Bandwidth (BAND): Buy, Sell, or Hold Post Q4 Earnings?

What a fantastic six months it’s been for Bandwidth. Shares of the company have skyrocketed 42.4%, hitting $22.83. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is there a buying opportunity in Bandwidth, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Is Bandwidth Not Exciting?

We’re happy investors have made money, but we don't have much confidence in Bandwidth. Here are three reasons there are better opportunities than BAND and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Bandwidth grew its sales at a 17% compounded annual growth rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the software sector, which enjoys a number of secular tailwinds.

2. Low Gross Margin Reveals Weak Structural Profitability

For software companies like Bandwidth, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.

Bandwidth’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 39.1% gross margin over the last year. That means Bandwidth paid its providers a lot of money ($60.86 for every $100 in revenue) to run its business.

The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Bandwidth has seen gross margins decline by 0.1 percentage points over the last 2 year, which is slightly worse than average for software.

3. Operating Margin in Limbo

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 metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

Looking at the trend in its profitability, Bandwidth’s operating margin might fluctuated slightly but has generally stayed the same over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was negative 1.9%.

Final Judgment

Bandwidth isn’t a terrible business, but it doesn’t pass our quality test. Following the recent rally, the stock trades at 0.8× forward price-to-sales (or $22.83 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at one of our top software and edge computing picks.

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