Fastly (NYSE:FSLY) was one of the year’s biggest gainers. Until recently, the shares were up more than 1,000% from their March lows. However, following a negative third-quarter preannouncement by the company, Fastly stock crashed from $123 to $90 in a single day, and it’s continued to drop.
Now it’s down to just $73 per share. From the recent highs, Fastly has lost 45% of its value.
Fastly’s huge plunge comes as a bit of a surprise. Even after it lowered its Q3 guidance, the company is still on a solid trajectory. And, at least according to the firm, the revenue slowdown is primarily due to weakness from its largest customer, ByteDance, which operates TikTok.
TikTok’s legal and political issues are well-known. So at first glance, Fastly stock is a buy on this short-term hiccup, right? Well, there’s more to the story.
Why Was Fastly’s Q3 Miss a Big Deal?
I was watching social media immediately following the disappointing earnings release. And, by far, the most common reaction by investors was astonishment at how a small reduction in the company’s outlook caused such a gigantic dive by the stock. After all, the company only cut its Q3 revenue guidance by a mere $4 million.
How does a $4 million shortfall cause traders to take billions off of Fastly’s market capitalization? The issue isn’t the specific guidance, but the message that the guidance reduction sent the market.
Investors had been under the assumption that any company benefiting from the work-from-home trend was going to post superb results through at least the end of 2020. As one bank that downgraded the stock said, it’s disappointing that any company ostensibly linked to e-commerce could experience decelerating revenue growth ahead of what everyone is expecting to be a record-breaking holiday-shopping season.
Growth Rates, Not Dollar Amounts, Are the Key
There’s a case for the decline of Fastly stock being a massive overreaction. Remember that the name was trading for less than $25 per share as the pandemic began last spring. No one expected Fastly to reach $100 in 2020 prior to that.
It was after the company’s jaw-dropping Q1 earnings report that the parabolic run started. So, in a way, it’s only natural that Fastly’s earnings are causing the pendulum to swing back so sharply now.
Let’s be honest for a second, though. You can’t justify Fastly’s $9 billion market capitalization — let alone its $15 billion market capitalization earlier this fall — based on its current results. The company’s revenue numbers simply aren’t anywhere close to justifying that market capitalization. Thus, the market is focusing on the company’s future results.
If a company’s revenue grows 36% every year, its top line doubles every two years. If it can continuously maintain 36% growth, the size of its business would increase tenfold by 2028. Merely reducing that annual growth rate to a still-healthy 24% per year, while still a healthy clip, would cause its revenue to only increase five times over the same time period.
To be clear, either outcome would be pretty incredible normally. But when a company that is only producing $250 million year in revenues now and is generating losses is valued at $15 billion, it has to generate hyper-growth to justify its stock price.
When it was changing hands for $130 per share, Fastly was priced for otherworldly results. Even the slightest bump in the road caused investors to fundamentally reassess its outlook.
Can Fastly Pull An Alteryx?
The obvious analogy for Fastly now is Alteryx (NYSE:AYX). Alteryx is a leading provider of software solutions for big-data analysis.
In August, Alteryx’s shares plunged; the stock plummeted from $170 to $110 following a dismal earnings report. The company had announced a sharp slowdown in its growth rate (its guidance cut was much worse than Fastly’s) and many well-known tech investors dumped their Alteryx positions.
AYX stock then drifted aimlessly for two months. However, earlier this month, suddenly Alteryx roared back to life. Its shares surged 25% higher following news that the company’s growth had accelerated again. Following Fastly’s plunge, traders suggested that it will follow in Alteryx’s footsteps.
However, there’s a key difference between the two companies. Alteryx is primarily an on-premise solution. This means that, unlike so many companies nowadays, Alteryx’s products aren’t primarily cloud-based.
As a result, the work-from-home trend hurt Alteryx, as companies had much less reason to install Alteryx’s solutions during the height of the pandemic. Not surprisingly, as more businesses are reopening and people return to offices, Alteryx has regained some traction.
Fastly, by contrast, is not positioned for a similar bounce-back as the economy reopens. In fact, the reopening may be a further drag on Fastly’s momentum.
The company’s hyper-charged growth came precisely because people were stuck at home, causing their demand for internet services to increase.
Fastly’s revenue from TikTok may increase going forward. But the broader macroeconomic environment is not likely to get any better for Fastly.
The Verdict on Fastly Stock
There’s often good money to be made buying these sorts of huge dips in the stocks of fast-growing companies. Fastly is still growing quickly, despite its slowdown, and the stock had a passionate fan base prior to its negative preannouncement. It wouldn’t take much — as we saw with Alteryx recently — to make investors bullish about Fastly again.
That said, before you take a big position in Fastly, please do consider that the comparison to Alteryx isn’t perfect. But Alteryx’s business was hurt by Covid-19, and its outlook is improving as life starts to return to normal.
Fastly, by contrast, may see an additional deceleration of growth as the economy further reopens. Fastly makes more money as its products are used more and any slowdown in internet usage is likely to have a negative impact on the company. Thus, if you buy the stock on weakness, monitor it closely to make sure its Q3 miss doesn’t turn into a trend.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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.