I believe that cloud computing company DigitalOcean (DOCN -3.98%) and supply side advertising technology (adtech) company PubMatic (PUBM -3.30%) are two companies that can grow at an above-average pace over the next five years. This places them in the growth-stock category for me.
DigitalOcean stock and PubMatic stock are also down 75% and 80%, respectively, from their all-time highs, making them worth investigating for anyone looking for a discounted investment.
Here's why these are two growth stocks to buy on the dip today.
1. DigitalOcean
A good business is often associated with strong cash flow. DigitalOcean went public in early 2021. In 2020 (the year leading up to its initial public offering), it had negative free cash flow of $57.5 million after generating revenue of $318 million. Therefore, I dismissed the company at first glance.
But I overlooked an important transformation already underway.
In 2019, DigitalOcean hired Yancey Spruill as CEO. He arrived emphasizing revenue growth and positive free cash flow.
The turnaround wasn't immediate, as evidenced by the $57.5 million outflow in 2020. But the company's free cash flow improved to a 6% margin in 2021, followed by a free-cash-flow margin of 13% in 2022.
An emphasis on better profitability hasn't robbed DigitalOcean of growth. The company ended 2022 with 677,000 customers using its cloud-computing services for small and medium-sized businesses, up from about 570,000 when it went public. And revenue of $576 million in 2022 was up 81% from revenue of $318 million in 2020.
DigitalOcean is targeting $1 billion in revenue in 2025, which looks attainable, given industry growth and the company's current growth rate. Moreover, management is also striving for a free cash flow margin of 30%. That means the company could be looking at annual free cash flow of $300 million within a couple of years.
DigitalOcean's market capitalization is currently $2.9 billion. That valuation looks compelling to me if the company achieves its goals. And it's why DigitalOcean stock is one of my favorites right now.
2. PubMatic
It's been nearly two years since PubMatic stock last sniffed an all-time high. However, investing in bargain stocks when the market is down can be a genius decision. And I believe it applies to PubMatic today.
PubMatic exists to help publishers sell their ad-slot inventory -- increasingly, these are digital-video publishers. The stock came crashing down as investors lamented the company's growth forecast. Management's guidance implies the possibility of a year-over-year revenue decline in the first quarter of 2023.
However, let's consider what PubMatic isn't losing: customer relationships. In 2022, the company secured or expanded 429 deals, and that counts for something. Moreover, even as growth slowed, it remained profitable. And it has over $174 million in cash, cash equivalents, and short-term investments. Considering it's also debt-free, PubMatic is standing on solid ground.
Fellow streaming-TV player Roku recently cited research noting a 7% year-over-year drop in U.S. advertising spend in the first quarter of 2023. Since PubMatic is an adtech company, weakness in the ad market is undoubtedly the reason it's expecting weak results in Q1.
However, pundits believe ad spend is down due to macroeconomic conditions. If correct, then it's reasonable to expect this to only be a temporary problem -- PubMatic's growth should rebound when eventual economic improvements bolster ad spend once more.
According to Insider Intelligence, ad spend for connected-TV is expected to roughly double from 2022 to 2026. Only around one-third of PubMatic's revenue currently comes from mobile and CTV video sources. But this part of the business is fast-growing and stands to benefit long term from the CTV ad-spend trend.
CTV ad-spend growth may not manifest in 2023 because of economic conditions. But the long-term trend appears to be intact, making now a good time to buy PubMatic stock because expectations are low.
The better buy today
In my opinion, DigitalOcean and PubMatic are two growth stocks to buy on the dip. But if I had to pick one today, I'd pick DigitalOcean. Whereas PubMatic's near-term growth is questionable, DigitalOcean's revenue could be up 29% year over year in the upcoming first quarter of 2023.
DigitalOcean doesn't report Q1 results until May 9. So investors will have to wait until then to see exactly how the company is doing. The dip in DigitalOcean stock is just as good as PubMatic's, but the near-term outlook for Digital Ocean appears more promising, making it the better buy today.
