It’s right there in the name. Fastly (NYSE:FSLY) stock has been giving traders gains at lightning speed. In fact, the stock has been a four-bagger already this year.
Fastly’s bull case almost writes itself: The company serves up core internet functionality. It provides basic hosting and traffic routing for many of the internet’s leading websites, and it adds in value-added services such as acceleration and cloud security as well.
With the novel coronavirus shutting down much of the world’s offices and in-person shopping locations, that activity has gone online. Fastly is cashing in on this switch.
The company announced fantastic earnings in May, and the stock has been sprinting since then. However, we’re starting to see signs that the stock has run out of gas.
Here’s how Fastly got to this point, and why its rally is cooling off now.
Fastly’s Rise to Prominence
Fastly has enjoyed the support of Abdiel Capital. Abdiel is a leading tech-focused fund, and it’s put up amazing numbers; according to Whalewisdom, the fund has surged roughly 500% over the past five years. It can credit its success in large part to early investments in Alteryx (NYSE:AYX) and Shopify (NYSE:SHOP). Abdiel made Fastly a core holding as well and added to it during the March crash.
Fastly also has an A-list group of customers. Big names include Shopify, Spotify (NYSE:SPOT), Stripe and Etsy (NASDAQ:ETSY). When you’ve got great investors and great clients, it’s a strong foundation for the company.
Despite having all that lined up, Fastly stock didn’t do much until this year. In fact, the stock was trading down from its initial public offering price at one point earlier in 2020. Then the pandemic hit, and everything changed.
It Is Fastly’s Moment Now
As you can tell from Fastly’s prestigious client list, the company provides the infrastructure for many of today’s most innovative internet companies. And as people ended up getting stuck at home for longer and longer periods of time, it drove more data demand online.
Companies like Spotify and Etsy are well-positioned to naturally pick up more traffic as people ride out the quarantines.
Here’s the kicker for Fastly: It bases much of its contracts on usage. Thus, as its clients see their traffic rise, they in turn pay more out to Fastly. The pandemic served as a direct supercharger to Fastly’s core business. Last quarter, Fastly grew revenues by 38%, easily topping expectations.
The company sharply raised guidance for the full year and noted that its customers were spending far more on services than previously. Fastly posted an astounding 130% net revenue retention rate. That means that the average customer spent 30% more on Fastly services than previously, even after accounting for customers that left the platform.
Valuation Has Run Ahead of Fundamentals
The problem for Fastly now is that the story is increasingly well-known. Many technical and momentum traders have latched onto Fastly as the stock has soared in recent weeks. It’s been a good trade until now.
But at some point, fundamental analysts will ask what FSLY stock is realistically worth. The stock has just gone from having a price-sales ratio of 5 to 30 in a quarter, after all. It doesn’t matter how good your business is performing right now, it’s hard to justify that much of a valuation increase.
Both Wells Fargo and Citibank’s analysts have downgraded Fastly recently on valuation worries. Fastly’s core services remain a contested field; the company faces tough competition from the likes of Cloudflare (NYSE:NET). And as the pandemic starts to recede in coming months, the surge in demand data may slow dramatically.
FSLY Stock Verdict
Fastly is doing everything right, from an operational perspective. And now, with the coronavirus, it’s gotten an amazing tailwind. Selling metered data is about the best vertical to be in right now with work-from-home being our dominant technological theme.
Even so, valuation kicks in as a limiting factor on stock prices sooner or later. Fastly has quadrupled in 2020 already and is up 7x off the March lows. Fundamentals have improved a lot, but are they four times better than they were six months ago? All that to say that it’s a good time to think about taking some chips off the table.
And if you want to stay long, there are ways to structure trades, such as selling puts or covered calls, that could yield better results in coming months. Selling puts allows you to benefit from high volatility while giving you a better entry point if the stock drops again. Meanwhile, covered calls allow you to collect some premium in the event Fastly stock trades sideways or down in coming weeks and months.
After a huge run, the odds favor FSLY stock taking a breather before making further gains.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned SPOT stock.
