1 AI Stock Beating Wall Street Expectations

AppLovin (NYSE:APP) is the parent company of the prominent app and mobile game marketing platform AppDiscovery. Shares of APP have been on a tear over the last month, with prices up by over 45% in the last 30 days.

This comes on top of what was already an impressive year for the stock with prices nearly tripling over the last 12 months.

Why is AppLoving stock advancing so fast, and is now the time to buy this app marketing leader?

Why Did AppLovin Stock Go Up?

The main reason AppLovin stock has gone up is revenues grew by 35% from the year prior, beating analysts expectations. In that report, the company detailed full-year revenues of $3.28 billion, up 16% from 2022. 

Much of this growth tailwind was the result of AppLovin’s new AI-powered ad engine. Software platform revenue grew 88% year-over-year in Q4, driven mostly by increased advertiser spending as a result of better ad performance.

There’s little reason to believe that this trend of higher ad spending will pull back anytime soon, especially since management notes that the AI ad engine is still improving. AppLovin also has the advantage of deploying AI in an area where its benefits are well-proven, potentially insulating it from a broader correction in artificial intelligence stocks should investors decide that the technology’s more general uses have been overhyped.

Earnings also advanced significantly in 2023. Net income for the full year was $356.7 million, compared to a loss of $192.7 million in 2022. On a-per share basis, this translated to EPS of $0.98 per diluted share.

Like revenues, earnings benefited disproportionately from the new ad engine toward the end of the year. Of the $356.7 million the company earned last year, $172.2 million was generated in Q4.

Perhaps even more positive than this strong earnings growth was a radical improvement in AppLovin’s cash flow over the course of 2023. The company generated $1.04 billion in free cash flow in 2023, up from just $388 million in 2022. This was by far the highest pace of FCF growth in the company’s history and represents a major fundamental improvement for investors.

Does Growth Justify Valuation? 

Following the surge in prices after the Q4 report, AppLovin’s valuation is elevated. The stock trades at 38.4x forward earnings, a level which certainly assumes a high level of continued growth.

Other valuation metrics are also fairly high, including a price-to-sales ratio of 6.2x and a price-to-earnings-growth ratio of 57.1x. It’s worth noting that these metrics may be high but are far from out of line for a growing technology firm.

In light of AppLovin’s recent performance and future growth prospects, such a premium valuation may not be unreasonable. Over the next 3 to 5 years, analysts expect to see the company’s earnings grow at a compounded rate of about 20% annually.

Using the $0.98 per diluted share reported for the trailing 12-month period as a baseline, this would suggest earnings of about $2.45 per share in five years. While this may represent an optimistic growth scenario, this would bring the price down to a relatively fair 24.6x the 5-year earnings forecast.

Taking into account analysts’ upgrades after the recent earnings report, this view of fair valuation also seems to have taken hold among Wall Street analysts.

The average price target for AppLovin shares is $62.15, while the most recent trading price at the time of this writing was $59.87 per share. This price target would only give APP shares a very modest short-term upside, but it does add weight to the argument that the stock is more or less fairly valued.

Debt Levels Are Surprisingly High

AppLovin’s most apparent risk is its high debt-to-equity ratio of 2.67x. Even for a high-growth tech company, this number is quite high.

Though the company does have ample cash to meet its current obligations, this debt load is noteworthy especially if the company’s growth doesn’t keep pace at the expected rate.

It’s also worth noting that AppLovin may be prematurely pursuing share buybacks. From such a young company, buybacks are arguably a costly chioice when compared to the alternative option in research and development, acquisitions or other growth initiatives.

Given the amount of debt AppLovin carries, this cash could also be invested in debt reduction to strengthen the company’s balance sheet.

Nevertheless, AppLovin’s management repurchased 54.3 million shares last year and plans to invest a total of $1.25 billion in buybacks.

These buybacks would make more sense if the company was nearing maturity or if its shares appeared significantly undervalued. As it is, they likely represent a less-than-optimal use of the company’s cash.

Is AppLovin Worth Adding to Your Portfolio?

While many tech companies are soaring on blind enthusiasm for AI, AppLovin has deployed the technology to produce demonstrable benefits for its customers. This has translated to higher spending on its ad platforms and, as a result, robust revenue and earnings growth.

Given the success AppLovin has had with this effort so far, it’s likely that the trend of higher spending will continue as app and mobile gaming businesses look for ways to enhance their own marketing with AI.

On the downside, AppLovin is priced at a fairly steep premium to its current earnings and carries more debt than some investors may be comfortable with. Both of these problems, however, may be offset by the company’s ongoing growth. If earnings and cash flows continue to increase, AppLovin may very well justify its premium pricing and improve its ability to pay down debt.

Ultimately, AppLovin looks like a potential buy for investors willing to hold the stock over several years. The company’s performance is impressive, and customers are clearly deriving enhanced value from its new AI-powered ad tools. This will likely give the company a decent runway for future growth.

While investors probably can’t expect the current blistering pace of returns to continue for much longer, AppLovin offers a strong long-term growth proposition.

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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.