The market is currently stuck in "don't fight the Fed" mode. As the U.S. Federal Reserve raises interest rates and tightens monetary policy to try and fight inflation, high growth but richly valued tech stocks have fallen out of favor among investors. Many of these companies have fallen by over 50% from all-time highs.
In spite of recent pain, though, some of these unloved stocks are fantastic long-term deals. Three that look like especially good buys right now are DigitalOcean (DOCN -2.37%), Unity Software (U -1.37%), and Applied Materials (AMAT 2.07%). Let's find out a bit more about these three apparently unloved tech stocks.
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1. DigitalOcean: Going after emerging leaders in cloud computing
Battling against cloud computing titans like Microsoft Azure, Amazon AWS, and Alphabet's Google Cloud is a tall order. But DigitalOcean has answered the call and has been outperforming many investors' expectations. For its latest feat: Q1 2022 revenue was up 36% year over year, and CEO Yancey Spruill and company expect full-year free cash flow profit margin to be 8% to 10% of revenue. Talk about a winning combination that is being overlooked by the market -- share prices are down nearly 67% from their all-time high.
Sooner or later, I think DigitalOcean's stock will begin to rise again along with actual business results. The small cloud platform believes it can achieve greater than 20% revenue growth in the next few years, which would put it on track to reach $1 billion in annual sales within two or three years. A key to its success against the odds is its affordable pricing and vast library of educational articles for web developers.
To the first point, DigitalOcean recently unveiled new pricing. A new $4-per-month pricing tier will debut in July 2022 for cloud developers at the "learning, experimentation, and proof of concepts" stage. For other cost-effective web hosting, the new pricing for a basic "Droplet" virtual machine will increase to $6 (from $5 before). Still super affordable versus the public cloud giants, but potentially a big boost for DigitalOcean's financials.
And on point two: education. DigitalOcean just made a small but unique purchase. Rather than go after some shiny new object in the world of cloud technology, it bought CSS Tricks, a learning site that attracts over 3 million visitors a month with thousands of articles and videos for software developers. Free education has been at the heart of DigitalOcean's marketing and customer acquisition strategy, so CSS Tricks and how it augments DigitalOcean's efforts to attract users will be an interesting element to keep an eye on. Shares currently trade for less than eight times enterprise value to 2022 expected sales. If DigitalOcean reaches its lofty revenue goals in the next couple of years, this looks like a fantastic deal right now.
2. Unity Software: A return to growth goals and on a path to profitability
Unity Software's stock has suffered as of late along with other high-growth technologists that don't yet turn a profit, but it had an additional headwind: During the Q1 2022 earnings update, management outlined why it was decreasing expected full-year revenue growth to 22% to 28%, versus stated long-term guidance for at least 30% annual expansion. The reason? Problems with monetizing some of its advertising tools for video game and app developers.
This is expected to be a temporary problem, though, and CEO John Riccitiello still expects the company to return to its 30%-plus revenue growth rate next year and continue at that pace for the foreseeable future. Additionally, Unity said it has been taking a hard look at its spending and thinks it will be able to reduce over $100 million a year in annualized expenses starting in the second half of this year. As a result, Unity expects to achieve adjusted profitability by the end of 2022.
Given the present stock market conditions, which favor robust profitability over all-out growth, this cut in spending is a positive for Unity. Profits and expansion are better than just one or the other.
Helping the long-term thesis for this business is the growing interest in Unity beyond just video game creation. Digital twins are one example -- 3D virtual representations of real-world locations that aid in design, planning, and simulation, part of what some might refer to as the "metaverse". Unity signed 34 new digital twin deals worth at least $100,000 in the last quarter in industries like construction and manufacturing.
Based on new 2022 full-year guidance, Unity stock trades for less than nine times enterprise value to expected revenue. The current year is poised to be a bit more muted than originally expected. But if Unity can return to its long-term projection of 30% growth in 2023, this stock looks like a bargain if you plan to hold for the next decade.
3. Applied Materials: Supply chains will only briefly dent this long-term winner
Let's shift focus to the type of stocks the market favors right now: stocks with steady growth, high rates of profitability, and excess cash to return to shareholders. Applied Materials fits all these criteria, yet the stock price is down 36% from its all-time high. What gives?
It all has to do with the global chip shortage and supply chain disruptions. During the quarter that ended May 1, revenue was up 12% from a year ago to $6.25 billion. Respectable, but that result was near the bottom of guidance provided a few months prior. CEO Gary Dickerson explained that demand for semiconductor fab equipment (the machines that manufacture chips) "has never been stronger, yet we remain constrained by ongoing supply chain issues." Basically, there aren't enough specific components available for Applied to complete and ship out all of the equipment being ordered from its chipmaker customers.
The good news is that delayed orders don't just disappear -- they will simply become realized revenue later on at the time Applied is able to get enough components to ship equipment out the door. In the meantime, the company anticipates revenue in its current quarter to be up 12% year over year at the midpoint of guidance, and for adjusted earnings per share to be up about 8.5%. Not as great as what was hoped for, but still a healthy increase.
Applied Materials stock currently trades for less than 17 times trailing 12-month free cash flow. To sweeten the deal, the company also returns almost all of its free cash flow to shareholders via a 0.9% yielding dividend and share repurchases ($1.8 billion worth in repurchases in the last quarter alone). I expect supply chain issues to be but a temporary blip on this semiconductor stock's long-term winning streak.
