Is it time to buy recent IPO JFrog (NASDAQ:FROG)? Not quite. Sure, the situation here with this software update tools provider looks interesting. But, with shares still up over 77% from their offering price, I’m taking my time.
Why? Long-term, I see big opportunity here. With corporate America pivoting towards cloud-based software-as-a-service (SaaS) for their business needs, this company’s solutions are more important than ever. Yet, at today’s valuation, shares still look richly priced. Even when taking into account the company’s recent growth rate (50%).
Don’t take that to mean I’m bearish. Far from it. It’s all a matter of entering a position at a reasonable price. In the months ahead, as insiders and early investors take profit, shares could head lower. But consider any sort of pullback prime time to buy.
When will this happen? You can’t time such a move. But, given the factors at play, an additional selloff seems inevitable. And once it happens, it’s time to leap into this cloud play.
It’s No Surprise FROG Stock Has ‘Crushed It’ Since Its IPO
At first glance, it’s hard to see why this stock, and the growth story behind it, would head lower in the near-term. You can say this is the right company, at the right time. Firstly, this company has strong exposure to the cloud megatrend.
But, instead of being a cloud services provider, the company is finding its niche in a middleman role. How so? By providing the DevOps tools software companies need to deliver updates for their respective platforms.
Given how much the software industry has moved to a cloud-based SaaS model, the company’s services are more important than ever. As I discussed previously, updates are much more continuous now that software hosting is moving from local disks to the cloud.
With this in mind, it’s no surprise JFrog has delivered such high (50%) growth numbers as of late. And, with such high levels of growth, investors were chomping at the bit to buy the stock once it went public on Sept. 16.
But, while a growth premium is warranted for FROG stock, today’s valuation is a bit too rich. Given the factors that could push shares lower in the near-term, now’s not the most opportune time to enter a position.
Why Shares Could Head Towards a More Favorable Entry Point
In the current market environment, you can argue it’s all about “growth at any price.” Valuation concerns aren’t much of an issue with stocks with a compelling growth story. And that’s the situation here with FROG stock.
Yet, although shares have held on to most of their gains (shares today are down about 14% from recent highs), further declines could be in the cards. What will drive an additional pullback? A few things come to mind.
Firstly, the IPO lockup expiration. With public offerings, insiders cannot sell shares until the “lockup period” expires. In the case of FROG stock, that lockup date ends six months from the IPO date. In other words, insiders can start cashing in next March.
I know you’re wondering, “there’s five months until then, couldn’t shares hold steady or head higher in the meantime?” Not quite. While the risk of a big selloff from insiders is months away, others who bought into the IPO could start to take profit as well in the meantime.
But, that’s not all! While valuations haven’t been a major concern now, they could be more of an issue in the coming months. As we saw with last month’s tech stock declines last month, frothy multiples could be cooling interest in tech stocks among investors.
That’s not to say there’s a big tech correction on the horizon. But, after outperforming much of the market, this year’s enthusiasm for tech stocks could take a breather. This may make it tough for JFrog shares to stay at their current price levels, much less head higher from here.
Strong Prospects, But Take Your Time
Given its exposure to cloud megatrends, there’s no denying there’s opportunity here with JFrog. But, taking a look at earnings and sales multiples, its valuation looks a bit too rich. Shares today change hands at a staggering price-to-earnings (P/E) ratio of 600x. The stock’s current price-to-sales (P/S) ratio? Around 50.3x.
Even when factoring in projected growth between 2020 and 2021 (37%), you can argue this stock has gotten ahead of itself. Add in the many factors that could fuel further near-term declines, and it’s clear now’s not the most opportune time to buy.
So, what’s the call? Wait for the next big pullback before leaping into FROG stock. Lower prices may offer a much more better long-term entry point.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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