Okta (NASDAQ:OKTA) stock has had a tremendous run in 2019. Okta Inc stock is up 85% this year. But can this software-as-a-service (SaaS) identity solutions provider climb further? Or have the shares become extremely overvalued? Carrying an enterprise value/sales (EV/Sales) ratio of 27.4, Okta Inc stock trades at a high valuation and has yet to generate a profit.
But the company continues to deliver material revenue growth. Its sales have grown from $41 million in 2015 to $399.3 million in 2019. And Okta’s strong franchise may make it a takeover target for its big-tech competitors.
Let’s take a closer look at OKTA, and see why now may not be the right time to buy OKTA stock.
For the quarter that ended on July 31, Okta’s sales jumped 49% year-over-year. While its sales have surged tremendously, the company continues to generate losses. Its operating loss came in at $43.6 million, or 31% of its revenues. For 2020, the company expects total revenue of between $560 and $563 million. That is a 40% bump from the prior year. But it also expects to continue to report operating losses, with a projected shortfall of between $64 and $62 million.
OKTA is beating its competitors in the cloud identity solutions space, as it has continued to sign new enterprise customers. As a result, it has been able to continue posting significant sales growth. But when will this sales growth translate into profits? OKTA has not said when it expects to become profitable.
In the meantime, Okta is financing its growth with convertible debt. In September, the company issued $1 billion of convertible notes that mature in 2025. Presumably, the company will have started generating a small profit by that time, giving it the ability to more easily refinance its debt.
But its use of convertible notes suggests that it may have to sell more shares of OKTA stock. In addition, convertible debt funds may be shorting the shares to hedge their position, causing downward pressure on OKTA stock.
Okta is poised to win big if it continues posting 40%+ sales growth. But at its current valuation, is OKTA stock a compelling buy for investors? Let’s take a look at its valuation and see whether the shares are undervalued or overvalued relative to its growth prospects.
OKTA Stock Is Overvalued, But It Could Go Higher
Okta Inc stock trades at a high valuation. Its projected 2020 EV/Sales ratio is an elevated 18.1. Compared to other enterprise SaaS providers, OKTA stock is no bargain:
Shopify (NYSE:SHOP): forward EV/Sales of 16.4
The Trade Desk (NASDAQ:TTD): forward EV/Sales of 9.1
Twilio (NYSE:TWLO): forward EV/Sales of 9.1
But many potential catalysts could push Okta Inc stock higher. First, the company’s growth could exceed average estimates. Deutsche Bank’s Gray Powell is confident that demand for Okta’s services will grow, even during an economic slowdown. He believes the company’s FY 2020 revenue growth could be 45%, exceeding estimates of 41% growth.
Second, despite the high valuation of Okta Inc stock, it may become a takeover target for a larger tech competitor. As InvestorPlace contributor Jamie Johnson discussed on Oct. 2, Microsoft is a major competitor to OKTA. Microsoft (NASDAQ:MSFT) could acquire the company and use it to gain meaningful market share in the identity solutions space. Other big tech names such as IBM (NYSE:IBM) may be willing to pay a premium to obtain Okta’s suite of solutions.
But takeover rumors should not be the sole reason investors buy Okta Inc stock. While the company could be acquired by a large competitor, at the current valuation of OKTA stock, such a deal may not be worth betting on.
The Bottom Line: All Bets Are Off With Okta Stock
Okta Inc stock is up 89% in 2019. But its shares, which closed yesterday at $118, have slid a great deal from their 52-week high of $141.85. While the stock has rebounded in recent weeks, the company remains overvalued.
Even with 40%+ annual growth, the company’s forward EV/Sales valuation exceeds that of SaaS peers Shopify, The Trade Desk, and Twilio.
However, Okta stock is likely not a compelling short candidate. If the company exceeds growth expectations, its shares could rebound back to their 52-week highs. Demand for cloud-based identity solutions may stay stable, even if a recession occurs. While a market correction could materially reduce the OKTA stock price, the shares probably won’t tumble tremendously.
Investors should stay on the sidelines on Okta Inc stock. For growth investors looking for a solid play, the company is a strong opportunity. But given the current valuation of OKTA stock, other growth stocks are more compelling. If Okta’s valuation drops to a level closer to similar SaaS names, investors should consider buying OKTA stock.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.