Investors have many different strategies for evaluating stocks. But if you are going to be a great buy-and-hold investor, there are a few key traits a stock should exhibit before you add it to your portfolio. These include, but are not limited to: a durable industry tailwind, great unit economics, rational capital allocators at the executive level, and a reasonable valuation.
Here are three stocks that fit these criteria, setting them up to be durable earners for shareholders for many years to come.
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1. Dropbox
You might know Dropbox (DBX -0.38%) as the popular file-sharing service from a few years ago that spawned clones from big technology competitors like Alphabet, Microsoft, and Apple. Dropbox still offers file sharing for its customers, but it has moved beyond just this one product to become a workflow and content collaboration platform for individual creators and small businesses. This includes multiple products developed internally (a better mobile application and robust PDF reader are two examples) plus acquisitions like e-signature company HelloSign and document analytics service DocSend. All these products are now bundled into different Dropbox subscription tiers that individuals and businesses can pay for.
Dropbox is seeing a nice tailwind for its services due to the steady rise of decentralized workforces, a trend that was accelerated by the COVID-19 pandemic. This has led the business to steadily grow its paying users and revenue per user over the last five years. In the first quarter of 2018, the company had 11.5 million paying users and average revenue per paying user of $114.30. In Q1 of this year, paying users hit 17.1 million and average revenue per paying user hit $134.63.
Over the last few years, with a steadily growing revenue base, Dropbox has shown great unit economics and cash generation. For example, this year management is guiding for $760 million to $790 million in free cash flow on total revenue of $2.32 billion to $2.33 billion. If it hits the high end of both of these guidance ranges, the company will achieve a 34% free cash flow margin this year, which is close to best-in-class software businesses like Adobe.
Dropbox is taking this cash and repurchasing its own stock at a consistent pace, lowering its share count and growing free cash flow per share for remaining shareholders. For example, in Q1 2022 the company bought back $260 million worth of its stock, or approximately 3% of the company at its current market cap of $7.7 billion. At this price, the stock trades at a forward price-to-free cash flow (P/FCF) of below 10 if it can hit the high end of its guidance range. This is an attractive valuation given the durable growth Dropbox's business has put up and should continue to put up in the coming years.
2. Electronic Arts
Second up is Electronic Arts (EA -0.65%), one of the largest video game publishers in the world. The company has been able to ride the growing wave of consumer spending on video games in the last few decades to great heights, with shareholders getting approximately a 25,000% return on their investment since 1990.
EA has a dominant position in the video game market with its sports video games, the most important being FIFA Soccer and Madden NFL. The company also has many popular non-sports franchises including The Sims, Battlefield, and Apex Legends.
The thesis for buying EA is simple: The growth in video games will continue and the stock trades at a reasonable valuation. With free cash flow per share (FCF/S) up 1,300% in the last 10 years, EA has not only been able to ride the general tailwind of video games, but it has returned capital to shareholders in a rational manner. Starting around 2015, management decided to start repurchasing shares with the excess cash EA's video game franchises were generating. This has led to shares outstanding falling from around 312 million to 281 million in the last five to seven years. While not a huge drop, a dropping share count is accretive for the remaining shareholders of EA stock.
EA Total Return Level data by YCharts
As of this writing, EA stock trades at a market cap of $31.5 billion. For the fiscal year that ended in March, it has guided for $1.9 billion in operating cash flow, the best profitability metric for valuing a video game business. That gives the stock a price-to-operating-cash-flow (P/OCF) of 16.5. With steadily growing franchises, a dropping share count, and a reasonable P/OCF multiple, now seems like a great time to pick up shares of EA stock.
3. Boston Omaha
Boston Omaha (BOC 4.34%) is an asset allocator across a variety of different businesses including broadband, billboards, and surety insurance. It also has an investment portfolio of different minority investments.
In 2021, Boston Omaha's operating businesses generated $57 million in revenue. There was a stated net loss from operations, but that occurred because the company is required to heavily depreciate its broadband and billboard assets. According to the 2021 annual shareholder letter, the billboard division is now generating north of $1 million in cash flow a month, or $12 million a year. The broadband division generated $4.6 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) last year, and with a new acquisition set to double its subscriber count, will likely start generating north of $10 million in EBITDA a year starting in 2022 or 2023.
On the minority investment side of things, Boston Omaha has seen tremendous success, particularly with its two pre-IPO investments in Dream Finders Homes, which tripled and quintupled Boston Omaha's investors' money in less than five years. Boston Omaha still owns a significant chunk of the business, with shares worth approximately $50 million as of this writing.
If you are going to bet on Boston Omaha, you are betting on co-CEOs Alex Rozek and Adam Peterson and the teams they've assembled across these different business units. The stock hasn't performed mightily since they took over (it is only up 38% since 2017), but with the cash-flowing businesses they've assembled and the results of the investments in Dream Finders Homes, I think the pair have put together a solid track record so far. At the current stock price, by excluding all the minority investments and cash/treasuries on the balance sheet, the market is valuing Boston Omaha's operating businesses at approximately $290 million. If you believe in the long-term earnings power of the broadband and billboard business and the capital allocation skills of Rozek and Peterson, now seems like a great time to be buying shares of this small-cap conglomerate.
