Why AppLovin Rallied in May

Shares of AppLovin (NASDAQ: APP) rallied 37.4% in May, according to data from S&P Global Market Intelligence.

AppLovin bounced back from the downturn in software stocks that emerged earlier this year after it reported very strong earnings in early May. Additionally, a prominent investor pitched AppLovin stock at the prestigious Sohn Investment Conference later in the month.

AppLovin beats with strong guidance

In the first quarter, AppLovin grew revenue 58.6% to $1.84 billion, with earnings per share rising 69.5% to $3.56. Both figures beat expectations. Meanwhile, second-quarter guidance of $1.915 billion to $1.945 billion in revenue and $1.615 billion to $1.645 billion in adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) also topped analysts' consensus.

Analysts cheered the quarter, noting that AppLovin continues to maintain a strong moat in mobile gaming digital advertising, while early efforts to expand into other ad formats, such as web advertising and connected TV, show promise.

Things got even better for AppLovin when it received more "love," so to speak, at the renowned Sohn Investment Conference late in the month. Ryan Packard, the Founder and Chief Investment Officer of Hiddenite Capital, pitched AppLovin at the conference, saying it was one of his Hiddenite's favorite ideas, and that his firm sees the company reaching a $1 trillion valuation in seven years or less. For reference, AppLovin's market cap is just roughly $200 billion today.

Additionally, sell-side analysts weighed in on AppLovin stock after earnings, with Morgan Stanley writing a positive note just before the end of the month. Analyst Matthew Cost made the additional point that AppLovin actually monetizes a very small portion of its ad inventory today, because just about 1% of ads convert to sales. Cost's thesis is that if AppLovin can just use AI to improve its conversion rate by even a little bit, that alone could be a big growth driver in the years ahead.

Image source: Getty Images.

AppLovin's future looks bright, but be aware of competition

AppLovin looks to be a strong long-term compounder, with high growth and very high margins. Given that its ad conversion rate is still low and that the company is only in the early stages of expanding its addressable market beyond mobile games, the future seems bright.

However, investors should be aware of competitive risks, such as those that have befallen other adtech companies of late, as well as the disruptive potential of AI. Companies that generate high margins tend to attract competitors, and many large companies may wish to take a piece of the programmatic digital advertising pie, as long as that pie remains large and profitable one for AppLovin.

Billy Duberstein and/or his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.