dotDigital (LSE: DOTD) is a company I know well. I’ve considered buying the stock before, but was put off by the valuation. So when I noticed that the share price crashed yesterday, it piqued my interest. Maybe now I have a buying opportunity.
The share price crashed hard though, down over 20%. In fact, it was the worst-performing company on the stock exchange yesterday. Something must have gone wrong.
Let’s take a look at the business to see what happened, and if the stock is now a buy for me.
dotDigital’s business
DOTD is a software as a service business. It provides a whole host of marketing campaign tools for a range of sectors, from email marketing to a full omnichannel approach.
I was first interested in the shares as the company achieves an almost 30% operating margin, and double-digit returns on equity. I view this as a sign of a quality company. But I was put off by the valuation, as the price-to-earnings (P/E) ratio reached upwards of 50.
Final results
It was the release of its final results that caused the share price to tumble. Headline revenue actually increased by a respectable 23%, to £58.1m, of which 93% is recurring due to the nature of the business. A boost in its SMS alert functionality helped drive the revenue growth. Cash flow was strong too, and the CEO said this will enable investment in its growth strategy.
But the increase in revenue only translated to operating profit growth of 5%. The company guided that profit margins declined due to the popularity of premium messaging channels (such as the uplift in SMS usage). Standard messaging channels such as email have 90%+ margins, while SMS margins are lower.
But looking at what the forecasts were for this year, the actual results seem to be in line. There were four updates from analysts today that all reiterated a ‘buy’ on the stock, with an average target price of 274.5p. The shares closed yesterday at 200p so there might be an opportunity here.
Valuation again
As to what caused the share price to crash so much, looking at the valuation, the plunge makes sense. For next year, the stock is still rated on a P/E of 50. This seems high for a company with earnings only forecast to grow by 5%.
I also think the share price crash has to be seen in the context of its recent run. Before this week, the stock had risen over 55% in 2021. Even after the fall yesterday the share price was still up 38% in a year. I view yesterday’s stock exchange action as some profit-taking after the results maybe didn’t hit the very high expectations that were priced in to the shares.
So for me, DOTD is still richly valued and I won’t be investing for my portfolio. I do think there’s a quality business here, but I will only revisit if the shares become even cheaper.
Dan Appleby has no position in any of the shares mentioned. The Motley Fool UK has recommended dotDigital Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
This post was originally published on Motley Fool
