Fastly (NASDAQ:FSLY) stock has been a big winner so far in 2020. The content delivery network (CDN) provider’s shares are up a staggering 350% since January. But, with the easy money already made, it may best not to dive in at today’s prices. Even after the recent pullback.
Why? Firstly, the company’s reliance on video sharing app TikTok as a revenue source. The company’s single largest customer, it made up 12% of sales for the first half of the year. But, with geopolitics potentially “canceling” TikTok in the U.S., this “story stock” could soon offer investors a terrible plot twist.
Sure, the recent sell-off may have priced-in this concern. But, there’s a much larger issue that could mean shares head lower going forward.
I’m talking about valuation. Granted, valuation hasn’t been a major concern among investors in today’s growth stock-oriented market. Yet, investors may start realizing growth stories like this one have rallied too far, too fast. In turn, valuation could contract, meaning heavy losses for those who buy now.
So, what’s the play here? This company is on the right side of trends, but the stock has gotten a bit ahead of itself. With this in mind, it’s best to sit this one out for now.
FSLY Stock, Valuation Concerns, and TikTok Risk
With the novel coronavirus creating a bubble in stay-at-home economy stocks, it’s no surprise shares have performed so well this year. Yet, while the outbreak still lingers on, the current environment can’t last forever.
Sure, Covid-19 will likely accelerate the pivot to remote working, which boosts demand for this company’s services. But, investors have more than priced-in this factor into FSLY stock and its peers. As a result, this stock currently trades at a frothy enterprise value/sales (EV/Sales) ratio of 37.1. Yes, other edge computing plays trade at similar multiples. For example, CloudFlare (NYSE:NET) currently sports an EV/Sales ratio of 35.2.
But, while a new paradigm may be happening, today’s valuations are not sustainable. Even as analysts project Fastly’s sales to grow around 33% between this year and the next.
When will the stay-at-home bubble burst? Everyone is waiting for a viable vaccine before declaring the Covid-19 era over and done with. But, the music could stop well before this happens.
How so? For starters, the other shoe could drop with TikTok. As InvestorPlace’s Chris Lau discussed Aug 19, the U.S. government banning or forcing a sale of the app could have material effects on the company. Sure, the company may not lose all of its sales to its largest customer. But, any stumble could destroy the growth story keeping shares at today’s frothy valuation.
Simply put, buying now, even as the growth train remains in motion, doesn’t look like a great opportunity. That being said, there’s still a solid bull case to be made for FSLY stock.
Bull Case Remains, But Runway Is Limited
With shares recovering after the TikTok news, Raymond James’ Robert Majek came out with an “outperform” rating, and a $100 per share price target, on Fastly shares. Majek’s rationale? Namely, his confidence in the company to grow its market share (thanks to the various strengths of its CDN platform). With recent customer sign-ups including Amazon (NASDAQ:AMZN), I agree this company could continue its epic rise to the top in its niche.
Yet, take a look again at Majek’s price target of $100 per share. This implies minimal upside from today’s prices. Sure, it’s impossible to call a top. And the market’s current enthusiasm for pandemic tech plays could continue until we have a vaccine.
But, at today’s prices, the risk/return doesn’t look much in your favor. For FSLY stock to move even higher, the company needs to get through the TikTok headwinds without any impact, as well as continuing to knock things out of the park in the growth department.
Yet, as our own Chris Markoch wrote earlier this month, there’s good reason why growth could take a breather in the next year. This company won big, as businesses adjusted to work-from-home,and e-commerce/social media sites boomed in usage thanks to the quarantine.
In short, consider much of the recent growth to be a one-and-done event. This could mean lower-than-expected growth going into 2021, which may cause today’s frothy valuation to contract.
Wait Things Out With This Edge Computing Play
So, what’s the play here with Fastly? I concede this company has the right ingredients to be for CDN what Shopify (NYSE:SHOP) has been for the back end of e-commerce. But, at today’s prices, it may be worthwhile to sit on the sidelines.
Bottom line: don’t buy the recent pullback in FSLY stock. Instead, take a wait-and-see approach for now.
Thomas Niel, contributor to InvestorPlace, has written single-stock analysis since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.