Short-seller reports can have a devastating impact on a stock. This year, tech company AppLovin (APP 3.08%) has been hit with multiple short reports questioning the validity of its business model. While the company has pushed back against its detractors, saying that it’s “building the world’s best advertising AI model,” many investors remain hesitant to take a chance on the stock.
The company has been growing its top and bottom lines rapidly, but the dark cloud hovering over the stock simply hasn’t gone away. Is there a way for AppLovin to turn things around this year, and could it be a great buy on the dip, or should you steer clear of it for now?
Can AppLovin’s impressive growth story continue?
One way AppLovin could put the questions about its business to rest would be by delivering strong results, growing its sales, and improving its bottom line. A big reason the company captivated growth investors in the past was its accelerating top-line growth.
APP Operating Revenue (Annual YoY Growth) data by YCharts.
As impressive as that growth rate was, it could get even more impressive in the future, as the company is looking to sell its apps business this year. AppLovin generates a majority of its revenue from its advertising segment, which helps businesses and developers reach the audiences they are pursuing. By contrast, the apps business, which includes free-to-play mobile games, makes money largely from in-app purchases.
Advertising segment revenues grew by 75% last year to $3.2 billion, but its apps business grew by only 3% to $1.5 billion, which dragged its overall growth rate down significantly. With that in mind, it looks like a transition to an entirely ad-based sales model could result in better growth numbers for AppLovin.
The danger, however, is that if President Donald Trump’s tariffs and trade wars cause an economic slowdown or recession this year, companies are liable to respond by scaling back on ad spending. That would not be a favorable situation for AppLovin. Whether its growth rate accelerates or slows down this year may be dictated less by the quality of its offerings than by macroeconomic conditions.
Does AppLovin’s reduced valuation make it a more tenable buy?
As of Monday’s close, shares of AppLovin had fallen by 30% year to date. That sharp decline has pushed its price-to-earnings multiple from over 100 down to 50. That’s still a steep premium, but one that may be warranted if the company’s growth rate remains strong.
Unfortunately, investors may not have much appetite for high-priced growth stocks right now given the uncertainty in the markets and the growing odds of a U.S. recession this year.
APP PE Ratio data by YCharts.
While the stock is no longer trading at over 100 times its trailing earnings, it’s by no means a bargain. Investors who buy it today are paying for a lot of expected future earnings growth, and there isn’t much margin of safety if the business struggles to deliver that growth in future quarters due to reduced ad spending.
Is AppLovin stock worth buying?
For those who have owned AppLovin over the past year, it has been a fantastic holding: Even with its recent decline, as of this writing, it’s up by about 240% over the past 12 months.
However, I’m not optimistic that the company will be able to turn the stock’s narrative around this year — at least, not unless the outlook for the U.S. economy significantly improves. Unless this tech stock falls to a much cheaper valuation that makes it too cheap to pass up — perhaps 30 times earnings — I wouldn’t take a chance on it today, as it could be a while before AppLovin is able to rally again.
David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AppLovin. The Motley Fool has a disclosure policy.