Shares in online marketing company dotDigital (LSE: DOTD) have taken a big hit this week. After starting Monday near 250p, the share price has fallen below the 200p mark.
So why has the DOTD share price fallen so far? And has this pullback provided a buying opportunity for me?
Why dotDigital’s share price crashed
The reason dotDigital’s share price has fallen this week is that the market was unimpressed with the company’s full-year FY2021 results, posted on Tuesday.
The results weren’t terrible, in my opinion. Revenue for the 12 months ended 30 June was up 23% to £58.1m (APAC revenue was up 47%) showing the company is still growing at a healthy rate. Meanwhile, recurring revenue as a percentage of total revenue increased to 93%, from 91% a year earlier.
However, there were certain things in the results the market didn’t like. One was the fact that adjusted earnings per share for the year were only up 4%, to 4.06p. That’s a low level of earnings growth relative to dotDigital’s recent valuation.
Another was that gross margin for the period declined to 82% from 92% a year earlier, impacted by the growth of premium messaging channels, such as SMS.
Overall, the results were just a little underwhelming and, as a result, investors took some profits off the table. It’s worth noting that before this week’s share price fall, the stock had risen about 80% over the previous 12 months. So a bit of profit taking here isn’t really that surprising. Ultimately, the stock had run a bit too far.
Should I buy DOTD shares now?
dotDigital is one of my favourite UK tech stocks. However, the last time I covered it in July, I was concerned that the stock’s valuation was too high. At the time, the forward-looking P/E ratio was near 60, which I couldn’t justify.
“The stock is priced for perfection and there’s very little ‘margin of safety’. If future results are disappointing, the share price could experience a significant decline,” I wrote at the time.
After the recent share price fall, the valuation here now looks far more attractive. If I assume earnings will grow 10% this financial year, the stock’s forward-looking P/E ratio is around 43 at the current share price. That’s still not cheap. However, I think it’s reasonable for a high-growth software-as-a-service company with 93% recurring revenue and a five-year average return on capital of 23.5%.
Importantly, the growth story here seems to be intact. Revenues are growing and management is confident about the future. “As we enter the new year, trading remains strong. Our healthy balance sheet, strong recurring revenues and cash generation provides the flexibility to invest in our growth strategy, giving the Board confidence in the Group’s long-term prospects,” CEO Milan Patel said in the group’s full-year results.
Of course, there are risks to be aware of. If interest rates rise, tech stocks like dotDigital could underperform. And if near-term growth is sluggish, the share price could take another hit.
Overall, however, I think the risk/reward proposition here is relatively attractive now. At a share price of below 200p, I’m a buyer of DOTD shares.
