Why Fastly, Datadog, PagerDuty, and Slack Stocks Plunged Today

What happened

Shares of cloud software companies Fastly (FSLY -0.56%), Datadog (DDOG -3.27%), PagerDuty (PD -0.53%), and Slack Technologies (WORK) tumbled on Friday as investors punished high-flying tech stocks.

Here's where the stocks stood at 11:10 a.m. EDT today:

Data source: Yahoo! Finance.

So what

Many tech stocks have soared since the market bottomed out in March despite a lingering pandemic and the worst economy in years. software-as-a-service (SaaS) stocks were already expensive before the pandemic hit; the rally pushed valuations even further into nosebleed territory.

FSLY data by YCharts.

A broad stock market sell-off started on Thursday, with the tech-heavy Nasdaq Composite plunging nearly 5%. The Nasdaq was down another 3.9% by late Friday morning. Expensive SaaS stocks have taken the brunt of the storm.

Fastly, a provider of edge cloud computing services, has been a big winner this year. The stock was up over 1,000% from its low at one point as investors bet that the company would thrive in a post-pandemic world.

Fastly's results have been solid. Revenue soared 62% in the second quarter, and the company was profitable on an adjusted basis. That growth has been well reflected in the stock price; at the 52-week high reached in August, Fastly traded for around 40 times forward sales. The stock has now plunged 36% from that high, and for good reason.

Cloud data analytics provider Datadog has been growing at a similar rate as Fastly, with revenue up 68% in the second quarter. The market has been valuing the company at an even frothier valuation. At its peak, Datadog stock was going for around 45 times forward sales.

Datadog stock hasn't suffered quite as much as Fastly's, but that may not remain the case as investors rethink the sky-high valuations awarded to SaaS stocks. Datadog is still trading for over 40 times sales following Friday's plunge.

PagerDuty has been getting hammered after reporting its second-quarter results on Wednesday. The incident-response software provider beat analyst expectations for earnings and matched them for revenue, but that was not nearly enough to satisfy investors. The stock has now tumbled around 23% from its pre-earnings level.

PagerDuty is growing far more slowly than either Fastly or Datadog, with second-quarter revenue up just 25.7%. The company is also unprofitable, even on an adjusted basis. PagerDuty stock hasn't garnered as rich a valuation, peaking at a price-to-sales ratio around 15 earlier this month. That multiple is now substantially lower after the post-earnings plunge.

Shares of workplace-collaboration software provider Slack have largely treaded water in recent months, no doubt under some pressure due to intense competition from Microsoft (NASDAQ: MSFT) Teams. Even so, the stock traded at a price-to-sales ratio as high as 25 in recent days. Slack's revenue soared 50% in the fiscal first quarter, although the company is unprofitable.

While Slack will certainly benefit from increased working from home, the competition with Microsoft shouldn't be ignored. Teams is bundled with some business Office 365 plans, giving the product a distinct edge in the workplace collaboration market.

Image source: Getty Images.

Now what

Is it reasonable to pay 30, 40, or even 50 times annual sales for a fast-growing subscription software company? Until recently, the stock market's answer was a resounding yes. Growth was all that mattered.

With a two-day sell-off in high-flying tech stocks underway, the premium that investors are willing to pay for growth stocks may be coming down. This sell-off may turn out to be a short correction that then leads to even higher highs, or it could mark the beginning of a steep downturn like the one in March. Only time will tell.