What a time it’s been for Bandwidth. In the past six months alone, the company’s stock price has increased by a massive 331%, setting a new 52-week high of $61.43 per share. 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 Do We Think Bandwidth Will Underperform?

We’re glad investors have benefited from the price increase, but we're swiping left on Bandwidth for now. Here are three reasons why BAND doesn't excite us and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Bandwidth grew its sales at a 15.2% annual 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 38.2% gross margin over the last year. Said differently, Bandwidth had to pay a chunky $61.76 to its service providers for every $100 in revenue.

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 0.5 percentage points over the last 2 year, which is slightly worse than average for software.

3. Operating Margin in Limbo

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales 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.

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 1.8%.

Final Judgment

We see the value of companies addressing major business pain points, but in the case of Bandwidth, we’re out. After the recent rally, the stock trades at 2.2× forward price-to-sales (or $61.43 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are superior stocks to buy right now. Let us point you toward our favorite semiconductor picks and shovels play.

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