The Nasdaq Composite index has fallen around 31% from its peak in late 2021, and many of the growth stocks on the exchange have fallen much further. This year, the market has been especially hard on digital advertising stocks, because the rapid growth of this industry during the most stringent COVID-19-related lockdowns has subsided.
These stocks have been hammered, but that doesn't change the fact that global spending on advertising is expected to climb from $772 billion in 2021 to more than $1 trillion by 2026. Those advertising budgets are increasingly heading toward two independent players in the programmatic advertising space, The Trade Desk (TTD 2.69%) and PubMatic (PUBM 7.14%).
Despite a strong secular tailwind at their backs, shares of The Trade Desk and Pubmatic have fallen 63% and 61% respectively from peaks they reached last year. Here's why I bought these stocks already and wouldn't hesitate to buy them again.
The Trade Desk
The Trade Desk has an important advantage over digital advertising giants Alphabet and Meta Platforms. While the tech titans enjoy an enormous share of the world's digital advertising dollars, they also own their own content platforms like YouTube and Instagram.
The Trade Desk operates an independent demand-side platform (DSP) that advertisers use to plan, launch, and optimize their digital ad campaigns. Since The Trade Desk doesn't have a presence on the sell side of the ad purchase equation, advertisers feel it offers more transparency than they get from Meta Platforms and Alphabet.
Increased transparency is resonating with digital ad buyers. Gross spending on The Trade Desk's platform soared 47% year over year to $6.2 billion in 2021. The company was also able to report a 95% customer retention rate in the first quarter, a rate it's been able to boast about for eight consecutive years.
With an asset-light operation, a lot of The Trade Desk's top-line revenue makes its way to the bottom line. The company has reported $394 million in free cash flow over the past 12 months. That's nearly triple the amount of free cash flow reported over the same period in 2019. With it having the leading independent buy-side platform, we can count on this company to soak up a large share of the growing global budget for digital advertising.
Pubmatic is an up-and-coming player on the supply side of the digital advertising equation. Unlike its largest rival, Magnite, PubMatic built its own infrastructure instead of acquiring it piecemeal from other businesses.
The benefits of an in-house technology stack are easy to spot. Pubmatic's margins are wide enough to allow for a significant operating profit. Despite being larger and more established, Magnite is still losing money.
According to eMarketer, U.S. advertisers spent $106 billion on programmatic display ads in 2021, which was 41% more than in 2020. A recession could cause ad buyers to lower their budgets this year, but the long-term upward trend favoring the types of ads PubMatic serves will eventually offset the macroeconomic pressure.
In the numbers
At recent prices, PubMatic is a relatively tiny company with an $820 million market cap. With a rapidly growing addressable market that is already more than $106 billion annually, simply maintaining its current share of the space for programmatic ads could send this stock many times higher in the years ahead.
Right now you can buy shares of The Trade Desk for 42 times forward earnings estimates. That's a high multiple, but I think this company can grow into its valuation even if a global recession causes advertisers to spend a bit less in the year ahead.
PubMatic shares trade at a more pessimistic 16.7 times forward earnings expectations. This multiple is in line with the average for the entire S&P 500 index. With a leadership position in the rapidly expanding market for programmatic advertising, PubMatic's growth story will likely be far more exciting than that of the average large-cap stock.