Three Big Earnings Season Surprises

The earnings season is in full swing, and the usual revenue and profit misses and beats come with it. But companies make all sorts of announcements during the earnings reports, and not all are revenue and profit related. Three companies made surprise announcements that are worth paying attention to, especially if you plan to invest in them or are an investor already: Palantir, PayPal, and PubMatic. 

Let's talk about their surprises. 

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I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of a series I started a few weeks ago to fundamentally research companies to  manage my real-money portfolio. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) ,  Shopify (SHOP),  Airbnb (ABNB), Unity (U), JD.com (JD), NVIDIA (NVDA) and several others. I also started sharing interesting investing-related stories. The first one was on what happens when the U.S. hit its 2% inflation target. More interesting stories are in the works. 

​Remember, this content is for education and sharing ideas and not advice to buy or sell any securities. 
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Palantir's Earnings Surprise

Palantir stock price is down by ~ 22% in the first 10 days of August, despite reporting a solid quarterly earnings report. Revenue was up, profits remained in the green, and the company announced the launch of its generative AI product, among other positive news. The surprise came when the company announced a $1B share buyback program. Typically, a share buyback program is quite investor friendly. It reduces the share count and creates more value for current shareholders. 

Companies buy their own shares for two primary reasons:

1. When they believe the current price is significantly lower than the company's value, 
2. When buying back shares is the best and the highest returning investment they can make with their cash instead of investing in R&D, acquisition, or even keeping cash on the balance sheet. From the market's reaction to the announcement, it seems investors do not agree with Palantir on either of those. 

Even after the recent price drop, the stock is priced 18 times its sales, so Palantir has to grow its revenue by ~30% per year in the next 10 years to grow into such a valuation. That seems unrealistic when the company just grew 13% year-over-year in the latest quarter. Investors must be worried that the company is "wasting" its cash resource on buying shares at an overpriced level. 

So why is Palantir's leadership spending $1B in buying its shares? There can be two reasons: 

1. They genuinely believe the company will be able to grow significantly faster or generate significantly bigger profits as the world's governments and companies adopt artificial intelligence and generative AI. Certainly, some analysts agree with this notion. For example, ARK Invest bought shares of Palantir after the price drop, and other analysts called the stock Messi of AI stocks. But most analysts don't agree with this analysis, and you can see the evidence of that in the avg. price target of ~11 per share for Palantir, 30% lower than its current price. 
2. The other reason for share buyback by Palantir can be a strategic decision to boost the company's earnings per share and improve its image among analysts and investors. Palantir has set its eyes on qualifying for S&P 500 index inclusion, and one of the requirements there is to have positive earnings. Buying back shares reduces the share count and boosts earnings per share, and this can be a part of the company's overall public relations and storytelling strategy to project a highly profitable and financially solid company. 

Based on my observations of Palantir's focus on storytelling and riding the wave of the market's momentum and sentiment, I believe the decision is a part of the company's story. 

PayPal's Earnings Surprise

The company released its earnings, and the stock price dropped ~6% after. There were lots of good news in the earnings, including 11% Y/Y payment volume growth and 12% transaction per active account growth. Also, the company is quite solid, fundamentally looking at the balance sheet and free cash flow. So what drove the price down? Investors are concerned about the drop in the company's transaction margin. PayPal's business isn't just the branded payment we are all familiar with. It operates Venmo and Braintree. Venmo is so popular that it has become a verb. I just parked my car in a parking lot, and the attendant told me to "Venmo" him the parking fee. It's so popular it's a verb. Braintree is a technology company that enables companies to process credit cards and other forms of payment on their website. And that business is the reason behind the lower transaction margin. For a mature company such as PayPal, profitability and maintaining or expanding is the most important metric investors look for. 

However, according to the management, several projects and initiatives in the works can improve transaction margin, including the growth of PayPal's unbranded check-out functionality and other value-add payment services that companies such as META and TikTok are adopting.

Despite the transaction margin worries, the surprise is in the company's valuation. PayPal generates $5B in free cash flow and shared a positive earnings report and forecast for the year, but the stock is priced 17 times its earnings and 13 times in forward earnings. In contrast, S&P 500's average P/E ratio is above 20 times. Even more surprising is the company's PEG ratio. The PEG ratio takes the P/E ratio and divides it by the earnings growth rate. If the PEG ratio is above one, it means the stock valuation is higher than the speed of its earnings growth, and if lower, it shows a lower valuation than what the company deserves based on its earnings growth rate. PayPal's PEG ratio is 0.7, indicating an undervalued stock despite a fundamentally solid business. 

This surprising undervaluation made me add PayPal to our Beaten Down portfolio, which is a portfolio of stocks getting punished by the market due to short-term miscalculations. The portfolio's picks, on average, have overperformed the market by more than 80%.

Here's the link to this portfolio in the show notes if you'd like to follow the portfolio and get notified of the new additions when we find new beaten-down stocks to add. 

PubMatic's Earnings' Reaction Surprise

And finally, the last earnings surprise comes from PubMatic (PUBM). The surprise isn't in what the company announced but in how the market reacted to the earnings report, dragging the stock price by more than 30% on the earnings day. The report wasn't stellar and came with flat revenue growth and negative GAAP net income due to a few one-time hits to the bottom line, followed by a few analysts cutting their price target for the stock. 

However, the report also had several early indicators of future growth. PubMatic invested and launched new products, especially in the video ad and ad supply optimization capabilities. It's already seen great traction with those new launches. It has also invested in its infrastructure to create incremental capacity without an impact on the margin. The flat revenue wasn't due to low engagement and activity but rather due to lower CPM. That means that due to overall economic concerns, advertisers spend less on ads or bid less fiercely than they used to, bringing the ad prices down and PubMatic's revenue down with it. 

Using common valuations metrics such as the Price to Sales or Price to Earnings ratio, the stock isn't cheap. For example, PubMatic is priced 7 times its sales. To reach 7 times sales growth, it requires 20% revenue growth per year in the next ten years. This revenue growth was once quite normal for PubMatic, but it feels quite out of reach compared to the last few quarters. Ultimately, it is still feasible if the advertising spending goes back to growth, and the company's new product launches should help. Also, high profit and the company's focus on strong free cash flow would help it grow into its current valuation. 

All in all, the 33% drop in the price seems to be an overreaction. Even the analysts cutting down their price target still price it 30% higher than the stock's current price. 

I still own PubMatic and plan to hold it, although I would want to closely watch and see the revenue and profitability grow as the digital ad market recovers in the next few quarters. 

See you next time!

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