Is Fastly’s Life in the Fast Lane About to Come Crashing Down?

The last and first time I wrote about Fastly (NASDAQ:FSLY) was at the end of July. At the time, it had just come down from FSLY stock bursting through $100 earlier in the month. Investors were wondering if that was it for the hard-charging edge computing company.

A magnifying glass zooms in on the Fastly (FSLY) website.
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A little more than 30 days later, I’m back for a second kick at the Fastly can. One thing that hasn’t changed is its volatility. On Aug. 5, Fastly hit a 52-week high of $117.79; within four days of trading, Fastly’s share price had fallen by 38% to $72.55, nowhere near its 52-week low, but a swift correction nonetheless.

I finished my July 31 article by arguing that Fastly’s competent management has done an excellent job keeping a lid on expenses, a trait that’s essential for fast-growing tech stories.

“To me, this demonstrates management has a keen eye on spending, something many tech firms are unable, or unwilling, to do. And that, more than anything, suggests Fastly’s future is a bright one,” I wrote.

“So, if you’re investing for the long term — despite what analysts have to say — I believe you shouldn’t be worried about buying at current prices. However, you might want to hold back a little cash just in case the dip isn’t quite finished.”

FSLY closed on July 31 at $96.49. As I write this, shares have closed at $80.92. There is a real possibility that you will get a chance to buy FSLY stock in the $80s or $70s between now and the end of the year.

Here’s why.

FSLY Stock Is Volatile

For the first year of Fastly’s existence as a public company, except for one burst in August 2019, it traded in a reasonably tight range between $15 and $25. Everything changed on May 7 when it announced strong earnings that blew past analyst expectations. FSLY jumped 46% on the news, and Fastly was off to the races.

In August 2019, Fastly’s high/low spread was $20.76 [$34.88 high, $14.12 low]. It didn’t hit that level again until this May when it was $24.96 [$45.53 high, $20.57 low]. To date, the highest spread’s been this past June, when it reached $46.41 [i$89.05 high, $42.64 low].

In the 12 monthly periods between its initial public offering and the end of April 2020, there was just one month (August 2019) with a high/low spread of $20 or more. In the six months since, there’s been four.

I’m no technical analyst, but this tells me investors, bullish and bearish, are getting worried about Fastly’s future direction. If you’re long Fastly, I believe you can use this added volatility to your advantage.  That’s because there’s almost a 100% chance that you’ll be able to buy FSLY below $90 in the next four months.

Valuation Stretched

Fastly is currently valued at 39 times sales. In 2019, according to Morningstar, it was one-quarter that amount. You can buy a lot of great companies for a lot less than 39 times sales. When I wrote about the company in late July, before it released excellent second-quarter results on Aug. 5, it was trading around 34 times sales.

So, even though earnings were 62% higher and it made an adjusted per-share profit rather than a loss, its stock lost altitude on the news.

InvestorPlace’s Ian Bezek recently discussed two reasons why investors might want to take a break from Fastly’s stock.

The first has had to do with the company potentially losing TikTok, its largest customer, which accounts for approximately 12% of its revenue. While that’s up in the air, fast-growing companies lose big customers all the time. Long term, I wouldn’t worry too much about the effects on the company’s business model.

The other point is valuation.

“FSLY stock is selling for a stunning 40 times trailing revenues and more than 25 times forward sales. These are simply mind-blowing figures. Even recently, more than 20 times sales was considered too expensive in nearly all cases,” Bezek wrote on Aug. 28.

“Maybe you could justify this sort of otherworldly valuation if Fastly was putting up triple-digit revenue growth. But revenue is growing at just 62% now and set for a sharp slowdown going forward.”

If you take the two points hand in hand, it’s clear that anything less than a home run when it reports its next earnings in early November should provide investors with a much nicer entry point and early Christmas present.

The Bottom Line

A quick look at Fastly’s margins and operating expenses in the second quarter shows that it continues to hold the line on spending while continuing to grow.

For example, its non-GAAP gross margin increased 610 basis points in the second quarter to 61.7%. Its operating margin saw a 13.9 percentage point improvement to -32.1%. Meanwhile, despite increasing its research & development and sales and marketing expenses during the quarter, it kept its total operating expenses at 80% of sales.

It’s on course to come very close to break-even on an operating basis. That’s key to moving the share price higher.

My InvestorPlace colleague, David Moadel, believes that FSLY stock will be much higher than $100 a year from now. I would tend to agree.

However, with the volatility ratcheted up, I would hold off buying until after it reports in November. Conversely, if it falls into the $80s, which it could before the Q3 2020 report, I’d buy at those prices. And if it falls into the $70s as it did in August, I’d back up the truck.

Fastly’s life in the fast lane might not come crashing down, but its share price could move into the slow lane for the next few weeks.

Long term, it remains a buy.

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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