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The Pullback You’ve Been Waiting for Has Finally Come: Which Tech Stock Should You Choose?

The pullback in technology stocks that everyone has been waiting for as a buying opportunity has finally come. Several of Canada’s highest-flying names have come down to the point where investors need to decide whether now is the time to start initiating a position or if you should get out of the way of what might be a runaway freight train. 

The ironic aspect of investing is that the moments that present opportunities are often masked in fear. The very reason stocks come down is that people have stopped loving them. It’s that simple. Investors need to choose whether the company is worth stepping into or whether the downside is so great that they should stay away.

If there are two stocks I have been waiting for pullbacks in,  Shopify  (TSX:SHOP)(NYSE:SHOP) and Kinaxis (TSX:KXS) are high on the list. Both of these stocks have had some significant capital appreciation of the past few years. The growth of the stock price has largely reflected high investor expectations, as these companies have delivered continuous financial gains over the past few years.

These companies are both compelling investments from a financial standpoint, albeit for different reasons. Both Kinaxis and Shopify have had impressive revenue growth for several years. Kinaxis grew its revenue by 22% year over year in the latest quarter and Shopify grew its revenue by an impressive 62%. Both companies are debt-free, which should help them weather an economic downturn and make them immune to rising rates for the most part. 

These companies are not equal, though, and there are some factors to consider before making a choice. Shopify is currently the clear choice from the point of view of revenue growth but falls short on earnings and free cash flow, which are still negative. Kinaxis may have slightly slower revenue growth, but it still has positive earnings and free cash flow. In the second quarter, Kinaxis increased its positive EBITDA 12% year over year. In the end, it comes down to whether you are looking for rapid growth or solid, steady growth that makes money. 

Which should you pick?

Well, as always, there is no simple answer.  In this case, it really depends on what you are aiming for. Both companies have relatively clean balance sheets and good business models. If you are looking for what appears to be the financially strong company, then, hands down, Kinaxis is the stock to own. It simply has a more established business with real earnings and free cash flow. In any case, the upcoming earnings announcements should help clarify which investment is the best choice.

Even though Shopify is growing at an extremely rapid pace, it’s the one I would choose of the two stocks listed. Rapid growth without earnings can be fickle, and paying up for a company’s future growth when it has little in the way of earnings has frequently been a recipe for disaster, although this is not always the case. For this reason, Kinaxis, with its free cash flow and growing earnings, has an edge over Shopify at the moment.

No matter what your choice, it pays to be conservative. Decide how much you want to invest in the company beforehand, so you don’t get in too deep. Leg in over a period of time in case there is more downside, averaging down your cost basis. If it happens to go up early, that’s great. It is very difficult, some may say impossible, to pick a bottom. If you choose to get in at these prices, have confidence that you have picked a great company to hold for the long term.

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Fool contributor Kris Knutson has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of Shopify and Shopify. Kinaxis and Shopify are recommendations of Stock Advisor Canada.

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