Is This a ‘Dead Cat Bounce’ for Okta Stock?

Since Okta (NASDAQ:OKTA) reported fiscal second-quarter results in late August, Okta stock has been heading in the wrong direction. In fact, the declines go back even further: Between July 26 and Sept. 27, OKTA stock lost 31% of its value.

This Looks Like a 'Dead Cat Bounce' for OKTA Stock
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Admittedly, the stock seems to have righted itself, with a 23% bounce over the following six sessions. But I’d expect the selling pressure to resume.

OKTA stock came down with other high-multiple software-as-a-service names — many of whom have similarly seen buying in recent sessions. But in a clearly nervous market, and with a highly questionable valuation, Okta stock has a clear path to at least dip back below $100.

Sector Pulls OKTA Stock Up — And Down

To be sure, the big selloff in OKTA seems externally driven. Okta’s Q3 earnings were fine as far as they went. Revenue growth of 48.5% year-over-year was nearly ten points higher than analyst consensus. An adjusted loss of 5 cents per share was half that projected by the Street. The quarter continues an impressive streak for Okta, which has beaten top- and bottom-line estimates for each of its ten quarters as a public company.

OKTA stock did sell off on the report, dropping 4.5% the next day. Somewhat soft Q3 guidance seems to be the culprit, though the outlook, too, was above Wall Street estimates. Still, the report clearly was not the major catalyst of the 30%+ pullback.

Rather, investors simply dumped high-growth, high-multiple stocks — and Okta certainly qualified. At July highs, OKTA stock traded at roughly 30 times FY20 (ending January) sales. Valuation concerns have hit that type of name hard.

Shopify (NYSE:SHOP) saw its bubble burst. Roku (NASDAQ:ROKU) pulled back 40%. SaaS names like Workday (NASDAQ:WDAY) and Alteryx (NYSE:AYX) came in as well.

To be sure, more than a few of those stocks have seen a nice bounce of late. Slack (NYSE:WORK), for instance, has bounced 21% in a matter of sessions after trading basically straight down after its direct listing. OKTA stock, too, has bounced. The question is if that bounce will hold.

The Valuation Problem

There are two reasons to fear that it won’t. First, the valuation concerns about high-flying stocks likely aren’t going anywhere. As I noted in July, there is no shortage of high-flyers at risk of crashing in what increasingly looks like an overheated market.

It may have been the WeWork debacle that finally catalyzed investor worries about just how ridiculous valuations had become. But once that concern exists, it’s likely to persist. It’s not as if these stocks now are cheap. OKTA stock still trades at 24x FY20 revenue. It’s not likely to be profitable until fiscal 2022.

To be sure, there’s still a case that Okta can grow into its valuation. SunTrust upgraded the stock last week, with a price target of $134 — roughly 20% upside at the moment. Its analyst, Joel Fishbein, projected revenue growth of more than 30% annually, with out-year free cash flow margins over 20%.

The catch is those numbers still leave valuation questionable. 35% annual revenue growth from this year’s roughly $565 million gets sales to $1.9 billion. 25% free cash flow margins suggest roughly $470 million in free cash flow.

That’s still a 30x multiple to free cash flow four years from now — if everything goes well. Even that ignores the fact that a chunk of that $470 million in FCF is going to come from share-based compensation, which is tracking to $100 million-plus this year.

It assumes that the company will hold off competition from Microsoft (NASDAQ:MSFT), Cisco’s (NASDAQ:CSCO) Duo Security, and the myriad other players InvestorPlace’s James Brumley highlighted on this site. Okta is going to grow, to be sure — but so much growth already looks priced in.

Is the Selloff Over?

The near-term concern is that the recent uptick is just a proverbial “dead cat bounce” — an interruption in a longer decline. And there are reasons to believe that will be the case not just for OKTA stock, but those like it.

Risks to the economy, and the market, clearly are mounting. A contentious 2020 presidential election looms. This hardly seems like the environment in which high-risk stocks are going to prosper.

And OKTA is a high-risk stock. Yes, there’s a huge market in authentication. Revenue growth suggests market share gains, which limits the competitive risk. It wouldn’t be stunning if a larger player like Microsoft decided to acquire the company. There is potential upside here, given growth, assuming all goes well.

But in the meantime, OKTA has trade with investors who may be unwilling to believe that all will go well. And there’s the obvious chance for a stumble. One only need to look at FireEye (NASDAQ:FEYE), a one-time, can’t-miss growth darling in the same industry (albeit with a very different model). It only takes one mistake to interrupt the growth trend — and bring valuation in enormously.

None of this is to say that OKTA is going to plunge, or that it’s a short opportunity. Rather, the point is that there is still a ton of risk here from valuation alone. OKTA is priced for perfection, which creates two problems. Okta needs to be perfect — and investors need to keep believing that it will be.

As of this writing, Vince Martin has no positions in any securities mentioned.

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