Over the past two years, the bulls have firmly controlled Wall Street. The mature stock-driven Dow Jones Industrial Averageyardstick S&P 500 (SNP INDEX: ^GSPC)and innovation-driven Nasdaq Composite (NASDAQINDEX: ^IXIC) have all risen to multiple record highs this summer.
But as the first three trading sessions of August showed us, stocks rarely, if ever, rise in a straight line.
While growth stocks have undoubtedly led the rally, it was the Nasdaq Composite that really took the hit this month. Over the course of three sessions, the index lost just under 1,400 points, or about 8% of its value. By the closing bell on August 5, the Nasdaq was down 13% from its all-time high.
Normally, stock market corrections provide an opportunity for long-term investors to open positions or increase their stakes in great companies at a discounted price. But because stocks have historically been expensive, investors (myself included) have been more selective with their purchases.
Given that history has not been kind to Wall Street, there is only one stock I seized upon to invest in during the recent sell-off on the Nasdaq.
NB!investors
Before I get into the juicy details that led me to add to one of my core stocks during the Nasdaq sell-off, I thought it was important to first discuss the reasons why I’m being so selective about my stock buying right now.
During bull markets, it’s not uncommon for investors to pay a premium for growth stocks. In fact, the democratization of information over the past three decades (thanks, Internet!), combined with historically low interest rates for much of the past 15 years, has increased the willingness of retail investors to take risks. This includes buying stocks with outsized price-to-earnings (P/E) ratios.
Sometimes, significantly higher than average price-earnings ratios can be justified. For example, companies with well-defined competitive advantages and/or sustainable moats typically command a higher valuation than their peers in their sector.
But when you look at the broader market as a whole, high valuations are rarely, if ever, a good thing.
The Shiller price-earnings ratio of the S&P 500 provides the best example of what happens when stock market valuations deviate too far from historical norms. The Shiller P/E is also known as the cyclically adjusted price-earnings ratio (CAPE ratio).
Unlike traditional price-earnings ratios, which take into account earnings over the past 12 months and can be disrupted by one-off events (such as COVID-19 lockdowns), the Shiller price-earnings ratio is based on inflation-adjusted earnings over the previous 10 years. This helps smooth out “gaps” in corporate earnings.
Backtesting back to January 1871, the average P/E for the S&P 500 Shiller P/E is 17.14. On August 19, the Shiller P/E closed above 36 and did not fall much below 33 even during the worst of the sell-off that began this month.
Including the present, there have been only six occasions in the past 153 years when the Shiller P/E exceeded 30 during a bull market rally. After the previous five occurrences, the Dow, S&P 500, and/or Nasdaq Composite ultimately lost anywhere from 20% to 89% of their value.
In other words, the Shiller P/E warns investors that stocks are expensive historically. And I’m a history student who loves studying Wall Street.
This high-growth, cash-rich, small-cap stock was my only purchase during the Nasdaq sell-off
Even with the Nasdaq down double digits in less than a month, I’m not eager to put my money to work, with one exception.
Instead of adding to my “Magnificent Seven” holdings, the only stock that caught my attention during the Nasdaq sell-off was an under-the-radar small-cap adtech company PubMatic (NASDAQ: PUBM).
While negative market sentiment during the first trading sessions of August weighed on PubMatic’s shares, it was the company’s second-quarter results, and in particular its full-year guidance, that drove the stock down.
PubMatic CFO Steve Pantelick highlighted that one of his company’s largest demand-side providers (DSPs) in the programmatic advertising space changed its bidding process in the second quarter. The change will result in slightly less revenue recognition for the remainder of the year. As a result, PubMatic’s full-year revenue outlook now forecasts $288 million to $292 million in revenue, down from a previous median forecast of $300 million ($296 million to $304 million).
This roughly 3% drop in sales at the midpoint wiped out more than 30% of PubMatic’s market value. More importantly, it created a pricing disruption that was too tempting to ignore.
The important thing to note about PubMatic’s revenue “miss” is that it won’t be an ongoing issue, nor was it unexpected. In an interview with Schwab Network following the company’s second-quarter results, PubMatic CEO Rajeev Goel pointed out that this large DSP was the last major DSP to make this bid conversion. Besides this one customer, the vast majority of PubMatic’s sales channels saw double-digit growth.
Now that these headwinds, which sent the company’s shares down more than 30%, have been addressed, we take a closer look at the a lot of reasons why sell-side provider (SSP) PubMatic is a smart buy.
Let’s take a look at the many ways PubMatic is a no-brainer purchase
For starters, it sits at the center of the fastest-growing niche within the advertising industry: digital advertising. Companies are steadily shifting their advertising budgets from traditional print and billboards to digital channels including mobile, video, and connected TV. PubMatic is ideally positioned to help publishers sell and optimize their digital display space.
PubMatic also faces macro headwinds. While recessions are a normal and inevitable part of the economic cycle, history shows that this cycle is not linear. While three-quarters of all U.S. recessions since the end of World War II have resolved in less than a year, the vast majority of economic expansions have lasted for several years. Patience is often a recipe for success for advertising-driven businesses.
On a more company-specific basis, perhaps the biggest advantage PubMatic has is that its management team didn’t take the easy route and chose to build out its cloud-based programmatic advertising platform. By not relying on a third party for this platform, the company’s operating margin can scale at a faster pace than other SSPs.
Additionally, PubMatic is in its 10th consecutive year of positive operating cash flow and is sitting on a mountain of capital. It ended June with $165.6 million in cash, cash equivalents and marketable securities, with no debt. Not only does this cash provide significant financial flexibility regardless of what happens to the U.S. economy and Wall Street, it has also allowed the company to repurchase $100 million of its common stock through July 31. Share repurchases typically have a positive impact on earnings per share, which can make a company more attractive to fundamentally-oriented investors.
The final piece of the puzzle with PubMatic is valuation. While price/earnings ratios work great for mature companies, cash flow is the better valuation metric when analyzing high-growth companies that are aggressively reinvesting in their platforms.
As of the close of business on Aug. 19, PubMatic shares were valued at 8.3 times Wall Street’s consensus estimate for 2025 cash flow. That represents a 38% discount to the future cash flow investors were paying at the end of 2023.
Additionally, PubMatic’s cash, cash equivalents, and marketable securities represent 24.3% of its market cap. Excluding that capital, PubMatic’s business is valued at nearly 6.3 times forward cash flow with continued double-digit revenue and earnings growth. It’s a shockingly cheap stock that I was happy to add during the Nasdaq sell-off.
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Sean Williams has positions in PubMatic. The Motley Fool has positions in and recommends PubMatic. The Motley Fool has a disclosure policy.
This Is The Only Stock I Invested In During The Recent Nasdaq Sell-Off — And It’s Still Astonishingly Cheap was originally published by The Motley Fool
