The bear market has taken its toll over the past year. With the Federal Reserve intent on raising interest rates and stomping out inflation, market participants have done a 180 degree turn -- going from ardent optimists to extreme pessimists.
While you might feel this fear yourself, now is not the time to run and hide with cash on the sidelines. If you have funds at your disposal, there are plenty of great businesses out there you can now buy at discounted prices.
Here's why I'm buying both Autodesk (ADSK -3.11%) and Dropbox (DBX -0.30%) -- two high-quality software businesses -- during this bear market.
1. A forgotten Silicon Valley darling
Dropbox was one of the storied start-ups to come out of Silicon Valley in the early 2010s. The file-sharing and cloud-storage company disrupted many of the legacy systems that individuals and small businesses were using with an easy-to-use platform. So much so that even Steve Jobs, CEO of Apple, threatened to put Dropbox out of business after founder Drew Houston turned down an acquisition offer.
Dropbox's product might not be the sexiest software out there, but it keeps people's digital lives moving, serving a vital role that can't be turned off just because the economy is in a downturn.
Years later, in 2018, Dropbox had its initial public offering (IPO) and opened at a price of $29 a share. Today, its shares are actually below the IPO price, at around $20.
DBX free cash flow. Data by YCharts.
But Dropbox's business has done just fine. Since the second quarter of 2018, paying users have grown from 11.9 million to 17.4 million, with the average revenue per user (ARPU) going from $116.66 to $133.34. More paying users giving Dropbox more money each year have led to steady topline growth for the company. With a large fixed-cost base and high gross margins, this growth has led to steady margin expansion.
For example, in the second quarter of 2018, Dropbox's adjusted operating margin was 14.1%. Today, it is 31.9%. This margin expansion has led to it becoming much more cash generative. Over the last 12 months, it has generated $713 million in free cash flow (FCF). Compared to a market cap of just $7.32 billion, that gives the stock a trailing price-to-FCF (P/FCF) ratio of approximately 10, which is much below the market average.
By 2024, management thinks it can start generating $1 billion in annual FCF. If it hits this target, Dropbox's stock will likely be much higher a few years from now.
2. The software backbone for infrastructure and construction
Industrialized construction and infrastructure projects are the backbones of modern society. Over the last few decades, the design, monitoring, and testing of these systems have moved from pencil and paper to software programs. Autodesk is the leading provider of software products to various users like architects, engineers, and construction workers.
For example, Autodesk's leading software product is Revit, a 3D design and simulation tool that has the majority share of the building information modeling (BIM) market. BIM is a design standard that many countries around the world are adopting in order to improve efficiency with construction projects.
However, no country is yet at greater than 50% BIM penetration across its various use cases, meaning that Revit has many years to grow around the globe. In turn, this should drive revenue growth for Autodesk.
Outside of Revit, Autodesk has many other software products that should ride this digital revolution. All of this has given the company a fantastic track record. Since its IPO a few decades ago, Autodesk's revenue is up a whopping 47,000%.
This fiscal year, Autodesk is guiding for FCF generation of just over $2 billion. At a market cap of $40 billion, the stock trades at a forward P/FCF ratio of 20. While not as cheap as Dropbox, Autodesk has a better record of growth and a more diversified business, meaning investors shouldn't be afraid to pay a premium valuation for shares.
ADSK revenue (TTM). Data by YCharts.
Autodesk is a complicated business, but the thesis is simple; the industrial and commercial worlds are moving to digitize more and more of their processes. At a reasonable price, Autodesk stock looks like an easy buy right now for investors looking to ride this tailwind.
