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I invested in AppLovin (APP) when the company was worth less than $15 billion. Today, that figure stands at over $113 billion after a 687% rally over 12 months. However, I’m a little concerned that the momentum might be running low simply because the company’s valuation may prove unsustainable unless it can present further catalysts. For now, I’m neutral on this stock, given the evolving interest rate environment, the potential for more risk-off sentiment, and the stock’s valuation.

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What’s Driven AppLovin’s Rise?

While I’m now neutral on the stock, I have to note that the company’s rise has been nothing short of remarkable. AppLovin’s ascent in the mobile advertising and gaming industry can be attributed to several key factors. At the heart of its success is the AI-powered Axon engine, which has revolutionized ad targeting and delivery. This innovative technology, which was something of an unknown entity at first, continuously learns and refines data, ensuring ads reach the right audience at the optimal time, significantly boosting user engagement and ad effectiveness.

AppLovin’s strategic focus on the mobile gaming sector, a market projected for substantial growth, has been central to the company’s success. Moreover, AppLovin’s unique combination of gaming development expertise and targeted advertising capabilities gives it a competitive edge over traditional ad platforms.

In turn, its financial performance has impressed the market, with AppLovin reporting a 39% year-over-year revenue increase to $1.2 billion in Q3 2024. Meanwhile, earnings per share more than quadrupled to $1.25, with Q3 earnings beating expectations by an incredible $0.33. Looking forward, the company’s expansion into new verticals, particularly e-commerce, presents significant growth opportunities, as leveraging its AI capabilities in these new sectors could further drive its success.

AppLovin’s Valuation May Be Hard to Justify

I’m currently neutral on AppLovin because, despite its impressive profitability and growth prospects, the valuation is hard to justify. The company’s financial metrics paint a picture of a high-performing business with significant potential, yet the current market valuation appears to be pricing in extraordinary future performance.

Starting with the positives, AppLovin presents exceptional profitability metrics, with an EBIT margin of 35.8% and a net income margin of 26.8%, both significantly above the sector median. The company’s revenue growth is equally impressive, with a 41.5% year-over-year increase, far surpassing the sector median of 4.4%. It’s an efficient operator, and the business is growing considerably.

However, the valuation metrics are exceedingly rich. The company’s forward price-to-earnings (P/E) ratio of 64.8x is 159.5% higher than the sector median. Similarly, the forward EV-to-EBITDA ratio of 63.9x is 198% above the sector median. These ratios suggest that investors are expecting exceptional earnings growth in the coming years.

While AppLovin’s consensus earnings growth estimates are very strong, with projected growth rates of 313.5% for 2024 and 46.5% for 2025, the current valuation demands sustained exceptional growth throughout the medium term. The price-to-earnings-to-growth (PEG) ratio of 2.6, which is 43.3% higher than the sector median, indicates that the stock could be overvalued relative to its expected growth.

Further AppLovin Outperformance Is Possible

For AppLovin’s valuation to be justified, the company would need to consistently outperform these already high expectations, delivering massive earnings beats in the coming quarters and years.

Interestingly, the market’s expectation for the current quarter is in line with the $1.25 delivered in Q3. If this forecast turns out to be correct, it would be the first time in eight quarters that earnings have not improved sequentially.

My hunch is that AppLovin will surprise again to the upside. However, it may need to be a considerable beat in order to justify the valuation and generate more share price momentum.

A Risk-Off Environment

My concerns about AppLovin’s share price momentum are also impacted by the Federal Reserve’s signaling that there will be fewer interest rate cuts in 2025. The announcement on Wednesday, December 20, resulted in the AppLovin share price falling around 7%.

Is AppLovin Stock a Buy, According to Analysts?

On TipRanks, APP comes in as a Moderate Buy based on 14 Buys, four Holds, and one Sell assigned by analysts in the past three months. Furthermore, the average APP stock price target is $323.67, implying 4.24% downside risk.

See more APP analyst ratings

The Bottom Line on AppLovin Stock

AppLovin’s rise has been nothing short of sensational. However, despite great profitability metrics, strong growth expectations, and new verticals, I’m neutral on the stock that has brought me such strong returns. The company’s impressive Q3 2024 performance, with $1.2 billion in revenue and a 39% year-over-year increase, highlights its potential.

Yet, the stock’s valuation raises significant concerns. With a forward P/E ratio that is 159% above the sector median and an EV/EBITDA multiple suggesting extraordinary expectations, AppLovin stock will likely lack momentum unless we see a huge earnings beat. While its AI-powered technology and expansion strategies are promising, it’s hard to invest more in this stock right now.

Disclosure