For many small tech companies, 2022 has been a revelation that conquering an industry doesn’t happen overnight. As the US Federal Reserve aggressively raises interest rates to quell inflation and runaway speculation, the realization of the importance of profitability is growing.
This does not mean that innovative growth is dead. However, with the end of the zero rate easy money era, companies must now focus on profitable expansion versus the growth-at-all-costs mindset that peaked in 2020 and 2021.
For Doximity (DOCS -2.95%), none of this is new. The small healthcare software company has always been focused on profitable growth, and it’s only just starting to pay off for shareholders. Here’s why this stock is still a buy in my book.
Doximity’s free cash flow more than doubled
In Doximity’s second quarter of fiscal 2023 (ended September 30), revenue grew 29% year-over-year to $102.2 million, beating management’s highest expectations ($100.5 million) a few months ago. The company reiterated its full-year forecast for revenue to rise at least 23% from last year.
Doximity has been grappling with a deceleration in digital spending as the effects of the peak of the pandemic fade. Nevertheless, although the company is not growing as rapidly as it has in the past two years, doctors, hospitals and pharmaceutical customers are sticking with many of the new and improved software tools they have started using. during confinements. This is good news for Doximity, as it has been able to steadily expand its relationship with its user base, especially in digital marketing with big pharma (the primary breadwinner) and new medical office products such as electronic signature and planning.
However, arguably the biggest news in the second quarter of 2023 is that free cash flow increased 109% year over year to $37.7 million. This represented a very good profit margin on free cash flow of 37%, compared to 23% in the same period last year.
Net income was $26.3 million, down from $36.1 million last year, primarily due to an increase in stock-based compensation for employees and non-cash amortization charges (primarily related to the acquisition of physician scheduling software Amion in early 2022). Nevertheless, despite a reduction in net income, Doximity remains a very profitable health technology business.
Why is the stock punished?
One of the arguments against owning Doximity was that record profit margins would shrink this year as the company’s hot streak cooled. However, as the healthcare industry began to normalize from the effects of the pandemic, that argument didn’t really pan out. On the contrary, some measures of profitability continued to rise, even though Doximity reported a slight slowdown in demand for some of its products.
In fact, there are reasons to believe that profitability will continue to strengthen in the future. Management said that after a significant downturn at the start of calendar year 2022, big pharma marketing is starting to show signs of life again. While there was once a flat outlook for pharmaceutical industry marketing spend year-over-year, expectations now show a high percentage growth rate compared to 2021. Digital ads offer a much better ROI, so companies like Doximity that provide a digital marketing hub are reaping the rewards.
And then there are telehealth products, including video and phone dialing directly from the Doximity app and other features like document management. It should be noted that Doximity reported having an impressive renewal rate of 100% so far this fiscal year with its enterprise telehealth customers. Digital tools like this are a new growth vertical for Doximity in addition to its advertising business, which also bodes well for profit margins as this segment expands.
After the last quarterly update, shares of Doximity traded for a rich free cash flow of 57 times over 12 months. This is a high price, even after the stocks have been pummeled by the bear market. The stock has fallen more than 50% in the past 12 months, mainly due to an exorbitant valuation that has been humiliated by rising interest rates. As a reminder, higher interest rates lower the present value of stocks.
Still, if Doximity can continue to grow its business by double-digits and maintain its high profit margins, it’s not an unreasonable price. And a stock buyback program certainly doesn’t hurt either. $70 million was repurchased in the first half of fiscal 2023, and a new repurchase authorization of $70 million was added. In the world of healthcare software technology, Doximity is a top option.
I will continue to add a few stocks to my current position each quarter after this latest earnings update.