to 2%.
For 2022, it only expects the midpoint of its adjusted operating income to come in at break-even levels. It mainly attributed that pressure to its acquisitions of the product security company Vdoo and the connected device-management software company Upswift in 2021. It plans to ramp up its spending again to integrate those two businesses this year.
Those headwinds might be transitory, but JFrog still expects them to reduce its adjusted net earnings to roughly break-even levels in 2022. On a generally accepted accounting principles (GAAP) basis, its net losses -- which already widened nearly sevenfold from $9.4 million in 2020 to $64.2 million in 2021 -- could continue to widen for the foreseeable future.
Is it the right time to buy JFrog?
JFrog looks a lot more attractive than it did in 2020, but it's not a compelling investment when plenty of other companies are growing at similar rates and trading at similar valuations. Many of those "hypergrowth" tech companies, like Palantir, are also maintaining higher and more stable adjusted operating margins than JFrog. Therefore, investors should wait for JFrog to fully integrate its latest acquisitions and stabilize its margins before jumping in.
