With the sector rotation that happened for the past 2 weeks, many tech stocks have dipped significantly. While the pullback has cause tech stocks valuation to drop, the technology sector’s forward earning is still high at 26.6x, as compared to its historical average of 21x.
I am still optimistic about tech stocks and believe in their future potential. However, I believe that going forward, we should only focus on those that are fundamentally undervalued or fairly priced. As long as its fundamentals are solid, you could consider adding them to your portfolio.
Today, we will look at 3 tech stocks with great business fundamental and are potentially undervalued.
Adobe Inc (NASDAQ: ADBE)
Adobe is a software company that has been used by many businesses around the globe for its range of creative’s products. If you are a creative yourself, you are most likely using adobe’s creative cloud.
From 2013, Adobe switched from offering online one-time purchase to an online service as a software (SaaS) business model. As such, instead of buying the software with a one-time payment, customers now have to pay a monthly fee for using Adobe’s products.
While the amount collected monthly is lower, it guarantees recurring revenue. Together with the lower barrier to use Adobe’s product that comes with this business model, Adobe’s revenue has been increasing yearly.
The revenue stream from Adobe’s main business, creative cloud, has been increasing over the years with new creative average recurring revenue (ARR) hitting a record of $1.47B in FY2020. Of the total revenue, more than 97% is subscription-based and recurring, providing Adobe with a constant revenue stream over the coming years.
*ARR is a way to measure how much recurring revenue a company can expect to receive yearly from its subscription service. This is used quite common with SaaS businesses like Adobe.
Source: Adobe Financial Report
Taking a look at the overall company financial, you can see that its total revenue has been increasing. With a high GAAP operating margin of 32.9%, it shows the huge economic moat Adobe has in this industry.
Source: Adobe Financial Report
Moving forward there is still a lot of room for Adobe to grow.
Given that the main bulk of its revenue is coming from America (58%), there are still a lot of possible new customers from other parts of the world like the Asia Pacific which currently takes up only 16% of Adobe revenue shares. Speaking of its competitors, I do not think they offer such a wide range of products as Adobe.
Moreover, with many schools using Adobe’s products as a means of teaching, companies often find it hard to switch to another software due to the steep learning curve for graduates to move to another software. This stickiness of the business bodes well for Adobe’s business as a competitor would have a harder time penetrating this market.
At US$444, Adobe can be considered fairly valued. If the tech sell-off continues, I would be willing to add this company to my portfolio, given that this is a great company with good fundamentals.
Mercadolibre Inc (NASDAQ: MELI)
Mercadolibre is a leading e-commerce and fintech company in Latin America. It is often dubbed as the Amazon of Latin America. Currently, it offers 6 different services to its users.
- Mercado Libre Marketplace is a fully automated e-commerce platform which enables Mercadolibre, its merchants and individuals to list product and conduct sales here.
- Mercado Pago FinTech platform is an integrated digital payment solution that complements the Mercado Libre Marketplace, by providing its users a way to securely send and receive payments. Beyond facilitating its marketplace transaction, Mercadolibre has also expanded its services to 3rd party.
- Mercado Envios logistics service provides the necessary logistic services like fulfillment and warehousing needed for its buyers and sellers.
- Mercado Libre Ads solution allows businesses to promote their products and services on the internet via an advertisement on their webpages.
- Mercado Libre Classifieds service allows users to list and purchase motor vehicles, real estate, and services. Compared to listing on the marketplace, users are only charged optional placement fees.
- Mercado Shops online storefronts solution allows users to set up, manage and promote their digital stores. These stores can be created for free, but users have to pay to access additional functionalities and value-added services.
- Mercado Credito offers credit to users, allowing users to take loans.
Over the years, MELI’s revenue has been increasing every year with its growth rate hitting 96.88% last quarter.
Likewise, its gross profit margin has been high at around 43%, which is comparable to Amazon’s at 39.6%.
In the 4th quarter of 2020, MELI gross merchandise volume increased by 110% and its unique active user grew 71.3% year on year, reaching 74 million. Total payment transactions through its payment service also increased 131% year on year to 659.3 million.
MercadoLibre Revenue (Millions of US $)
Source: marcotrends
Fantastic growth aside, the main risk to investing in MercadoLibre would be the execution risk. While its revenue has been growing, MELI has not been profitable in the last 3 years. If MELI can keep up with its current growth, sure, it will turn profitable soon. However, there is still a risk that this may not turn to fruition.
An additional risk is MELI’s exposure to the South American economies. With MELI operating in these countries, it is exposed to the local currencies there. Any weakness in the local currencies could affect MELI revenue, which in the case of 2020 had resulted in a loss of $42.5 million in foreign currency.
Source: Mercadolibre Financial Report
MercadoLibre has a great business in two of the fastest growing sectors namely e-commerce and digital payment. If it is executed well, it has the potential to be what Amazon is today. It is worth noting that in its early stages, Amazon was also unprofitable due to its focus to expand its business. We could possibly see this for MELI.
With the drop in MELI’s share price, this stock is getting more appealing.
Facebook Inc (NASDAQ: FB)
Facebook is the most popular social media platform worldwide with more than 2.74 billion monthly active users. Apart from Facebook (the social platform) as its main business, the company also owns 3 other social media platforms namely WhatsApp, Facebook Messenger, and Instagram. All of them sit in the top 10 most popular social networks in terms of active users as well:
Source: Statista
With a total of 3.3 billion people using at least one of Facebook’s social media platforms, advertisers can target nearly half of the world’s population just by advertising with Facebook. For this reason, advertising makes up the main chunk of Facebook revenues.
Source: Facebook Financial Report
With greater access to the internet over the world, digital advertising has been increasingly popular among businesses as a low-cost way to acquire customers. Over the last 4 years, we observed that Facebook’s revenue and net income have been increasing consistently. (The slight dip in net income in 2019 was due to higher tax provision and operating expenses). As digitalization continues, Facebook would continue to benefit from higher advertising revenue in years to come as more retailers focus on the online space.
Source: Facebook Financial Report
Source: Facebook Financial Report
Digging deeper into its advertising revenue by user geography, close to 50% of Facebook Q4 2020 earnings come from the US & Canada, even though it makes up a small proportion of Facebook monthly active users. This suggests that Facebook has a lot of room for growth in the Asia Pacific region for the coming years as this region has the most active users on Facebook.
Facebook is not without its risk. Over the years it has been accused of breaking antitrust laws and many others. The most recent saga would be Facebook banning news on its social platform in Australia due to the Australian government’s proposed legislation that would force tech platforms to pay news publishers for content. While Facebook has lifted the ban, the future is still uncertain as Facebook only has 2 months to reach an agreement with news publishers in the country.
Compared to its average PE ratio of 35, Facebook is currently trading at a discount with a PE of 25.8 At the current price, Facebook is at an attractive price for investors to pick up.
Disclosure: Out of all the 3 stocks discussed, I currently have a position in Facebook as a long term play.
