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2 Software Stocks to Buy Hand Over Fist, and 1 To Avoid

The state of growth tech stocks has changed dramatically over the last nine months. Many flew high until late last year, but amid the bear market, a few have failed more than 80% from their 52-week peak.

This means that many of these stocks have become great buys. Nonetheless, a few remain on the avoid list, meaning investors should remain selective with where they add positions. With an understanding of these factors, investors may want to consider Duolingo (NASDAQ:DUOL) and roku (NASDAQ: ROKU)while steering clear of quickly (NYSE: FSLY).

Overlooking this small-cap stock would be remove the faux pas

Jake Lerch (Duolingo): Occasionally, we can get lost in a sea of ​​numbers when researching stocks. Scrutinizing revenue, earnings, and free cash flow can make the eyes glaze over. And yes, all these figures are important. But ultimately, if a company can provide customers with a life-changing product, that company is likely to succeed — and enrich its shareholders in the process. Just ask long-time shareholders of Manzana, Teslaor microsoft.

Duolingo might not be the next Apple, but its product can be life-changing. The company runs a language-learning website and app. It offers over 40 language courses, including English, Chinese, German, French, Italian, and many others.

However, what really separates Duolingo from other language-learning companies is its focus on fun. It’s part of the company’s “gamification” strategy. Duolingo’s steps of language mastery are arranged like levels in a game. Learners win badges for sign-in streaks; Users can post their accomplishments on social media, generating kudos from friends and family. While the company offers a free version of its app, it generates most of its revenue from paid subscriptions to its premium mode.

Duolingo is small, with a market capitalization of only $4.3 billion. However, it already boasts some impressive metrics. Daily active users (DAUs) were 12.5 million as of the first quarter of 2022 — up 31% year over year. What’s more, paid subscribers rose to 2.9 million, an increase of 60% year over year.

Despite these solid figures, the stock has dropped 28% over the last year. But, if you’re an investor looking for a mid-cap stock that could translate into a winner a year or two down the road, Duolingo is a name you should know.

A possible recession will not stop this tech giant’s business case

Will Healey (roko): In the streaming universe, channels, viewers, and advertisers have flocked to Roku. As a primarily neutral platform, it has attracted streaming channels, and its inexpensive players, affordable TVs, and easy-to-use platform continue to attract viewers.

However, most of its revenue comes from advertising. It offers advertisers the ability to target specific markets, and data analytics tools to measure their success. Additionally, television advertising is transitioning to streaming, and Roku should continue to drive higher revenues as that trend claims larger shares of the TV ad market.

Nonetheless, its stock has struggled in the current bear market. Amid that sell-off, Roku stock has lost more than 80% of its value, likely due to a slowdown in growth with the end of lockdowns and a drop in consumer spending.

In the first quarter of 2022, net revenue came in at $734 million. While that increased 28% year over year, it fell short of the 55% net revenue increase in 2021. Roku also reported a Q1 loss of $26 million, down from a $76 million profit in the year-ago quarter. Increases in the cost of sales amid supply chain challenges and rising operating expenses brought about that loss.

But despite the disappointment, the shift in ad dollars to streaming will probably continue. Consequently, the company expects revenue growth to pick up, increasing to 35% in 2022.

Moreover, its price-to-sales ratio has fallen to four, its lowest level since 2017 and down from a peak of 33 in early 2021. As the market recovers and the shift to streaming ads continues, Roku stock looks increasingly like a stock to buy now and hold forever.

Time to disconnect from this former highflier

Justin Pope (Fastly): This content delivery network provider was arguably the toast of Wall Street during COVID-19 in 2020; the stock soared from roughly $20 per share to nearly $130 at its peak. Today shares trade at just $12. Fastly’s been bruised and battered in this bear market, but don’t assume it’s poised to see its former highs.

Fastly operates a content delivery network (CDN). Massive amounts of data constantly travel the world through the internet. For a long time, information would travel from on-premise servers to wherever in the world users needed it. This would potentially create slow or ineffective network performance if data had to travel long distances.

A CDN network stations servers worldwide, all with stored copies of the data it hosts. When that data is needed, the CDN sends that data from the servers located closest to the destination, providing quick and reliable speeds.

Fastly bills customers based on the traffic volume on its network, and it enjoyed strong growth from some big customers, including TikTok. However, Fastly lost TikTok’s business and hasn’t been able to recover. You can see below how revenue growth has slowed, and cash burn has deepened.

FSLY Revenue (Quarterly YoY Growth) data by YCharts

Fastly’s struggles reached a head in May when CEO Joshua Bixby announced plans to leave the company. He’s waiting to step down until Fastly hires a new CEO, which essentially makes him a licking duck at the moment.

So, where do investors go from here? Perhaps new leadership will turn things back in the right direction. Maybe a larger technology company could acquire quickly. But these are what-ifs; the company has roughly $934 million in debt against $640 million in cash and short-term investments, a negative net balance. The stock price is down, making it harder to issue new shares to raise cash if needed.

Things could work out in the long run, and investors could do very well if that comes to pass. However, a bear market like this pummels both strong and broken companies, and there are probably too many better opportunities out than Fastly’s stock.

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Jake Lerch has positions in Tesla. Justin Pope has positions in Roku. Will Healy has positions in Roku. The Motley Fool has positions in and recommends Apple, Fastly, Microsoft, Roku, and Tesla. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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