jFrog (NASDAQ:FROG) highlights two very different ways of looking at the market right now, and offers an opportunity to decide whether you like FROG stock over the long term.
The first way is to view tech stocks, in particular, as a massive opportunity.
The world is set for significant technological change over the coming decades. The companies that can capitalize on the opportunities created by that change should profit handsomely.
Investors have piled into the leaders in sectors with long-term growth potential, such as electric vehicles, semiconductors, and software.
The second way is to question whether the market has become far too optimistic — or simply lost its sanity. Yes, there will be changes in coming years. But change doesn’t happen as quickly as optimists usually believe.
The investors snapping up dot-com stocks in the late 1990s weren’t wrong about the transformational power of the Internet. The Internet has revolutionized the way we live.
But those optimists weren’t particularly good at picking the winners, nor did that revolution happen in simply a matter of years.
Many fundamental-minded investors view this market as repeating the mistakes of that market. Valuations are as high as they’ve been in over 20 years. ‘Hot’ stocks keep rising: many have better than tripled from March lows.
Those investors are not going to like FROG stock. But it’s worth noting one key point: those investors haven’t been right yet. Maybe that changes, or maybe FROG stock is the next growth winner.
The Case for FROG Stock
The FROG story is a good one. Its tools streamline the software development process. Most notably, they allow for continuous updating both of on-premise and cloud-delivered programs.
Obviously, jFrog is selling into a large and growing the market. As the expression goes, software is “eating the world“. And so if investors are willing to pay handsomely for software stocks, as is the case, they should be willing to pay up for a supplier to those fast-growing companies.
Admittedly, the story isn’t perfect. Competition is a potential risk. The most direct competitor is GitHub, which is now owned by Microsoft (NASDAQ:MSFT).
jFrog is going up against giants. But it’s holding up well so far. Growth has been impressive, with revenue rising 50% year-over-year in the first six months of that year.
That’s on top of a 65% increase in sales in 2019. Thanks to gross margins over 80%, jFrog already is near breakeven in terms of net profit. With the initial public offering in the books, the company should be self-funding from this point forward.
The question remains, however: is the story good enough? After all, FROG stock is expensive.
More than a few observers believe that the stock is too expensive. David Moadel wrote this week that it’s time for caution after big jump following jFrog’s initial public offering. Chris Lau and Tezcan Gecgil argued that investors needed to wait for a dip.
To some extent, that dip has arrived. FROG stock has pulled back about 14% in the last six trading sessions. But it still sits 70% above its IPO price.
And the stock remains dearly valued. Based on trailing twelve-month figures, FROG trades at nearly 50x revenue, even backing out cash on the balance sheet. That’s one of the highest multiples in a tech market that already is facing valuation concerns.
The other stocks getting that kind of multiple generally are outgrowing jFrog. 50% revenue growth year-to-date is impressive, certainly. But it’s not, on its face, enough to justify that kind of revenue multiple.
Personally, I’m sympathetic to the argument that FROG stock simply needs to get cheaper. Fundamentally, it makes some sense.
Will History Repeat?
But it bears repeating: investors (and authors) who have focused on valuation over growth usually have been wrong. (To be clear, I include myself in that group.) Stocks that look “too expensive” generally keep getting more expensive. “Cheap” names generally struggle.
And that gets back to the core debate over the market, a debate which FROG stock highlights. Is the continued growth in dearly-valued stocks a sign of a bubble continuing to inflate? Or is it a rational response to massive tech trends, lower “safe” yields in the bond market, and other factors?
If an investor believes the former, FROG stock is an obvious no-go. It’s a nice story, but it’s not nice enough to justify a $7 billion market capitalization on the back of less than $130 million in revenue.
But if an investor believes in the power of growth, and in owning the most attractive stories first, jFrog fits the bill. It’s serving a massive market. It has by all accounts an exceptional product offering. FROG stock is what growth stock investors have been looking for in recent years. And it bears repeating: for the most part, those investors have been right.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.