To say the least, 2022 has not been kind to high-growth tech stocks. Companies that once seemed unshakable have had their market capitalizations eviscerated amid higher inflation, rising interest rates and general concerns about future growth.
While the tech sector likely needed a correction, this shakeout may have created new opportunities for investors who are comfortable with volatility.
Two of the tech stocks that may be good buys today are DigitalOcean and Atlassian. Both of these companies are still growing robustly, even though they have sold off alongside less successful tech firms this year. Here’s what you need to know about these two growth stocks and why they could be reasonable buys while prices remain low.
Cloud computing company DigitalOcean (NYSE:DOCN) has had a trying year in terms of share prices. The stock is down over 56 percent YTD, including a drop of about 25 percent at the start of Q3 as some analysts downgraded guidance.
Despite this bearish market sentiment, there are several positive aspects about DigitalOcean for investors to like.
To begin with, DigitalOcean’s revenues are still growing at a rapid rate. In Q1, revenues rose 36 percent year-over-year. Given the challenging business environment at the beginning of 2022, this is no small accomplishment.
The company is also in the early stages of profitability, putting it well ahead of many high-growth tech companies that have seen similar selloffs in 2022.
Management expects continued revenue growth above 30 percent, which could push both earnings and share prices markedly higher.
The company has also built itself a bit of a moat by catering to small businesses that are normally underserved by other cloud computing service providers.
By establishing a presence in this niche, DigitalOcean should be able to effectively compete with companies like Alphabet, Microsoft and Amazon that focus on enterprise clients. As of the most recent reporting, DigitalOcean had approximately 623,000 customers.
Share Buybacks A Tailwind For DOCN
A final reason for investors to take a second look at DigitalOcean at the moment is its growing share repurchase program.
In late May, the board announced a $300 million allocation for share repurchases. This was in addition to a program of the same size that was announced in February and completed in May.
The rapid pace of repurchasing demonstrates both an internal belief in DigitalOcean’s ability to generate free cash flow on an ongoing basis and a commitment to improving shareholder returns using that cash.
With that said, DigitalOcean does come with its share of risks.
Most concerning is its debt-to-equity ratio of 3.42, well over what would be considered a safe range. The stock is also trading at a forward P/E of over 50. This second point isn’t as worrisome as it looks at face value, given the company’s ongoing growth potential. However, slower growth or lower earnings in the future could call this high valuation into question and cause further selloffs.
Today, DigialOcean’s median target price from 11 analyst forecasts is $55. This would give investors a return of 56 percent against the current price of $35.25.
Analyst sentiment is beginning to turn slightly more bearish, suggesting that the upside could be lower than reflected by the current slate of ratings.
However, DigitalOcean still appears to have ample long-term potential. Assuming management can deliver its target growth rate and maintain free cash flow growth, investors who buy at today’s prices and hold have a good chance of seeing strong returns over the coming years.
Collaboration software company Atlassian (NASDAQ:TEAM) has had a similar year to DigitalOcean, selling off by just over 50 percent. This is despite the fact that the company is still turning in solid growth numbers, suggesting that the market may have oversold Atlassian as part of the tech sector’s overall drop.
In the most recent quarter, Atlassian reported revenue growth of 30 percent for a total of $740 million. Recurring subscription revenue, a key factor for long-term predictable cash flows, increased 59 percent to $555 million.
The company’s balance sheet also remained relatively strong with a combined cash and equivalents position of $1.3 billion.
Atlassian boasts an impressive organic market reach, spending relatively little on marketing. This allows it to focus more heavily on reinvesting in research, which in turn should allow it to continue gaining ground within its addressable market.
Assuming this remains the case, investors can expect Atlassian to continue rolling out new, improved versions of its products that will generate further sales and earnings from both new and existing customers.
TEAM Profitability: A Bumpy Ride
The company has, however, gone back and forth on profitability. A year ago, Atlassian reported positive net income of $159.8 million. In the most recent quarter, net income reflected a loss of $31.1 million.
This sharp reversal certainly accounts for some of the headwinds Atlassian’s stock has faced this year. The move back into losing territory is likely temporary, and the company’s growth should point it solidly back in the direction of profitability.
Atlassian also has a bit of a concerning debt outlook, with a debt-to-equity ratio of 3.3. The stock trades at 128 times expected forward earnings, meaning that Atlassian will need to continue delivering excellent growth numbers to justify its price.
Its positive free cash flow of $312 million in the most recent quarter, however, goes a way toward blunting these concerns.
Like DigitalOcean, Atlassian’s median target price of $300 gives it strong upside potential over the coming 12 months. Compared to the current price of $188.89, this would be a gain of 58.9 percent. While the returns could very well be lower, this obviously leaves plenty of room for Atlassian to miss and still produce solid gains for investors.
Overall, Atlassian’s growth and organic reach appear to be enough to compensate for its temporary risks. The slide away from profitability is obviously concerning, but Atlassian could be a solid growth stock to own if it manages to turn that trend around while continuing to increase its revenues.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.