One of the surprise comeback stories of 2021 has been Dropbox (NASDAQ:DBX). Shares of the file storage and collaboration platform are up about 40% year to date, while the S&P 500 index has returned 16%.
Even with stiff competition from giants like Microsoft and Alphabet, Dropbox has steadily grown its business over the past few years, made some smart acquisitions, and is employing an aggressive capital return strategy. But with shares outpacing the market so far in 2021 after a few years of disappointing returns, is now the time to sell your Dropbox shares and lock in those gains?
Financials keep improving
In its latest quarter ending in March, Dropbox grew annual recurring revenue (ARR) to $2.1 billion, up 13% year over year. This isn’t crazy growth compared to other software stocks, but unlike many of its peers, Dropbox is actually profitable. In the first quarter, net income increased 21% to $47.6 million, while free cash flow hit $108.8 million, up more than four times from the prior-year period.
As it slowly scales its paying users, Dropbox is seeing strong operating leverage, which should allow it to steadily increase its profit and cash flow margins over time. During the first-quarter earnings call, management upped its full-year free cash flow guidance to a range of $670 million to $690 million. Dropbox’s goal is to hit $1 billion in annual free cash flow by 2024. Raising its 2021 guidance shows the company is well on its way to reaching that figure and is likely a big reason the stock is up so much this year.
Part of the reason Dropbox has sustained solid growth is the two bolt-on acquisitions it made to improve its platform. In 2019, it acquired digital signature company Hellosign, which has a similar product to Docusign. According to management, Hellosign signature requests were up over 70% from 2019 to 2020. Dropbox doesn’t disclose how much revenue Hellosign brings in, but this strong growth in usage shows how integrating the product into Dropbox and cross-selling it with Dropbox subscriptions can help improve Hellosign’s business.
More recently, Dropbox acquired DocSend, another document-based subscription product that allows users to get real-time control and insights after sending documents to third parties. It is popular among investment funds, marketers, and investor relations teams, and it should help Dropbox improve its value proposition for paying subscribers if the product gets bundled with traditional Dropbox subscriptions.
Valuation is inching higher
With the stock up 40% but its overall financials not growing nearly as fast, Dropbox’s valuation has crept up in the first half of 2021. Its market cap is now $12 billion, giving it a forward price-to-free-cash-flow (P/FCF) ratio of 18 if it can hit the midpoint of its full-year 2021 guidance. This isn’t overly expensive, but considering the company’s modest growth rate, it doesn’t look like a bargain either.
To help return value to shareholders, Dropbox is implementing an aggressive share repurchase program (this can also help mitigate valuation concerns). This winter, it authorized $1 billion in share repurchases on top of its old $600 million program, which will help the company reduce its share count (a good thing for existing shareholders).
In the first quarter, Dropbox repurchased $432 million worth of stock, bringing its share count down to 401 million compared to 413 million a year ago. The company is funding some of these buybacks with its own profits, but some of it is coming from the $1.4 billion in convertible debt it raised this winter. These bonds, which mature in 2026 and 2028, can be converted into Dropbox stock by the bondholders if Dropbox’s share price passes a certain level, reversing some of the benefits of the recent repurchases. If Dropbox continues growing free cash flow though, this shouldn’t concern shareholders.
So is it time to sell?
Even though the stock is up so much this year, now does not look like the time to sell Dropbox stock. The valuation is still reasonable, and if Dropbox can continue growing its free cash flow while simultaneously buying back stock, its valuation should stay reasonable even if shares continue to rise. In fact, if you don’t own shares of Dropbox, now might be as good of a time as any to buy a stake in this business, especially if you’re turned off by the sky-high valuations of other software and technology stocks.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.