I invested in AppLovin (APP) when the company was worth less than $15 billion. Today, that figure stands at over $113 billion, following a 687% rally over twelve months. However, I am a little concerned that momentum may be running out simply because the company’s valuation could prove unsustainable unless it can provide further catalysts. For now, I am neutral on this stock given the changing interest rate environment, the potential for riskier sentiment and the stock’s valuation.
While I’m now neutral on the stock, I should note that the company’s rise has been nothing short of remarkable. AppLovin’s rise in the mobile advertising and gaming industries can be attributed to several key factors. At the heart of its success is the AI-powered Axon engine, which has revolutionized ad targeting and delivery. Initially an unknown entity, this innovative technology continuously learns and refines data, ensuring ads reach the right audience at the optimal time, significantly increasing user engagement and ad effectiveness.
AppLovin’s strategic focus on the mobile gaming sector, a market expected to grow substantially, has played a central role in the company’s success. Additionally, AppLovin’s unique combination of gaming development expertise and targeted advertising capabilities gives it a competitive advantage over traditional advertising platforms.
In turn, its financial performance has impressed the market, with AppLovin reporting a 39% year-on-year revenue increase to $1.2 billion in Q3 2024. Meanwhile, earnings per share more than quadrupled to $1.25, with third quarter earnings exceeded expectations by an incredible margin. $0.33. Looking ahead, the company’s expansion into new verticals, particularly e-commerce, offers significant growth opportunities as leveraging its AI capabilities in these new sectors could further enhance its success.
I am currently neutral on AppLovin because, despite its impressive profitability and growth prospects, its valuation is difficult to justify. The company’s financials paint a picture of a high-performing business with significant potential, yet the current market valuation appears to price in extraordinary future performance.
Starting with the positives, AppLovin presents exceptional profitability figures, with an EBIT margin of 35.8% and a net income margin of 26.8%, both significantly above the industry median. The company’s revenue growth is equally impressive, up 41.5% year-over-year, well above the industry median of 4.4%. It is an efficient operator and the business is growing significantly.
However, the valuation metrics are extremely rich. The company’s forward price-to-earnings (P/E) ratio of 64.8x is 159.5% higher than the industry median. Similarly, the forward EV/EBITDA ratio of 63.9x 198% is above the industry median. These ratios indicate that investors expect exceptional earnings growth in the coming years.
While consensus expectations for AppLovin’s earnings growth are very strong, with expected growth rates of 313.5% for 2024 and 46.5% for 2025, the current valuation requires continued exceptional growth over the medium term. The price-to-earnings-growth ratio (PEG) of 2.6, which is 43.3% higher than the industry median, indicates that the stock could be overvalued relative to expected growth.
To justify AppLovin’s valuation, the company would have to consistently exceed these already high expectations and deliver huge earnings numbers in the coming quarters and years.
Interestingly, the market expectation for the current quarter is in line with the $1.25 achieved in the third quarter. If this forecast comes true, it would be the first time in eight quarters that earnings have not improved sequentially.
My suspicion is that AppLovin will once again positively surprise. However, it may need to make some significant moves to justify the valuation and generate more momentum for the share price.
My concerns about AppLovin’s stock price momentum are also affected by the Federal Reserve’s signal that there will be fewer rate cuts in 2025. The announcement on Wednesday, December 20 resulted in AppLovin’s stock price dropping by approximately 7%.
On TipRanks, APP comes in as a Moderate Buy based on 14 buys, four holds, and one sell assigned by analysts over the past three months. Moreover, the average price target of APP stock is $323.67, implying a downside risk of 4.24%.
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The rise of AppLovin has been nothing short of sensational. However, despite excellent profitability figures, strong growth expectations and new verticals, I am neutral on the stocks that have given me such strong returns. The company’s impressive performance in Q3 2024, with revenues of $1.2 billion and up 39% year-over-year, highlights its potential.
However, the share’s valuation gives rise to major concerns. With a forward price-to-earnings ratio 159% above the industry median and an EV/EBITDA multiple that suggests extraordinary expectations, AppLovin stock likely won’t have momentum unless we see a huge upside in earnings. While the AI-powered technology and expansion strategies are promising, it is difficult to invest more in this stock at this point.
