Suddenly, valuation concerns have returned to a market that less two weeks ago was roaring to new all-time highs. That’s bad news for growth stocks.
The tech-heavy NASDAQ Composite has declined an even 10% over the past six trading days. The index’s most dearly-valued stocks generally have fared even worse.
The selling appears driven by valuation. After all, there’s been little major news. In fact, one of the market’s best growth stocks seems like it could have been a catalyst for this pullback. On Sept. 1, Zoom Video Communications (NASDAQ:ZM) soared a staggering 41% after its second consecutive blowout earnings report.
Two days later, the selling began. ZM may have crystallized valuation fears: few, if any, stocks better highlight the divergence in this market between growth and valuation than Zoom. The stock entered the earnings report incredibly trading at over 100x trailing twelve-month revenue.
Going forward, the question for growth stocks as a group is whether the recent declines are just a brief correction, or the beginning of a much-needed return to sanity. There have been no shortage of investors calling that portion of the market a bubble, while others ask how the market could soar amid a still-raging worldwide pandemic.
But for growth stocks individually, the more interesting question is whether some quality names have been unfairly sold off. More than a few have been punished despite impressive recent earnings reports. For investors who see the current tech weakness as a buying opportunity, earnings losers offer interesting targets. These 10 growth stocks all posted seemingly impressive reports — yet were punished anyway:
- Pinduoduo (NASDAQ:PDD)
- Slack Technologies (NYSE:WORK)
- DocuSign (NASDAQ:DOCU)
- Gan Ltd (NASDAQ:GAN)
- Smartsheet (NYSE:SMAR)
- MongoDB (NASDAQ:MDB)
- Lovesac (NASDAQ:LOVE)
- Splunk (NASDAQ:SPLK)
- PagerDuty (NYSE:PD)
- Chewy (NYSE:CHWY)
10 Growth Stocks: Pinduoduo
To be fair, by the standards of this market, PDD stock hasn’t exactly crashed. The stock fell 13.5% after its Q2 report on Aug. 21, and actually has rallied since (albeit by less than 1%).
But in the context of the results for the quarter, any kind of selling seems surprising. Pinduoduo posted a modest profit in the quarter against expectations for a loss. Revenue was slightly softer than Wall Street projected, but increased 67% year-over-year. Gross merchandise value (the amount of merchandise sold through the platform) rose an impressive 79%.
In other words, Pinduoduo seems to have delivered. Its growth did benefit from the coronavirus pandemic, but also outstripped that of larger rivals Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD). The upstart is taking market share.
It’s possible political considerations are playing a role. On this site, Josh Enomoto cautioned against PDD stock based on apparently rising chances that President Trump will be re-elected. But BABA and JD had held up well before the past few sessions.
The issue simply seems to be valuation. PDD still trades at 18x trailing twelve-month sales. That’s a huge multiple for a retailer. And with a 200%-plus rally off March lows before earnings, the market simply have priced in expectations that even one of the market’s best growth stories couldn’t quite match.
WORK stock has gained 14% so far this year, yet somehow still feels like a massive disappointment. The platform should be a significant “work from home” beneficiary, but it hasn’t really participated in that rally. Zoom, for instance, has rallied an incredible 493% so far this year. Many other communications plays have more than doubled.
WORK stock in fact sits well below its direct listing price from 15 months ago. Investors simply haven’t gravitated to the story the way they have to those of so many other growth stocks in tech.
Here, too, valuation may be one reason why. WORK still trades at almost 20x revenue, even after a 14% decline following what was seen as a soft second quarter report.
In that context, Q2 wasn’t quite good enough. Investors focused on Slack’s billings, which grew ‘only’ 25% year-over-year.
But that aside, the quarter looks impressive. Slack broke even on an adjusted basis against expectations for a loss. The coronavirus pandemic had an impact, and business should normalize in the second half of the year and beyond.
WORK stock certainly looks intriguing at the moment, as a stock that simply is due to catch up with the rally at some point. Of course, investors could have made a similar argument for most of the last year. I did so in February.
DocuSign stock has crashed 26% in the last seven sessions. The catalyst seems simple: DOCU went too far, too fast.
Notably, Docusign saw a huge sympathy rally on Zoom’s massive earnings beat, as did other work from home plays. While ZM gained 41%, DOCU rose nearly half as much. At that point, the stock had rallied 263% in 2020. Even for one of the biggest winners from the pandemic, that apparently was too much.
A blowout earnings report wasn’t enough, either. Relative to analyst expectations, DocuSign’s report wasn’t quite as good as Zoom’s, but it was impressive nonetheless. 45% revenue growth suggests that the company indeed is benefiting from a shift to e-signatures.
In other words, there seems little reason to panic. DOCU is still up 1.6% over the last month despite the pullback. The story clearly remains intact. Valuation still is a concern, with the stock trading over 30x revenue, but investors in growth stocks in August were willing to look past that concern for quality names. DocuSign still seems like one of those quality names; it just needed a breather.
GAN has been one of 2020’s big winners as well. A U.S. initial public offering in May raised capital — and awareness. The gambling software provider found a willing audience as optimism toward U.S. sports betting rose. With state governments facing significant budget crunches from the pandemic (and in some cases, civil unrest), the odds of faster and wider legalization seem higher. That should be a boon for the industry and for supplier Gan.
But the optimism has cooled somewhat in recent weeks. DraftKings (NASDAQ:DKNG), for instance, still trades below early June highs even after a recent rally. And in that environment, even impressive results from Gan on Aug. 21 weren’t enough. Revenue nearly doubled year-over-year, and the company picked up Penn National (NASDAQ:PENN) as a key client.
GAN sold off anyway, dropping 18% on the Aug. 21 release. It eventually drifted to its lowest levels in almost three months before a recent, modest, rally.
Valuation still is a concern at this point. The stock trades at 111x next year’s consensus earnings per share estimate. But the growth potential is obvious, and if Gan can keep winning clients like Penn, the current pullback will in retrospect look like an obvious buying opportunity.
The story for Smartsheet sounds much the same. Like Zoom, Slack, and many others, the company provides a cloud-based platform for enterprises. SMAR stock rallied sharply into earnings, closing at an all-time high on Sept. 2. Q2 earnings were released after the close that day and looked impressive. Revenue increased 41% year-over-year, and net free cash flow approached breakeven.
Guidance was a little soft, and that appears to be a core culprit in a post-earnings sell-off. SMAR stock dropped 16% after earnings and kept fading. It now sits some 22% off its highs.
But as is the case with so many of these growth stocks, the story simply hasn’t changed that much. Valuation still is high. Growth still impresses. And the pullback leaves the stock about where it started. In fact, SMAR actually is up only 4.47% so far this year, significantly underperforming broad market indices.
So as far as growth stocks, if investors are looking for stocks left behind, SMAR is an interesting choice, particularly after the post-earnings pullback.
MDB stock has also roared into earnings and has faded since. Including a sell-off on the day of earnings (Sept. 2), MDB has pulled back some 17%.
To be sure, earnings looked strong. Revenue increased 39% year-over-year. Non-GAAP gross margin reached 72%, a solid figure even by cloud standards.
But as Dana Blankenhorn argued in July, significant concerns remain about profitability. And Q2 hardly answered those questions. Non-GAAP operating loss did improve, but still sat at $10 million against roughly $15 million the year before.
On the whole, the reaction to earnings seems logical. The report was good — but not quite good enough to support a rally into the release. Valuation remains a question mark. Even off 17% from the highs, MDB stock still seems like one that needs market sentiment to stay elevated. Otherwise, a bigger crash is not out of the question.
LOVE is one of the few growth stocks outside of tech at the moment. The furniture manufacturer had been a big winner heading into earnings last week, moving from below $5 in April to over $35 in August. The same tailwind boosting the likes of Wayfair (NYSE:W) and Overstock.com (NASDAQ:OSTK) — a pandemic-driven shift to online furniture shopping — seemed a potential boon for Lovesac.
The Q2 report certainly seems to confirm the optimism. Comparable sales (which include sales made, not necessarily revenue yet booked) rose a sizzling 72%. Despite significant showroom closures due to the pandemic, total revenue still rose 29%. On an Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) basis, Lovesac swung to profitability.
Yet the report wasn’t good enough: LOVE stock fell 15.6%. on Wednesday. A relief rally on Thursday mostly reversed the following day.
The reaction seems due mostly due to market conditions, rather than the release itself. That seems to create an opportunity for bulls. If you liked LOVE above $30, you should love LOVE now.
For Splunk, earnings themselves weren’t much of a catalyst in the recent decline. On Aug. 27, the day after the company’s Q2 release, SPLK stock dropped just 0.6%. It then rallied in two of the next three sessions.
But in the tech market of the last two weeks, mixed earnings weren’t quite good enough. SPLK now sits 14% below pre-earnings levels.
That might create an opportunity. Splunk is one of the better “big data” plays out there. Tezcan Gecgil argued at the end of last month that the stock was a buy on any dip — and we’ve quickly seen the dip.
Still, as with so many growth stocks, valuation is a concern. SPLK is cheaper than peers relative to revenue, but this still is a company valued at $31 billion despite posting minimal profits, even on an adjusted basis. Elastic (NYSE:ESTC) and Datadog (NASDAQ:DDOG) are tough competitors. It might take a bigger dip to make Splunk stock truly compelling.
There are two ways to look at the 26% decline in PD stock after earnings last week.
The first is that PagerDuty simply reported at the wrong time. In the middle of a valuation-driven sell-off in tech more broadly, even essentially in-line earnings weren’t enough. But with revenue up 26% and losses slightly better than expected, the quarter suggests the story remains intact.
The second is that neither the report nor PagerDuty are good enough. As one investor put it, “If you are persistently cheap in tech, there is a reason.” Q3 guidance looks somewhat soft, particularly in the context of the performance of other work from home plays.
And so at least by the standards of growth stocks, there’s an interesting “value trap or value play?” argument with PD stock at the moment. PD is cheap (again, by the standards of the group). The question is if Q2 earnings suggest it should be cheap.
I’ve been a bull on CHWY since its IPO last year, and owned the stock until this summer. At that point, with the stock in the mid-$50s, valuation became too pressing a concern.
As was the case with so many growth stocks before the recent sell-off, CHWY stock promptly raced through those valuation concerns, briefly clearing $70 at the beginning of the month. The stock has dropped 24% since, including a 10% sell-off on Friday following Q2 earnings after the close on Thursday.
From here, the new, lower price of $54 still seems broadly correct. The company posted a strong quarter, with revenue up 47% year-over-year. Adjusted EBITDA turned positive.
But there’s still a long way to go. Adjusted EBITDA margins were less than 1% on $1.7 billion in revenue. There’s still a concern about just how profitable Chewy can be, particularly with competition from the likes of Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT).
In many ways, CHWY epitomizes the current debate over growth stocks. This seems like a wonderful business. But the question is the price. And right now, investors seem more worried about the price — here and across the market — than they have in a long time.