The last year or so has been brutal for many technology investors. While the S&P 500 is actually up about 8.7% over the last 12 months, there are many growth and high technology investments that are trading down 30% or more. One example that exemplifies the situation is the popular ARK Innovation ETF, which is down almost 51% from this time last year.
These drawdowns are admittedly stress-inducing, but if you have the stomach for volatility, that also can present opportunities to buy stock in great companies when they are trading at a discount. Here are two stocks you'll regret not buying during this ongoing market downturn.
1. Spotify: Down 53.8% from 52-week highs
First up, we have music and audio streamer Spotify (SPOT -0.77%). The global platform has 406 million monthly active users (MAUs) and 180 million premium subscribers that pay a monthly subscription for ad-free and downloadable music listening. For whatever reason, investors have soured on the business recently, with the stock down 53.8% from 52-week highs set in November 2021.
Despite the drop, the underlying business is doing quite well. Revenue grew 24% year over year last quarter to $2.9 billion, driven by new premium subscribers and Spotify's revamped advertising business. Advertising revenue was $430 million in the fourth quarter, making up a small portion of Spotify's consolidated revenue. However, it is growing quite quickly, at 40% year over year. Why? Because Spotify has been investing heavily in podcast content and podcast advertising with acquisitions of major studios and exclusive licensing deals with top shows like the Joe Rogan Experience and Call Her Daddy. To monetize this content, the company last year launched the Spotify Audience Network, a dynamic advertising platform similar to Alphabet's YouTube (but for audio). With the overall podcast industry expected to grow at a 30% clip through 2028 combined with Spotify being No. 1 in market share in many top markets, I am confident that the advertising business can grow at a high rate for many years.
In 2021, Spotify generated $11.4 billion in revenue and $3.1 billion in gross profit. Its margins are low right now, but over time, management expects the business to achieve 30%-40% gross margins (as opposed to 25% right now) and 10%-plus profit margins as it matures. With a current market cap of $27.7 billion, that gives Spotify stock a price-to-sales ratio (P/S) of 2.4. If Spotify had 10% profit margins today, that would give the stock a price-to-earnings ratio (P/E) of around 24. To be clear, the company is not generating much, if any, profit right now, which is likely why the stock is down so much. But with the long runway of growth ahead of it and a low P/S, Spotify stock looks like a solid buy at these prices.
2. Dropbox: Down 32.2% from 52-week highs
Unlike Spotify, Dropbox (DBX 2.04%) is highly profitable and generates tons of cash. The file-sharing and workflow platform generated $707 million in free cash flow last year, which, compared to its market cap of $8.5 billion, gives the stock a dirt-cheap price-to-free-cash-flow ratio (P/FCF) of 12. The stock is trading down about 32.2% from 52-week highs set in September 2021.
So what gives? Why is Dropbox stock so cheap right now? Two reasons come to mind. First, Dropbox has ample competition from the likes of Microsoft, Alphabet, and Apple. These technology giants all have file-sharing services, and Alphabet's Google Drive is offered for free to hundreds of millions of users around the globe. Given the scale and ability to give these services away, investors likely are scared about Dropbox's long-term viability as a business. However, I think this bear case is flawed because Dropbox has grown its business steadily even though these offerings have been around for the last five years. In 2018, Dropbox had 12.7 million paying users with an average revenue per user (ARPU) of $119.60. At the end of 2021, it had 16.8 million paying users with an ARPU of $134.78.
So not only has Dropbox been able to grow its users while the tech giants undercut it with free products, it has actually been able to charge more for its services over time. This is because file sharing is a sideshow for the technology giants (Google Drive hasn't been updated in years), and with Dropbox's focus, it has been able to build a better value proposition for creators and small businesses.
In 2022, Dropbox is guiding for $2.33 billion in revenue and a range of $760 million-$790 million in free cash flow. If it hits its revenue target, that will only be 8% year-over-year growth, which might make some technology investors shy away because Dropbox is not growing as fast as some investing favorites. However, with such a discounted cash flow multiple, Dropbox doesn't need to grow that much in order to be a worthwhile investment over the next decade, which is why I think it can be a low-risk bet for technology investors to buy right now.