A myriad of worries has conspired against the stock market so far this year, including inflation and the Federal Reserve's aggressive interest rate hikes to help get skyrocketing prices under control, supply chain disruptions, and war in Ukraine. Tech stocks in particular are out of favor at the moment while the market flocks to investments in energy and physical infrastructure. The Nasdaq Composite has fallen about 28% from its all-time high.
Amidst the pain in the stock market, though, companies that specialize in technology infrastructure are actually performing quite well. Money is flowing into the tools needed to enable cloud computing and related next-gen tech initiatives. Three companies that are booming are DigitalOcean Holdings (DOCN -0.90%), Twilio (TWLO -0.55%), and Fortinet (FTNT -0.97%). Here's why all three tech infrastructure stocks are buys in my book.
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1. DigitalOcean: A ridiculous sell-off in a stand-alone public cloud leader
Much of the narrative surrounding the recent sell-off in high-growth tech stocks has to do with rising interest rates. The internal mechanism that governs short-term stock prices uses interest rates to discount future expected cash flows. Thus, as interest rates climb, the present value of stocks declines. What were once high-growth-but-no-profit companies trading for more than 20-times expected sales have been humbled.
One such example is DigitalOcean. But there's one big caveat. This cloud computing platform company is growing fast and it's profitable, at least on a free cash flow basis. During the first quarter of 2022, revenue was up 36% year over year to $127 million, and free cash flow was $5 million. That's a slim profit margin, but much of that is related to the timing of payroll taxes and other seasonal expenses. For full-year 2022, CEO Yancey Spruill and the top team think revenue will be up about 32% year over year, and free cash flow margin will improve to at least 8% of total sales.
DigitalOcean is able to pull off its fast-growing and efficient business model by generating hundreds of thousands of visitors to its website each month with free educational content for software developers. To bolster this strength, DigitalOcean acquired a learning site called CSS Tricks, which receives 3 million unique visitors every month. To supplement this strategy, DigitalOcean is also starting to build a sales team, which contributed 3% to overall growth in the last quarter.
In the next few years, DigitalOcean believes it will sustain at least a 20% revenue growth rate and remain profitable along the way. In spite of its respectable expansion since its IPO in early 2021, shares are down 24% from where they made their publicly traded debut, and are valued at just 4.7 times expected one-year forward sales. If you think public cloud computing has a long runway ahead of it, this small company looks like a fantastic deal right now.
2. Twilio: Business communications migrating to the cloud
After decades of development, we are now entering the fifth generation of mobile network services (aka "5G"). But 5G networks aren't just about smartphones anymore. High-speed internet is becoming omnipresent, and as it does, communications tools are evolving beyond traditional mobile talk and text.
That's where Twilio comes in. The company operates a cloud-based library of software that helps companies build communications tools that meet the modern needs of their customers and employees. Among these applications are everything from text messaging (a low-margin but profitable business Twilio is using to invest in newer stuff) to video, online AI chatbots, and customer interaction analytics. The product Flex is a full-fledged contact center toolkit that businesses can deploy to make their customer service operations more efficient.
Flexible and cloud-based communications tools that break the barriers of traditional voice and text are in high demand, and Twilio is on fire as a result. Q1 2022 revenue was up 48% year over year to $875 million (or up 35% year over year on an organic basis). Over the next few years, CEO Jeff Lawson thinks organic growth of at least 30% per year is attainable. The rub many investors have with the company is that it loses money right now -- though that is intentional, as it's reinvesting all its profits plus a little extra to promote expansion. Nevertheless, with a rock-solid balance sheet featuring $5.2 billion in cash and short-term investment offset by debt of just $986 million, Twilio is in great shape to keep the pedal to the metal.
After getting slammed by the market, Twilio now trades for less than 3.7 times one-year forward expected sales. If profitability is what you're waiting for, management believes it will begin to achieve that (on an adjusted basis) in 2023. This communications software platform looks really cheap right now if you believe Twilio can pull off its ambitious financial guidance over the next few years.
3. Fortinet: New clouds need new data centers and new security hardware
Looking for a company that has a longer track record of delivering growth and is highly profitable? Check out Fortinet, a "legacy" cybersecurity company that provides firewalls (hardware that monitors the traffic in and out of a physical location) and related hardware.
I put the term "legacy" in quotations because even though cloud-native security products are in vogue right now, there's nothing old-school about what Fortinet provides. Sure, remote work has changed the game. More workers than ever before are accessing their employer's data and work apps from outside of the office. That's where companies like CrowdStrike are making their hay. But as cloud computing proliferates, more data centers are being built and upgraded. Each one of those requires new security hardware to keep those physical assets safe.
And that's where Fortinet really shines. Total revenue was up 34% in Q1 2022 to $955 million, a continuation of more than a decade of rapid double-digit sales growth as a public company. Over one-third of sales were product-based, which grew at a sizzling 54% rate from the year prior. Free cash flow was $274 million, a very healthy 29% profit margin.
Besides its hardware, Fortinet also has plenty of software-based security offerings too. Filed as "service revenue," this segment grew 24% in Q1 and is expected to accelerate later in 2022. Fortinet has a long track record of investing in steady and profitable growth and now trades for just 34 times trailing 12-month free cash flow as of this writing. It's my personal favorite cybersecurity stock to buy right now.
