Dropbox (DBX 1.33%) stock has been stuck in the mud for years. Shares are trading around their 2018 IPO price of $21 per share, even with the overall market up close to 50% in that same timeframe. This underperformance has continued in 2023 with investors pushing the stock down more than 11% after its fourth-quarter earnings announcement on Feb. 16.
However, if we take a look at Dropbox's financial growth since going public, it is a lot stronger than what its stock price returns might suggest. This difference between share price and business performance makes Dropbox dirt cheap at the moment, and this is the perfect time to scoop up some shares for your portfolio.
Poorly received Q4 earnings
At a high level, Dropbox's Q4 earnings looked adequate. Revenue grew 5.9% year over year to $598.8 million, even with major foreign currency headwinds. On a currency-neutral basis, revenue grew 9.2% year over year. Moving further down the report, the company's cash flow was solid with free cash flow generation of $181.7 million in the quarter, or a free-cash-flow margin of 30%. No surprises there.
So what gives? Why are investors selling Dropbox? It all came down to stagnating user growth and management's commentary on the earnings call. Executives said churn across Dropbox's cloud storage and file-sharing subscription business is slightly elevated compared to a few quarters ago. This is likely due to the recent price increases the company has implemented, which are starting to flow through as its customers renew their contracts. While this is slightly concerning, Dropbox is still seeing incremental revenue gains from these price increases, which should be a good thing over the long term.
On the user front, Dropbox's total paying users hit 17.77 million in the quarter, up from 17.55 million in the third quarter with the majority of this growth coming from its recent acquisition of Formswift. At first glance, stagnating customer growth is not good, but I don't think there is any reason to be concerned here. On the conference call, the executive team said this stagnation was mainly due to losing a large university client with an extremely low average revenue per user (ARPU). So while it had a big effect on the paying user number, it did not have much of an effect on revenue.
What to watch in future years
In the short term -- meaning the next few quarters -- it will be important to watch how Dropbox can manage its business through high inflation and a potential U.S. recession. Investors should also be watching how the recent price hikes affect churn as more and more customers come up for contract renewal. If the company can get through this period relatively unscathed, it is a great indicator that Dropbox and its ancillary services are a necessity for its customers regardless of the economic environment.
Over the next few years, investors should be tracking a few key performance indicators (KPIs) for Dropbox. First and foremost is the growth in paying users, which Dropbox has consistently enjoyed since going public. Second, investors should be looking at growth in ARPU, which will hopefully start to kick into gear once the price increases come into full effect. Growing both paying users and ARPU over the long term is a recipe for Dropbox to grow its revenue steadily each year.
On cash flow, Dropbox has a goal of hitting $1 billion in annual free cash flow by 2024, up from $764 million in 2022. For the current year, management provided free-cash-flow guidance of $825 million to $855 million, which puts it on solid footing to hit its $1 billion target. Investors should hold management's feet to the fire when looking at the company's cash flow going forward. If it significantly underperforms this guidance, that means something has gone wrong with Dropbox's business.
The stock is dirt cheap
The most attractive quality of Dropbox's stock today is its cheap price. At a market cap of $7.7 billion, shares trade at 9.3 times the low end of its 2023 free-cash-flow guidance and 7.7 times management's 2024 cash flow target. A stock trading at a forward free cash flow multiple below 10 is dirt cheap, no matter how you slice it.
To take advantage of this cheap multiple, Dropbox management is aggressively repurchasing its own stock, thereby reducing shares outstanding and further increasing free cash flow per share. That number is the key driver of shareholder returns over the long haul, so investors should be applauding these buybacks, especially at a current market cap well below $10 billion. This is the cherry on top that makes Dropbox a great buy-and-hold stock right now.