Earlier in October, shares of AppLovin (NASDAQ:APP) fell precipitously, bucking a powerful trend of positive returns that has allowed the stock to deliver a trailing 12-month gain of nearly 300 percent.
While AppLovin has regained much of the ground it lost, this selloff may make investors wonder about the stock’s prospects. Is AppLovin stock a sell, or can shares fully recover and keep making steady progress from here?
AppLovin’s Gathering Headwinds
The primary cause of APP’s recent selloff was a report from Bloomberg revealing that the SEC was investigating AppLovin for its data collection practices. The investigation seems to stem from AppLovin’s alleged use of personal data to target ads, something that could put it in violation of its various partners’ service agreements.
Unsubstantiated reports have also come out that AppLovin made it possible for apps to be downloaded onto smartphones without the owner’s consent. Multiple state attorneys general are also reportedly investigating AppLovin.
Unsurprisingly for a stock that has been massively outperforming the broader market over the past couple of years and which may have become overvalued, AppLovin has also been the subject of multiple short-seller reports.
Like the SEC, various shorts have accused AppLovin of violating the terms of service of app stores and providing its targeted ads to users without consent. It’s worth noting, however, that short interest in APP still remains fairly modest at less than 6 percent of the stock’s float.
It’s also interesting to note that this isn’t the first time short-seller reports have played a role in a selloff for APP. In March, shares briefly plunged by about 20 percent on a report from short firm Muddy Waters. This report was among those that alleged AppLovin was committing TOS violations and also went further by suggesting that the business’s techniques could easily be replicated by competitors.
AppLovin’s management, however, has firmly denied these criticisms and accused the short-sellers of trying to drive down share prices in order to profit from their short positions.
These developments represent rare disruptions in what has been a blistering few years for the business. Once primarily a mobile gaming platform, AppLovin has completely restructured itself as an AI-driven ad delivery platform. This has allowed it to tap into one of the most lucrative areas of early for success for AI, as the technology has demonstrated impressive abilities in more efficiently targeting and delivering ads.
AppLovin Trading at Sky High Multiples
Even with its recent difficulties, AppLovin’s valuation is still extremely high at 95.5 times earnings, 41.8 times sales and 78.0 times cash flow. At $643.10, APP shares are also still within 1 percent of the analyst consensus price target of $648.75. AppLoving does, however, still have a strong consensus buy rating with 16 buys, three holds and only one sell.
It’s also worth noting that these high valuation metrics are, to some extent, supported by equally impressive measures of profitability. AppLovin’s trailing 12-month net margin has been 44.8 percent, surpassed by an even higher return on invested capital of 53.2 percent. Return on equity, meanwhile, has skyrocketed to nearly 260 percent.
Profitability Gets Ever Stronger
In addition to very attractive profitability, AppLovin has also successfully delivered four consecutive quarters of revenue growth and 10 quarters of earnings growth. The business’s strong growth was on full display in Q2, which saw revenue growth of 77 percent to $1.26 billion and net income growth of 164 percent to $820 million. Free cash flow also rose to $768 million from $445 million in the year-ago quarter.
AppLovin is even pursuing a fairly aggressive share buyback program, something that sets it apart from many high-growth tech startups. In Q2, management bought back about $341 million worth of APP shares. Though small in comparison to what has become a market cap of over $200 billion, this buyback shows management’s commitment to returning extra cash to shareholders as its free cash flow expands.
Even more importantly, AppLovin is expected to keep delivering strong growth going forward. For Q3, management’s guidance shows further revenue growth to a range of $1.32 billion to $1.34 billion. Annualized earnings growth is also projected to exceed 50 percent over the coming 3-5 years, though it’s worth noting that this could reflect a best-case scenario that may prove overly optimistic.
On the whole, AppLovin’s business appears to be quite strong, even with some regulatory doubts beginning to swirl around it. AI-powered advertising is also still in its early stages, meaning that businesses like AppLovin that establish early leads could have long growth runways as the technology improves and more customers take advantage of it.
Is Now the Time to Sell AppLovin?
While the SEC’s decision to look into AppLovin’s data collection procedures is understandably worrisome for investors, nothing has yet come of either the probe or the various short reports that would seem to put the business in any actual danger. To a large degree, this fact is reflected in the rapid recovery APP has mounted.
Though the stock is still down about 4 percent on a trailing 30-day basis, it has been able to make up most of the ground it lost earlier in the month. As such, this downturn appears to be following the same pattern as the earlier one in March, which was followed by a gradual recovery and steady progress toward new highs.
A particularly high valuation, however, could prove to be a bit more of a substantial negative for investors. Indeed, this month’s convulsion could be an indicator that the market is beginning to get nervous about how high AppLovin’s prices have gone. With the stock trading at such high multiples to its earnings and revenues, any developments that negatively impact growth could set APP up for a more lasting downward correction.
Even so, AppLovin remains extremely profitable and has delivered a remarkably solid track record of growth for its investors. Though the stock may be too expensive to buy at today’s prices, there doesn’t yet seem to be a compelling argument for selling APP. While future developments from the SEC investigation could potentially put more real pressure on AppLovin’s business, the stock is likely better to hold than to sell unless more concrete problems arise.
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.