Two winning stocks in a $300 billion market

More of us will work from home, even once the pandemic is history. This pair will profit from the trend.

Rodney Hobson is an experienced financial writer and commentator who has held senior editorial positions on publications and websites in the UK and Asia, including Business News Editor on The Times and Editor of Shares magazine. He speaks at investment shows, including the London Investor Show, and on cruise ships. His investment books include Shares Made Simple, the best-selling beginner's guide to the stock market. He is qualified as a representative under the Financial Services Act.

As Covid-19 vaccinations proceed apace in countries such as the UK and India, and with President-elect Joe Biden set to speed up jabs in the United States, it could be that employees can look forward to seeing their colleagues some time soon. 

On the other hand, it seems likely that many companies of various shapes and sizes have discovered that working from home is a better alternative to long commutes and high office rents. At the very least, quite a few companies will have developed a hybrid workforce with some employees operating part of the time from home and others in the office.

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The pandemic has forced a wide range of companies to accelerate their transition to cloud computing as a way of keeping home workers fully connected to each other. Spending on cloud services could easily top $300 billion as it absorbs an increasing proportion of overall IT spending over the next three or four years.

One company that would benefit considerably from this scenario is Dropbox (NASDAQ:DBX), which calls itself “the world’s first smart workspace” offering cloud storage and content management. Although it is up against the might of Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOGL), it is no tiddler, with a recognised brand and a global base of more than 600 million users across 180 countries.

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Even so, it would be rash to assume that Dropbox will continue last year’s stellar growth, which saw third-quarter results beating analysts’ expectations, with revenue up 13.8% year-on-year. Growth is already slowing, from 16.4% in the second quarter, and the company’s guidance for the final quarter is 12%. The figures will be released in early February but could well reflect the impact of increased competition, causing revenue growth to slow to high single digits by the end of 2021.

Source: interactive investor. Past performance is not a guide to future performance

What is encouraging is that, like many high-tech companies, Dropbox has built a solid user base before working on converting freeloaders into paying customers, then into users of higher paying services, then into return customers. Of those 600 million users, only about 16 million actually cough up.

Third-quarter revenue was boosted by a 9% increase in paying users and from a greater use of higher-priced subscription plans. Annual recurring revenue improved by 12% and adjusted earnings per share doubled as operating margins improved.

Another positive sign, though it initially knocked the share price, is that Dropbox itself has found that allowing employees to work from home has its benefits. Its decision to make 315 employees, 11% of the workforce, redundant was not a sign of retreat but an acknowledgement that it needed fewer support staff if there were fewer workers in the office. 

This will release cash to be ploughed into parts of the business that return the most profit or are growing fastest. Management is targeting free cash flow of $1 billion in 2124.

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Chief operating officer Olivia Nottebohm leaves at the beginning of February, but chief executive Drew Houston, a co-founder of the company, and chief financial officer Tim Regan provide more than adequate continuity.

Discover what’s inside the Box

An investment alternative, with a shorter name and a smaller presence, is Box (NYSE:BOX), a leader in the sophisticated world of content management services, which is in an early stage of shifting onto cloud computing.

It has been held back over the past 12 months by the impact of Covid-19 on smaller businesses that form a large part of its customer base. Even so, revenue grew 10.6% in the third quarter to 31 October, beating analysts’ forecasts.  

Source: interactive investor. Past performance is not a guide to future performance

As at Dropbox, growth has slowed slightly, though not alarmingly, from 11.4% in the second quarter, while the number of paying customers is growing. Although a loss was recorded, the underlying figures moved into a small profit. Box is concentrating on growing those profits by cutting costs, improving margins and requiring all future spending to demonstrate a strong return on investment.

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Dropbox shares started trading at $28 nearly three years ago but have fallen back from an early overoptimistic peak just below $40. A solid floor has been established at $17. Box has moved erratically between $11 and $29 but has settled in a tighter range just below $20.

Hobson’s choice: Buy Dropbox up to $23. Some analysts think it will reach $30 this year but there could be resistance around $25. Box is worth considering below $20. The target here is at least $23.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.