2 software stocks to buy and 1 to avoid

The situation for growth stocks has changed dramatically over the past nine months. Many were flying high until late last year, but amid the bear market some have fallen more than 80% from their 52-week highs.

That means many of these stocks have become great buys. Still, a select few remain on the avoid list, meaning investors should remain selective about where to add positions. With an understanding of these factors, investors should consider this Duolingo (DUOL 5.89%) and roku (ROKU 4.17%)when dodging Quickly (FLY 3.01%).

To overlook this small-cap stock would be quite a faux pas

Jake Lerch (Duolingo): Occasionally we get lost in a sea of ‚Äč‚Äčnumbers when researching stocks. Looking at sales, earnings and free cash flow can make your eyes glaze over. And yes, all those numbers are important. But ultimately, if a company can offer its customers a life-changing product, that company will likely succeed — and enrich its shareholders in the process. Just ask long-standing shareholders Apple, Teslaor Microsoft.

Duolingo may not be the next Apple, but its product can be life-changing. The company operates a language learning website and app. It offers over 40 language courses including English, Chinese, German, French, Italian and many others.

However, what really sets Duolingo apart from other language learning companies is their focus on fun. It’s part of the company’s “gamification” strategy. Duolingo’s levels of language proficiency are arranged like levels in a game. Learners win badges for enrollment series; Users can post their achievements on social media and generate kudos from friends and family. While the company offers a free version of its app, it generates most of its revenue from paid subscriptions to its premium mode.

Duolingo is small, with a market cap of just $4.3 billion. However, it already boasts some impressive metrics. Daily active users (DAUs) totaled 12.5 million in the first quarter of 2022 — a 31% increase year over year. In addition, the number of paid subscribers grew to 2.9 million, a 60% increase over the previous year.

Despite those solid numbers, the stock is down 28% over the past year. But if you’re an investor looking for a mid-cap stock that could become a winner in a year or two, Duolingo is a name to know.

A potential recession won’t stop this tech giant’s business case

Will Healy (Roku): In the streaming universe, channels, viewers, and advertisers are flocking to Roku. As a primarily neutral platform, it has attracted streaming channels, and its cheap players, affordable TVs, and user-friendly platform continue to attract viewers.

However, most of the revenue comes from advertising. It offers advertisers the ability to target specific markets and data analysis tools to measure their success. Additionally, TV advertising is shifting to streaming, and Roku should continue to generate higher revenue as that trend claims larger shares of the TV advertising market.

Still, the stock has struggled in the current bear market. Amid this selloff, Roku stock has lost more than 80% of its value, likely reflecting a slowdown in growth as lockdowns ended and a drop in consumer spending.

In the first quarter of 2022, net sales were $734 million. While that was up 28% year over year, it fell short of the 55% increase in net income in 2021. Roku also reported a loss of $26 million in the first quarter, compared to a profit of $76 million in the year-ago quarter. Increases in cost of sales due to supply chain challenges and rising operating expenses led to this loss.

But despite the disappointment, the shift in advertising dollars toward streaming is likely to continue. As a result, the company expects revenue growth to pick up and grow to 35% by 2022.

Additionally, the price-to-sales ratio is down to four, its lowest since 2017 and down from a peak of 33 in early 2021. As the market recovers and the shift to streaming ads continues, Roku stock is looking more and more like a buy now and hold forever stock.

Time to break away from this former high achiever

Justin Pope (Quickly): This content delivery network provider was arguably Wall Street’s toast during COVID-19 in 2020; the stock went from about $20 a share to nearly $130 at its peak. Today shares are trading at just $12. Fastly has been hurt and battered in this bear market, but don’t assume it’s ready to revisit its previous highs.

Fastly operates a Content Delivery Network (CDN). Huge amounts of data are constantly traveling around the world via the Internet. For a long time, information migrated from on-premise servers to anywhere in the world where users needed it. This would potentially result in slow or ineffective network performance when data has to travel long distances.

A CDN network deploys servers around the world, all with stored copies of the data it hosts. When that data is needed, the CDN sends that data from the servers closest to the destination, providing fast and reliable speeds.

Fastly bills customers based on the volume of traffic on its network and has seen strong growth from some large customers, including TikTok. However, Fastly lost TikTok’s business and failed to recover. You can see below how revenue growth has slowed and the cash burn has deepened.

Chart showing Fastly's decline in revenue and free cash flow since 2020.

FSLY Sales data (quarterly year-on-year growth) from YCharts

Fastly’s struggles came to a head in May when CEO Joshua Bixby announced plans to leave the company. He’s holding off on resigning until Fastly hires a new CEO, essentially making him a lame duck for now.

So where do investors go from here? Perhaps new leadership will steer things back in the right direction. Perhaps a larger tech company could acquire Fastly. But these are what-ifs; The Company has approximately $934 million in debt versus $640 million in cash and short-term investments, a negative net balance. The stock price has fallen, making it harder to issue new shares to raise cash if needed.

Things could work out over the long term, and investors could do very well if that happens. However, a bear market like this hits both strong and broken companies, and there are probably too many better opportunities than Fastly’s stock.

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