Over the past six months, Olo has been a great trade. While the S&P 500 was flat, the stock price has climbed by 38.2% to $8.97 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Olo, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is Olo Not Exciting?
We’re happy investors have made money, but we're swiping left on Olo for now. Here are three reasons why we avoid OLO and a stock we'd rather own.
1. Low Gross Margin Reveals Weak Structural Profitability
For software companies like Olo, 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.
Olo’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 54.7% gross margin over the last year. That means Olo paid its providers a lot of money ($45.33 for every $100 in revenue) to run its business. 
2. Operating Losses Sound the Alarms
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain 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.
Olo’s expensive cost structure has contributed to an average operating margin of negative 4.8% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Olo reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.
3. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Olo has shown mediocre cash profitability over the last year, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 7.4%, subpar for a software business.
Final Judgment
Olo isn’t a terrible business, but it isn’t one of our picks. With its shares topping the market in recent months, the stock trades at 4.5× forward price-to-sales (or $8.97 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're fairly confident there are better investments elsewhere. We’d recommend looking at a top digital advertising platform riding the creator economy.
Stocks We Would Buy Instead of Olo
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