To buy stock in a growing, tech-driven business today, investors typically have to pay a pretty penny in relation to the company’s earnings. While many of these great businesses often deserve the premium multiples that the market attributes to them, Mr. Market occasionally hands out a few discounts as well.
Whether it’s due to a few bad quarters, woeful projections, or a number of other causes, stocks can every so often grow disconnected from the future earnings of the underlying businesses. Dropbox (NASDAQ:DBX) and Nintendo (OTC:NTDOY) are two technology stocks that fit that mold today.
Dropbox, the popular file-sharing and content-collaboration platform, allows users to securely upload files, share and sign documents, collaborate on projects, and plenty more.
As with many file-storing services, Dropbox’s users are quite sticky. Porting over documents and getting accustomed to a new system can be a bit of a hassle. Not to mention, it can disrupt workflow since teams often collaborate on projects simultaneously now. The heavy friction of the replacement process has helped Dropbox generate a net revenue retention rate north of 90% and allowed the company to increase its average revenue per user (ARPU) by 5% over the prior year.
Between the increase in ARPU and its user growth of 8%, the company is currently on track to generate more than $2.1 billion in annual recurring revenue — a 13% boost from the same period a year ago. But it’s not just the revenue growth that should have investors excited. Dropbox is taking several steps to boost its free cash flow per share at an even faster rate.
In February 2021, the board of directors approved a $1 billion share repurchase program. At the time, that amounted to more than 10% of the company’s market cap, and today it equates to roughly 8%. With this action, shareholders should see a greater percentage of the company’s earnings come to them.
Additionally, the pandemic helped inspire Dropbox to lean up its operations. In January, management took the tough step of reducing its workforce by 11% and followed with a commitment from the company to go “all-in on remote work.”
With the strong revenue growth, sizable buyback program, and reduced operating costs, Dropbox believes it can reach $1 billion in free cash flow (FCF) by 2024 — a 104% increase from the latest fiscal year. That’s plenty of growth for a company trading at a price to trailing-12-month FCF of 21 times.
Nintendo has been a stalwart of the video game industry for roughly 50 years. But it wasn’t until just recently that the company finally pieced all of its experience and assets together.
In March of 2017, Nintendo released the best-selling console of the last three years, the Nintendo Switch. It combines the convenience of a handheld console with the benefits of a stationary one. However, unlike Nintendo’s previous consoles, Switch users’ accounts are no longer linked to a specific piece of hardware. Instead, by introducing Nintendo Online, users can save their data to the cloud and access downloaded digital games on new versions of the platform, like the Switch Lite.
This online focus has made upgrading to new Switch iterations easier for customers. It has helped Nintendo sell nearly 85 million units since the launch of the Switch, with expectations to sell another 29 million this year. Pairing this massive installed base with the company’s world-famous portfolio of brands like Mario, Zelda, and Pokémon (of which Nintendo owns at least 33%) has helped the company drive robust profit growth through an increase in its game sales. Since 2017, Nintendo’s annual operating profits have grown more than 20-fold, reaching a record of $5.8 billion in its latest fiscal year!
However, despite that remarkable growth, the stock currently trades at a price-to-operating-income multiple of 12 times. That’s well below the valuation of gaming peers such as Activision Blizzard and Electronic Arts.
While there are always a number of factors that can lead to a depressed stock price, worries over cyclicality seem to be bogging down Nintendo. Management doesn’t combat this much, either, as it continues to provide ultra-conservative guidance despite constantly beating its own expectations.
Yet even if management’s 2021 estimates prove to be correct and the number of new consoles sold declines over the next year, the path toward greater profits in the long term is still clear. As more and more households adopt different versions of the Switch console, game development will become more profitable since the company will have a larger customer base to sell to. And game purchases are becoming increasingly digital, which should reduce distribution costs as well.
Should Nintendo’s track record of profit growth persist, the current stock price will look quite cheap in hindsight.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.