Investor Joel Greenblatt (Trades, Portfolio) is most famous for creating the “Magic Formula.” This systematic way of beating the market involves buying stocks that are both “cheap” and “good” as categorized by high returns on capital.
The guru applies a more advanced strategy as the founder and fund manager at Gotham Asset Management, an investment firm with $4.13 billion in assets under management. Running a diversified portfolio, Greenblatt bought over 200 stocks in the first quarter and sold many others.
In this discussion, I will take a look at two top software stocks Greenblatt bought during the quarter. Let's dive in.
HubSpot
HubSpot Inc. (HUBS, Financial) is a software company that specializes in customer relationship management and marketing automation. The business has also expanded its offering to a sales hub, a service hub and an operations hub.
The company operates with a subscription business model, which offer "freemium" features such as CRM. This is a brilliant strategy as it means HubSpot’s business customers upload their customers details, enabling a sticky onboarding onto the service.
I also like to think of HubSpot as similar to Salesforce (CRM, Financial) but for small and medium-sized businesses specifically, although the business has expanded upmarket to the enterprise level.
Growing financials
HubSpot reported strong financials for the first quarter. Revenue of $501.62 million beat analysts' forecasts by $26.74 million and increased by a solid 26.8% year over year. This was driven by strong customer growth of 23% year over year to 177,000 customers.
Management praised the bimodal go-to-market strategy that was executed during the quarter. This strategy focuses on driving volume at the lower end of the market through inbound marketing efforts and content marketing while simultaneously increasing value with its larger customer base.
Its multi-hub cross-selling strategy is also working well, with 45% of its annual recurring revenue now derived from three or more of its hubs.
On the artificial intelligence front, HubSpot has rolled out Chat Spot in public alpha. This is basically a content assistant that connects directly with HubSpot tools. A customer can use it for keyword research related to search engine optimization and even image generation.
Moving on, it recorded an overall earnings loss of 78 cents per share, which beat forecasts by 29 cents.
The company also has a solid balance sheet with $1.4 billion in cash and short-term investments and $797 million in total debt.
Valuation
HubSpot trades with a price-sales ratio of 12, which is 18% cheaper than its five-year average.
The GF Value Line indicates a fair value of $633 per share based on historical ratios, past financial performance and analysts' future earnings projections. Thus, the stock is modestly undervalued at the time of writing.
Guru interest
Greenblatt entered a 1,540-share position during the quarter. The stock traded for an average price of $365 per share during the three-month period, which is approximately 29% cheaper than where it traded at the time of writing.
Ray Dalio (Trades, Portfolio)'s Bridgewater Associates also loaded up on shares at a similar level.
Twilio
Twillio Inc. (TWLO, Financial) is a software company known for its series of communication-based APIs. These include its automated text message feature, which has been widely used by major companies such as Airbnb (ABNB, Financial) and Netflix (NFLX, Financial).
The company also offers a virtual call center called Twilio Flex, which has been popular with companies aiming to streamline customer service operations.
The newest platform is called Twilio Engage. This is a rebrand of Segment, which the company acquired for $3.2 billion in 2020. It is a customer data platform which enables personalized messages to be delivered to customer segments. This platform has huge potential in the digital marketing space as it allows the merging of what has historically been siloed data.
According to MarketsandMarkets, the worldwide big data industry was valued at $162.6 billion in 2021 and is forecasted to grow at an 11% compounded annual rate, reaching a value of $273.4 billion by 2026. I expect Twilio to benefit from this growth trend as well as increased connectivity from internet of things devices and, of course, increasing internet penetration in emerging markets.
Solid financials
Twilio reported strong financials for the first quarter of 2023. Its revenue of $1 billion beat analyst forecasts by $3.81 million and increased by 14.99%.
This growth rate was slower than prior years, with a 35% growth rate in 2022 and a 61% growth rate in 2021. However, the slowdown was expected due to the recessionary environment, which has caused slower demand across the board.
During the earnings call, management pointed to a slowdown in the crypto market, which has impacted some of its customers usage of the platform.
Moving on, the company reported an earnings loss of $1.84 per share, which missd analyst forecasts by 45 cents. Its non-GAAP earnings, however, came in at 47 cents, topping estimates by 26 cents.
Twilio has a strong balance sheet with $3.9 billion in cash and short-term investments. The company does have high total debt of $1.2 billion, but the vast majority ($987 million) is long-term debt and, therefore, manageable.
Valuation
Twilio trades with a price-sales ratio of 2.15, which is 85% cheaper than its five-year average.
The GF Value Line indicates a fair value of $443 per share, indicating the stock is undervalued at the time of writing. GuruFocus does warn of a possible value trap, but I believe this is unjustified.
Guru interest
In terms of guru investors, Greenblatt purchased 11,403 shares of Twilio in the first quarter. The stock traded for an average price of nearly $62 per share, which means it was trading 23% lower at the time of writing and, therefore, could offer good value.
Paul Tudor Jones (Trades, Portfolio) also added to his position at a similar level, as did Al Gore (Trades, Portfolio)'s Generation Investment Management.
Final thoughts
Both HubSpot and Twilio are great software companies poised to benefit from the continued growth in the digital marketing industry, with a specific focus on automation.
I believe HubSpot has a strong market position overall and great financials, but Twillio trades at substantially cheaper valuation. Therefore, growth investors may prefer HubSpot, but value investors may be more inclined to like Twilio.
