For many small technology companies, 2022 was a revelation that conquering an industry doesn't happen overnight. With the U.S. Federal Reserve aggressively hiking interest rates to cool off inflation and rampant speculation, the realization that profitability does matter is sinking in.

This isn't to say that innovative growth is dead. However, with the era of zero-interest rate easy money coming to an end, businesses now have to focus on profitable expansion versus the grow-at-any-cost mindset that reached its peak in 2020 and 2021. 

For Doximity (DOCS -2.48%), none of this is news. The small healthcare software company has always been focused on profitable growth, and that is only just beginning to pay off for shareholders. Here's why this stock is still a buy in my book. 

Doximity's free cash flow has more than doubled

In Doximity's fiscal 2023 second quarter (ended Sept. 30), revenue increased 29% year over year to $102.2 million, beating the high end of management's expectations ($100.5 million) a few months ago. The company reiterated full-year guidance for revenue to be up at least 23% compared to last year.

Doximity has been struggling with a deceleration in digital spending as effects of the peak pandemic wind down. Nevertheless, while the company isn't growing as fast as it was in the last couple of years, physicians, hospitals, and pharmaceutical customers are sticking with many of the new software-enhanced tools they began using during lockdowns. That has been good news for Doximity as it has been able to steadily expand its relationship with its user base -- particularly in digital marketing with big pharma (the main breadwinner) and new physician office products like e-signature and scheduling.  

Arguably the biggest news in Q2 2023, though, was that free cash flow increased 109% year over year to $37.7 million. That represented a very healthy free cash flow profit margin of 37% compared to 23% in the same period last year.  

Net income was $26.3 million, down from $36.1 million last year, primarily due to an increase in employee stock-based compensation and non-cash depreciation and amortization expenses (mostly related to the acquisition of physician scheduling software outfit Amion early in 2022). Nevertheless, despite a reduction in net income, Doximity remains a highly profitable business in the health tech space.

Why is the stock being punished?

One of the arguments against owning Doximity was that record profit margins would ease this year as the company's hot streak cooled off. However, as the healthcare industry has begun to normalize from the effects of the pandemic, that argument hasn't exactly materialized. On the contrary, certain profitability metrics have continued to rise, even as Doximity has reported a bit of softening in demand for some of its products.

DOCS Revenue (TTM) Chart

Data by YCharts.

In fact, there's reason to believe that profitability will continue to strengthen going forward. Management said that after a big slowdown earlier in calendar 2022 that big pharma marketing is starting to show signs of life again. Where once there was a flat outlook for year-over-year pharmaceutical industry marketing spending, expectations are now showing a high-teens percentage growth rate compared to 2021. Digital ads provide a much better return on investment, so companies like Doximity that provide a digital marketing hub are reaping the rewards.  

And then there are telehealth products, including video and phone dialing direct from the Doximity app and other features like document management. It's worth noting that Doximity said it had an impressive 100% renewal rate so far this fiscal year with its enterprise telehealth clients. Digital tools like this are a new growth vertical for Doximity on top of its ad business, which also bodes well for profit margins as this segment scales up.  

After the last quarterly update, shares of Doximity traded for a rich 57 times trailing-12-month free cash flow. It's a steep price tag, even after shares have been pummeled by the bear market. The stock is down over 50% in the last 12-month stretch, mostly owing to a sky-high valuation that has been humbled by rising interest rates. As a reminder, higher interest rates lower the present value of stocks.  

Nevertheless, if Doximity can continue growing its business by a double-digit percentage and keep its profit margins running high, it isn't an unreasonable price tag. And a share repurchase program certainly doesn't hurt either. $70 million was repurchased through the first half of fiscal 2023, and a new $70 million buyback authorization was added. In the world of healthcare software technology, Doximity is a top-notch option.  

I will continue to add a few shares to my existing position every quarter after this latest earnings update.