Are Digital Ad Stocks Oversold?

Our theme of Ad Tech Stocks – which includes Internet platforms and ad technology players – has declined by over 18% over the last month, as the U.S. and the global economy face multiple headwinds. The theme also remains down by about 50% year-to-date, compared to the Nasdaq-100, which remains down by roughly 30% over the same period. The U.S. economy contracted over the last two-quarters straight and inflation has shown little signs of cooling, coming at a higher than expected 8.3% for August. The Federal Reserve is also continuing with its path of outsized rate hikes. Last week, the central bank raised its benchmark rates yet again by 0.75%, taking the Federal Funds Rate to over 3%, from just about 0.25% at the start of this year.

High inflation and a slowing economy are forcing companies to revisit their advertising budgets and this is having a direct impact on ad-tech players. Most recent quarterly earnings from companies including Meta, the parent of Facebook, Roku, and Snap have also been disappointing with revenue growth falling short of estimates. Meta, for instance, saw its first-ever year-over-year revenue decline, as sales fell 1%. Apple’s privacy changes on its iOS platform have also made it difficult for many players to provide personalized advertising.

However, there are some redeeming factors as well. While the advertising market is likely to be impacted across the board in the event of a recession, digital ads offer better measurement and targeting capabilities versus other advertising formats and this could play in the favor of ad tech majors as customers look for better returns on their ad spends. Moreover, valuations in the sector are beginning to look attractive once again. For example, Facebook trades at just 12x consensus 2023 earnings, while Alphabet trades at just about 16.5x 2023 earnings. Even once high-flying Roku stock trades at just a little over 2x projected revenue for 2023, down from 20x plus levels just about a year ago. It’s very likely that growth will eventually pick up for most of these companies as the economy recovers and inflation cools, giving these stocks the potential to be re-rated higher.

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[1] Month-to-date and year-to-date as of 9/30/2022
[2] Cumulative total returns since the end of 2016