With outsized inflation, rising interest rates, a stock market correction, and the looming possibility of a U.S. recession, everyday investors want to know what to do with their money. Investors tend to turn to the professionals for insight, and the pros seem to be turning to cash.
According to the Bank of America Global Research Fund Manager Survey, fund managers in October reportedly reached their highest cash levels since 2001. These managers are supposed to grow invested capital for their funds. But they're increasingly avoiding what's seen as a turbulent market and are now sitting on 6.3% cash, preferring the safety of interest income at improved rates. I strongly suspect many investors are following the fund managers' lead and moving to cash as well. That's not necessarily a bad thing. Maintaining at least some cash position in a portfolio (the general recommendation is a minimum of 5%) is advantageous.
However, I believe that advertising technology (adtech) company PubMatic (PUBM -2.27%) and equipment rental company United Rentals (URI 5.45%) are two stocks that offer better potential returns than cash and are worth buying today. Here's why.
1. PubMatic
Two things are simultaneously true in the advertising space at the moment. First, advertising budgets are pulling back. Second, digital advertising is still poised to take market share from traditional advertising over the long term. PubMatic's stock price is hurting because of the first truth. But the stock could still be a market-beater because of the second truth.
PubMatic's co-founder and CEO Rajeev Goel got straight to the point in his opening statement during a conference call to discuss financial results for the third quarter of 2022. Goel said, "As we suspected, Q3 marked an inflection point with respect to a deteriorating economic environment." Q3 revenue consequently came in lower than expected, growing just 11% year over year to $64.5 million.
PubMatic also lowered its outlook for the fourth quarter. Management expects Q4 revenue of $75 million to $78 million, compared to $75.6 million in the fourth quarter last year. Slow growth in Q3 and Q4 reflects the slowdown in the advertising space in general.
Advertising as a whole will eventually bounce back when economic conditions improve. And programmatic digital advertising -- one of PubMatic's specialties -- will likely see even larger gains. Multiple third parties attest to it but the latest study from Technavio is particularly promising. According to its research, programmatic ads should grow at a nearly 27% compound annual growth rate (CAGR) through 2026 -- that's more than a tripling over a five-year span.
Understand that PubMatic can easily wait out the slowdown in its market. The company has earned $15.9 million in net income through the first three quarters of 2022, and it has $166 million in cash, cash equivalents, and marketable securities with no debt. It's likely that many of PubMatic's smaller competitors aren't in such a great financial position, allowing PubMatic the luxury of patiently waiting to gain market share as weaker competitors are weeded out.
The market is thinking about near-term results in the adtech space and PubMatic stock consequently sold off. But thanks to this, the stock now trades at its cheapest price-to-sales valuation ever and at a very reasonable price-to-earnings ratio of about 21.
PUBM PS Ratio data by YCharts
In other words, now is an opportune moment to put that sideline cash to work with PubMatic, investing in a company at a reasonable valuation but with high-return potential when advertising begins its recovery.
2. United Rentals
I'm not sure why any buy-and-hold investor wouldn't want United Rentals in their portfolio. Over the past 10 years, the stock returned about 750% compared to the 190% return for the S&P 500. And the factors driving these returns over the past decade are still relevant for the decade to come.
United Rentals is the largest equipment rental company in the world, with equipment options for both industrial and do-it-yourself customers. Its current inventory of equipment available for rent cost $17.4 billion to build out -- a high barrier to entry and a competitive advantage. And this equipment generates consistent free cash flow (FCF) for United Rentals.
United Rentals is on track to generate $1.7 billion in FCF in 2022, meaning the stock trades at about 14 times its FCF -- a reasonable valuation for a proven market-beater. But it's what management does with FCF that makes this investment a consistent winner. Management either grows free cash flow per share by repurchasing shares or it simply grows its business by acquiring other companies at compelling prices.
As the 10-year chart below shows, United Rentals share count consistently trends lower while its FCF per share consistently trends higher.
URI Average Diluted Shares Outstanding (Quarterly) data by YCharts
In 2022, United Rentals repurchased $1 billion in shares and it just approved a new $1.25 billion repurchase plan. However, it won't be buying back shares for a little while because in November it acquired the eighth-largest player in its space, Ahern Rentals.
Acquiring Ahern Rentals for $2 billion is a great use of resources for United Rentals. The company is purchasing its competitor for just 6.5 times its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). For perspective, United Rentals generated roughly $5.3 billion in trailing-12-month adjusted EBITDA, so its own shares trade at 4.6 times adjusted EBITDA.
In other words, United Rentals could repurchase its own shares at a lower price. But that wouldn't grow its business. By contrast, it can pay a slightly higher valuation for Ahern Rentals and grow its business substantially. This is the right move, especially since Ahern Rentals is expected to be immediately accretive to United Rentals FCF and will only get better as it's fully integrated into the company.
Put that excess cash to work
There's nothing wrong with keeping a cash position on the sidelines. The stock market could always drop more and present investors with better deals. However, I believe we've seen that both PubMatic and United Rentals trade at reasonable prices now and offer long-term upside. Therefore, now's a good time to put excess cash to work by buying these two stocks.
