A Bull Market May Be Coming, but These 2 Tech Stocks Keep Struggling -- Time to Sell?

For some high-growth tech-stock investors, it's been two years (in some cases, a little more) of suffering. Some early pandemic winners like Zoom Video Communications (ZM 0.05%) hit their all-time highs all the way back at the end of 2020. Others like PubMatic (PUBM 2.19%) have been mostly downhill since their 2021 initial public offerings (IPOs).  

What's frustrating now is that a bull market seems to be trying to find some footing, led especially by tech infrastructure stocks like semiconductors and energy. Not only are Zoom and PubMatic getting left behind, but they both provided a weak outlook for the calendar year 2023. Is it time to sell these two struggling tech stocks? 

1. Zoom Video: Growth is finished, now it's a matter of "how cheap is cheap enough?"

Zoom Video Communications was a high-growth and promising stock before the pandemic, and became an economic lockdown darling when the world quickly pivoted to remote work. But since then, Zoom has sputtered. It's beginning to appear that 2020 broke this software communications company, turning it into more of a sluggish utility stock than a nimble software outfit. 

The final financial report for fiscal 2023 (the 12 months that ended January 2023) painted a less-than-perfect picture. Fourth-quarter revenue beat management's guidance and came in at $1.12 billion, or up 4% year over year (or up 6% when excluding the negative impact of a strong U.S. dollar). Net loss was $104 million, and free cash flow was positive $183 million -- the discrepancy between the two is primarily employee stock-based compensation of $518 million. Full-fiscal-year stock-based comp was $1.29 billion, which Zoom mostly offset with stock repurchases (funded by free cash flow) of $1 billion.  

But it was the outlook for fiscal year 2024 that really disappointed. Revenue is expected to be in a range of $4.435 billion to $4.455 billion, basically flat with the just-completed fiscal year (though the U.S. dollar is having another negative impact on that outlook).  

By some metrics, Zoom is cheap. The stock trades for less than 17 times trailing-12-month free cash flow. Even should revenue continue to sputter, the company took steps to boost its profit margin going forward. Zoom also has a fortress balance sheet featuring $5.4 billion in cash and short-term investments and no debt.  

But being a value investor requires a very different skill set than being a growth investor. Patience can be tested to a far greater degree with a "value stock" as shareholders are often required to wait for the market to recognize slow but steady progress from management to improve profitability. Meanwhile, other areas of the economy are already back in growth mode and receiving investor attention.

I still own my small position in Zoom and have no plan to sell anytime soon. But be mindful of the fact that it could still be an arduous road ahead for this once-magnificent growth company. Zoom looks more like a boring old telecom stock than ever before. 

2. PubMatic: The promise of higher profit margins isn't materializing ... yet

PubMatic's transition from fresh IPO growth stock to value stock came about in an altogether different manner. With economic uncertainty cropping up the second half of 2022 and lingering so far in 2023, digital advertising has slowed in dramatic fashion. Indeed, when financial conditions tighten, marketing activity is often the first part of a company's budget to take a hit. Small companies like PubMatic, which offers software for media outlets looking to list and manage ad slots available for sale, suffered. 

Q4 2022 revenue was $74.3 million, down slightly from $75.6 million the year prior. While PubMatic's small connected-TV segment (think streaming video services) continued to grow at a robust pace, display ads (banner style ads featuring text, images, and links), about two-thirds of PubMatic's sales, dragged down results.  

But most frustrating is that the company's promised profit margin expansion might take longer to deliver than anticipated. Management put cost reduction plans in place toward the end of 2022, but it's saying those will take time to bear fruit in 2023. Adjusted earnings before interest, tax, depreciation, and amortization (EBITDA) margin is forecast to be more than 30% for 2023, compared to 38% in 2022. Free cash flow is expected to be "similar to 2022," implying about $38 million (or about a 15% free cash flow profit margin).  

Management did at least provide a vote of confidence by putting a $75 million stock repurchase plan in place, which can be executed through the end of 2024. PubMatic ended the year with $174 million in cash and short-term investments and no debt, so the company is well positioned to return that excess cash to shareholders via stock buybacks.

Like Zoom, PubMatic could be viewed as cheap by some metrics. Shares trade for under 20 times trailing-12-month free cash flow as of this writing. But this is another potential "value story" that will take time to unfold. Patience could eventually be rewarded for shareholders of this company, so I'm not inclined to sell -- and especially not if the digital ad industry begins to pick up steam again later this year. But if you stand by PubMatic, be prepared to strap in for a bumpy ride for some time longer.