Why Digital Ad Stocks Have Rallied Big This Year

Our theme of Ad Tech Stocks – which includes Internet platforms and ad technology players – has seen a solid rally this year, rising by about 40% since early January. This compares to the S&P 500 which was up by about 7% over the same period. While the theme had a tough 2022, there are a couple of factors that have resulted in a reversal for digital advertising stocks.  Inflation has cooled off a bit in recent months and this is a positive for advertisers, given that companies who were scaling back on marketing spending over the last year due to rising costs, could boost their advertising budgets once again. Moreover, the U.S. Federal Reserve is also going a bit easy on its interest rate hikes, with the last hike standing at just 25 basis points, compared to multiple hikes of 75 basis points last year. The slower pace of rate hikes is also turning investors’ attention back to technology and growth stocks.

The recent earnings from many of the major advertising players have also been quite encouraging. Facebook parent Meta exceeded revenue estimates for Q4,  noting that it would get more cautious about its spending while announcing a $40 billion stock buyback. The Trade Desk stock (NASDAQ:TTD) also posted quarterly good numbers, with revenue up 24% year-over-year and profits surging 88% to $71 million. Roku stock (NASDAQ:ROKU) too, beat estimates, with revenue remaining roughly flat versus last year, versus the company’s guidance of a 7.5% year-over-year decline. While Google’s parent Alphabet posted disappointing numbers, it is looking to scale back on its costs this year and that should help earnings.

So what’s the outlook like for the theme?  EMarketer indicates that the digital ad market could grow by about 10.5% this year, an acceleration from the estimated 8.6% growth in 2022. ^[1] However, this would be well below the 29% growth seen in 2021 during the Covid-19 pandemic. The longer-term story for digital ads also remains intact, given the increasing digitization of the economy and the better targeting and measurement capabilities. Moreover, valuations in the sector are starting to look quite attractive once again. For example, Meta Platforms trades at about 15x projected 2024 earnings, with the stock still about 55% below its 2021 highs. Google parent Alphabet trades at just about 16x projected 2024 earnings. It’s very likely that earnings growth will eventually pick up nicely for most of these companies as inflation continues to cool and ad spending rises.

[1] Month-to-date and year-to-date as of 2/17/2023
[2] Cumulative total returns since the end of 2016

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