Peter Lynch, one of the greatest investors of all time, has said: “I can’t say enough about the fact that earnings are the key to success in investing in stocks. No matter what happens to the market, the earnings will determine the results.”
I believe this. Therefore, as a long-term investor, I try to watch earnings growth and predict where it will be in five years or so. The idea is that if earnings go up, the stock price eventually will as well. The ups and downs along the way are just noise.
However, I was recently reminded of just how patient investors have to be sometimes. Take Sprouts Farmers Market as an example. Its earnings per share (EPS) has consistently increased since it went public 11 years ago. But after going nowhere for 10 years, Sprouts’ stock has skyrocketed 200% in the past year, finally reflecting its long-term EPS growth.
Investors must stay patient because sometimes it can take time for earnings to lift a stock price higher. But sooner or later, they will be rewarded. Therefore, patience is needed for investors in Airbnb (NASDAQ: ABNB), PayPal Holdings (NASDAQ: PYPL), and PubMatic (NASDAQ: PUBM). But here’s why I believe earnings are headed higher for this trio of phenomenal stocks.
1. Airbnb
With over 125 million nights and experiences booked in the second quarter of 2024 alone, Airbnb is a well-known and well-adopted travel booking platform. Hosts list their spaces for rent as well as posting tailored travel experiences.
Travelers go to the platform to book, and Airbnb sits in the middle, quietly taking its high-margin cut of the deal.
Indeed, Airbnb’s business model is extremely lucrative. With its second-quarter profit margin of 20%, few companies can surpass its profitability. And from the perspective of free cash flow, things are even better with a 41% margin.
If there’s a knock against Airbnb, it’s that the platform is already large, and growth is consequently slowing: Second-quarter revenue was up only 11% year over year. That’s why management is turning its attention elsewhere.
The truth is, Airbnb’s core platform is rock solid — millions of people use it without prompting from advertising. This is allowing management to enter a “new phase.” It aims to launch multiple new businesses every year. Many will fail. But it hopes that a small percentage will succeed and contribute to the growth of the company.
Airbnb’s earnings are strong and should stay strong. And if this phenomenal stock can find new sources of growth, earnings could head higher in the coming years, lifting the stock price.
2. PayPal
Over the last 12 months, fintech pioneer PayPal has earned just over $4 per share. Four years ago, its earnings were about the same, meaning growth has been lacking. And investors can point fingers at its lack of earnings growth when explaining the lackluster stock price.
However, PayPal is already on a better path for earnings growth now. The company reworked its management about a year ago, and this new team is forging important new partnerships, margins are improving, and it’s looking to develop new ways to grow the business.
Regarding specifics, PayPal has long known it has valuable consumer data. And it seems like management is finally figuring out ways to package this to improve its services for merchants. More details would be nice. But one important detail is that the company hired Mark Grether earlier this year to head up its advertising business — the same Grether who quickly built a $1 billion ad business for Uber.
With margins improving under new management and with new potential revenue streams coming online, PayPal’s earnings should finally return to growth, which should in turn lift the stock in coming years.
3. PubMatic
Whereas Airbnb and PayPal are household names, PubMatic is far smaller and obscure. But I still feel comfortable calling it phenomenal. As I’ll explain, this little company dares to be different.
PubMatic’s market capitalization is only $750 million as of this writing. But this small company is determined to keep a clean balance sheet, with no debt and $166 million in cash, cash equivalents, and short-term investments as of the second quarter of 2024. That’s unusual for a company this small.
Moreover, PubMatic chooses to own and operate all of its hardware infrastructure as well, rather than rely on public cloud providers, where it can’t control pricing. That’s not necessarily an easy road to walk, but it does give it a greater degree of control over its business.
PubMatic is an advertising technology company that works with publishers to monetize content. It hasn’t been a great environment for these kinds of companies lately. But PubMatic is still modestly growing and running a profitable business. And it’s in great shape for earnings growth when its market eventually heats back up.
In coming years, it will be important for investors to not focus so much on the stock prices for Airbnb, PayPal, and PubMatic. As I pointed out with Sprouts stock, the price can stagnate for a really long time. But if earnings are growing and the business has the opportunity for more growth in the future, then these will be stocks to continue holding, while expecting prices to eventually catch up.
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Jon Quast has positions in Airbnb and PubMatic. The Motley Fool has positions in and recommends Airbnb, PayPal, PubMatic, and Uber Technologies. The Motley Fool recommends Sprouts Farmers Market and recommends the following options: short December 2024 $70 calls on PayPal. The Motley Fool has a disclosure policy.
Prediction: These 3 Phenomenal Stocks Are Set to Soar was originally published by The Motley Fool
