Shares in online advertising specialist Rhythmone(LSE: RTHM) have risen by over 7% today following the release of an upbeat third quarter update. It shows that the business is continuing its march towards profitability, which it's aiming to achieve in financial year 2017. In the last year its shares have more than doubled. Does this mean that the opportunity for a capital gain has passed, or is now the right time to buy the stock ahead of potential profitability?
An improving business
The third quarter performance of Rhythmone was in line with previous guidance. It produced sequential monthly growth in sales and EBITDA (earnings before interest, tax, depreciation and amortisation), with core products now accounting for 84% of total sales. This performance was led by strong growth in programmatic platform revenues, which achieved benchmark highs across multiple time frames.
During the period, the company moved into five new EU markets, bringing the total to 14 in the current year. It also expanded its platform infrastructure and doubled its data capacity in Amsterdam to help scale new supply and demand activity in the year. Furthermore, the acquisition of Perk provides the opportunity for synergies between the two businesses as well as growth potential. It's on track to close by the end of the current month.
As mentioned, Rhythmone is on the way to returning to profitability. Consensus forecasts suggest that this will take place in the next financial year, before it posts a rise in earnings of 70% in the following year. If it is able to achieve this level of financial performance then further share price gains seem likely. After all, Rhythmone trades on a relatively lowly valuation. It has a price-to-earnings growth (PEG) ratio of just 0.2, which indicates that there's significant upside potential.
Its valuation is far lower than that of sector peer Sage Group(LSE: SGE). Sage is expected to post a rise in its bottom line of 15% this year, followed by growth of 9% next year. This puts it on a PEG ratio of 2.1, which indicates that it lacks value for money at the present time.
Certainly, Sage is a lower-risk buy than Rhythmone, given their current level of financial performance. Sage has delivered four consecutive years of profit growth and its strategy has been tried and tested. Furthermore, the chances of a downgrade to the company's guidance is relatively slim since it has a consistent and robust business model. By contrast, Rhythmone remains lossmaking and at the start of a period of integration with Perk.
Therefore, while profitability is on the horizon, there's still a long way to go - especially as it nears its seasonally slowest quarter of the year. However, given its wide margin of safety, it appears to be worth buying and could even outperform its more expensive, but better quality, sector peer.
So, why is it not the top growth share for 2017?
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Sage Group. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.