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Should You Buy Dropbox?

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Before the advent of the cloud storage there was almost no way to easily share files with other people.

If you worked on a team you had to manually send everything through attachments in emails. And this was after you spent the time to upload everything.

If you had to have something edited, then you’d have to upload something… Someone else would have to download it. Edit it. Then reupload the file. And then resend it via email.

This process lasted multiple iterations… Was incredibly tedious and frustrating. Took up an enormous amount of time. And often you’d have to wait to work on something while someone else was working on it, so your team was sure to be working on all the same version of something.

And then you had to try to keep this file under 25 MB in size just to be able to email it.

If it was over that size limit you had to figure out some other way to share it with someone.

This process wasn’t fun.

But then the glorious cloud computing storage revolution arrived and simplified things enormously.

One of the first to gain a large share of people’s files online was Dropbox (DBX).

Dropbox was founded in 2007 and became operational for public usage in 2008.

It’s a file storage company where you can upload any kind of file to one place. And then share it automatically or with only certain people as you see fit.

All in one convenient area.

This streamlined the prior tedious process enormously. And made working with a team infinitely easier and more productive.

Because this service helped so many people it grew rapidly and then many companies released competitors to its service once they noticed the huge demand.

• Google Drive

• Box

• Microsoft OneDrive

• Apple iCloud

Just to name a few of its large competitors.

From there the company IPO’d on March 22nd, 2018.

Before Dropbox and cloud storage working in a team of any size was tedious, frustrating, and time consuming.

But the launch of Dropbox changed all this and helped explode the cloud storage space industry that it now competes in.

This is all great but it’s not the important question we need to answer today though which is… Should you buy Dropbox stock to take advantage of this still massively growing cloud storage space?

That’s what we’ll answer today.

We’ll begin figuring this out by looking at its profitability and cash flow.

Is Dropbox Profitable?

Let’s do a quick rundown of Dropbox’s profitability and cash flow. Because profits and cash flow drive the long-term value and pricing of a stock over time.

I measure this in part by looking at two important metrics.

Operating profits and free cash flow/sales (FCF/Sales).

On an operating profit basis Dropbox’s produced an average operating profit margin of negative 24.8% per year every year over the last 5 years.

Even though it IPO’d in 2015 its financial info goes back to 2015.

I look for any company to produce above 10% margins on a consistent basis to consider as an investment.

And Dropbox’s got negative margins in this case.

Not good.

These numbers also fall well below my threshold of what I look for to consider for investment.

But it’s also not the full story…

In the full year of 2019 Dropbox produced a much-improved negative 4.8% operating margin for the full year.

And in the trailing twelve-month period (TTM) it improved further to negative 1.9%.

EDITORS NOTETTM is the last 12 months data going backward consecutively.

Most startup companies produce unprofitability for years after they IPO. So, this is too be expected… But it’s also rapidly approaching profitability now just 3 years after its IPO.

These more recent numbers still fall well below my minimum threshold to consider as an investment. But the move toward profitability is impressive.

And operating profit margin is only one set of numbers.

What about its FCF/Sales?

Over the last 5 years Dropbox’s FCF/Sales is 16.2% on average per year.

This is fantastic… At first glance.

Its achieving this huge free cash flow margin in large part by issuing more shares over the years.

Since its IPO in 2018 its already issued 55 million new shares. This is an increase in share count of 15.3% since 2018.

This dilutes shareholders and lowers the per share value of the company.

Think of this like a pizza.

When Dropbox issues more shares, the same size of pizza stays… But more people are around to eat it.

If a company keeps doing this the same size of the pizza remains but you continually get to eat less and less of it due to more people being around.

Right now, it’s using equity to keep the business running and growing. Many startups and high growth companies do this to continue growing.

• Uber

• Airbnb

• Tesla

These are just a few names of businesses in the high growth arena who followed this same model to becoming the behemoths they are today.

And it can work for a while… But at some point, the company needs to generate higher operating profits and cash flow from its operations to grow the business in a healthier way that doesn’t harm current shareholders.

The continued issuance of shares and dilution is also why Dropbox’s shares have fallen from its all-time high of $39.60 per share on June 15th, 2018 to $20.12 per share as of this writing. Or a fall of 49.2% since then… Because it keeps diluting shareholders.

This lowers the earnings per share. Which lowers the value per share of the company.

Both operating profit and free cash flow are important because they help show you the profitability of the company.

The more profitable a company is the higher its value goes over time. And the more money it can spend on innovations and serving customers.

Dropbox doesn’t meet my minimum threshold to consider it an investment based on operating profits. And its diluting shareholders to keep its free cash flow high so this is also a negative… But what about its valuation?

Dropbox Is Massively Overvalued

As a conservative investor I want to recommend solid, safe, and relatively low risk investments to you.

Often those are achieved by high profit margins and low debt. But it’s also necessary to look at valuation too.

Because if you buy overvalued assets there is a lower margin of safety. Which means the investment is riskier.

I want to buy assets that are undervalued in a best-case scenario. And at worst fairly valued.

Unfortunately, Dropbox falls into the overvalued category…

Its current P/E is 232.9.

Its current P/CF is 16.2.

And its forward P/E is 28.2.

I look for companies to sell at ratios below 20 on these metrics to consider the investment undervalued.

And the only one falling below this threshold is the cash flow metric… But this isn’t really a “true” number because its not cash flow from operations. Its mostly from the issuance of shares.

According to its current valuation its massively overvalued due to its low and negative profitability from operations.

Will Dropbox reach profitability and true positive cash flow from its operations soon?

Personally, I hope so because I love and use Dropbox almost every day.

But I don’t recommend stocks based on speculation and hope.

Because of its low profits, negative cash flows, rampant speculation in its stock buying, and sky-high valuation I recommend you stay away from Dropbox stock for now.

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Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above.

 

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