Over the past six months, JFrog has been a great trade. While the S&P 500 was flat, the stock price has climbed by 38.9% to $42.20 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in JFrog, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is JFrog Not Exciting?
We’re happy investors have made money, but we're sitting this one out for now. Here are two reasons why we avoid FROG and a stock we'd rather own.
1. Operating Losses Sound the Alarms
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
JFrog’s expensive cost structure has contributed to an average operating margin of negative 21.6% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if JFrog reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.
2. Cash Flow Margin Set to Decline
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the next year, analysts predict JFrog’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 26.5% for the last 12 months will decrease to 20.7%.
Final Judgment
JFrog isn’t a terrible business, but it doesn’t pass our quality test. With its shares outperforming the market lately, the stock trades at 9.2× forward price-to-sales (or $42.20 per share). Investors with a higher risk tolerance might like the company, but we don’t really see a big opportunity at the moment. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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